Competitiveness at the Crossroads (2012) is an alarming report with far-reaching implications. Forget the U.S. budget sequester. Set aside the financial bubbles on which the economy currently rests. Pay attention to something much more fundamental: America has lost the ability to compete in the international marketplace.
The report was written by three distinguished professors at Harvard Business School—Michael Porter, Jan Rivkin and Rosabeth Moss Kanter—as part of a competitiveness initiative begun in 2011. As Professor Porter explains, “there was a clear feeling that something different was happening in the U.S. economy—this was not just a deep recession caused by the housing mortgage crisis and so forth… something more was going on.”
The signs of the problem had been visible for some time. Job creation had stalled around 2000. Wages had been stagnating for well over a decade ago. Worse, “virtually all the net new jobs created over the last decade were in local businesses—government, healthcare, retailing—not exposed to international competition. That was a sign that the U.S. businesses were losing the ability compete internationally.”
Let’s ask the Harvard MBA alumni
How had the disaster happened? To find out, the professors had the inspired idea of asking their own Harvard Business School MBA alumni. The results are surprising and, in their own way, illuminating.
The respondents were over 6,000 people “from every sector of the economy, with heavy representation in finance and insurance, manufacturing, and professional, scientific, and technical services. Nearly a third of the 2012 respondents reported a title of chief executive, chair, president, founder, owner, managing director, managing partner, or a similar title at the very top of an organization.”
As graduates of Harvard Business School’s MBA program, they are thus the very crème de la crème of American business, or what the study appreciatively calls “business leaders”.
Since the essence of strategy, as Professor Porter has stressed for several decades, concerns coping with competition, those responsible for strategy—business leaders—will surely shed light on what has gone wrong with American competitiveness and how to fix it.
The role of management in the loss of competitiveness
In the survey, Harvard’s MBA alumni were asked how American business stacks up against its competition on a variety of issues. The quality of management is obviously one of the most important of those issues: if there are disastrous shortfalls in the ability to compete, then surely the quality of management itself—the art and science of getting things done—must have a lot to do with it. Indeed if there are widespread failures in competitiveness across the whole economy, then it is likely that we have something even more serious: a generic problem with the strategies being pursued.
So do the business leaders see the quality of their own management as a problem?
Not at all.
Not only do they see management as a relative strength of American business. They see management as “strongly improving”.
American business is unable to compete internationally. But management—relative to competitors—is both strong and improving?
An odd concept of management
What alternate universe are these business leaders living in?
What sort of “management” is it where the quality of management is strong and improving and yet firms can’t compete internationally?
The business leaders indicate in their responses that their high-quality management can’t compete because of government-created constraints, such as the political system, the tax code, the regulations, the legal system, K–12 education, and fiscal policy. In other words, the loss of competitiveness isn’t the business leaders’ fault: “Don’t blame us: we are not responsible!”
Astonishingly, the report itself cites the business leaders’ view that management is strong and improving and the leaders’ own lack of perceived responsibility for causing or resolving these problems, as “good news” and indeed a “great strength” of the U.S. economy (page 6).
The end of “can-do” management?
How can business leaders and the competitiveness report itself be talking about management as strong and improving when firms are consistently failing to compete internationally?
Apparently, this kind of management isn’t about the art and science of getting things done and overcoming constraints, whatever they happen to be. It isn’t the kind of enterprising “can-do” management that opened up the American continent several centuries ago, that constructed the transcontinental railroads in difficult conditions, that won several world wars, that accomplished mission impossible by landing a man on the moon only seven years after setting out to do so, and that invented the Internet and created Silicon Valley from scratch.
High-quality management that can’t compete?
So what sort of “management” is it?
Here the report is helpful. “The basic narrative begins in the late 1970s and the 1980s. Through globalization, it became possible and attractive for firms to do business in, to, and from far more countries. Changes in corporate governance and compensation caused U.S. managers to adopt an approach to management that focused attention on the stock price and short-term performance.” (emphasis added)
As a result, “firms invested less in shared resources such as pools of skilled labor, supplier networks, an educated populace, and the physical and technical infrastructure on which U.S. competitiveness ultimately depends.”
These management actions in turn gave rise to “serious social problems (loss of jobs, stagnating income, growing inequality) and eventually a decline of the public sector (an inability to fund health and pensions, or investments in “the commons” such as infrastructure, training, education, and basic research, fields that the private sector had abandoned.)”
The report thus accepts that the decline of the public sector and the failure to invest in shared resources are not root causes of the decline in competitiveness. They are the consequence of the focus on the short-term and the stock price.
The concept of management that the leaders and the report is talking about is thus management that is high-quality if it succeeds in firms meeting their quarterly numbers and getting their stock price up, even if it means failing in the larger task of competing internationally.
Strong innovation that can’t cope with competition?
A similar picture emerges on the issue of innovation. The business leaders were asked what how American performance in terms of entrepreneurship and innovation stacks up against competitors. The response was again that innovation and entrepreneurship are strong and improving.
And once again, the report hails this response as “good news” and “a strength” for the U.S. economy.
“Innovation” that can’t cope with international competition is “good news” and “a strength”?
Economists that have studied innovation in depth question the premise that U.S. innovation is strong and improving. Thus Nobel Prize winner Edmund S. Phelps recently pointed to studies showing that in the early 1970s the rate of indigenous innovation (as measured by its estimated contribution to the rate of growth in labor productivity) dropped by about half — to around 1 percent since then, from about 2 percent before then.
The economist Robert J. Gordon has also recently noted a marked slowdown in innovation.
So what sort of innovation could these business leaders be talking about? When a firm is focused on short-term profits and the stock price, it’s possible that managers are innovating, but with innovations related to efficiency and cost reductions. By contrast, value adding innovations, particularly game-changing innovations, are likely to be viewed as too risky and expensive to invest in. The firm will consistently gravitate to safer cost-saving innovations, even if this approach will set the firm on a track that consistently leads to loss of global competitiveness and eventually corporate death.
And this is what has happened. As Allen Murray writes in the Wall Street Journal, “market-leading companies have missed game-changing transformations in industry after industry—computers (mainframes to PCs), telephony (landline to mobile), photography (film to digital), stock markets (floor to online)—not because of ‘bad’ management, but because they followed the dictates of ‘good’ management.”
Profess Phelps concludes: “A return to the productivity growth and broad economic inclusion of the past will require nothing less than a revival of the high dynamism that underpinned that performance. In the business sector, it is necessary to put an end to infighting in established companies and the shortsightedness of chief executives who know they have only a few years in which to haul in some big bonuses. There is a need for a wider embrace of the old ethos of imagination, exploration, experiment and discovery.”
Where did the short-term focus on stock price come from?
Why do business leaders focus on the stock price and the short-term with such disastrous consequences for management, innovation and competitiveness? Where does this thinking come from?
The answer is close at hand. It was outlined by Harvard Business School professor, Clayton Christensen in a talk in November 2011: the thinking comes from the business schools themselves:
“The problem lies with the business schools which are at fault. What we’ve done in America is to define profitability in terms of percentages. So if you can get the percentage up, it feels like we are more profitable. It causes us to do things to manipulate the percentage. I’ll give you a few examples.
- There is a pernicious methodology for calculating the internal rate of return on an investment. It causes you to focus on smaller and smaller wins. Because if you ever use your money for something that doesn’t pay off for years, the IRR is so crummy that people who focus on IRR focus their capital on shorter and shorter term wins.
- There’s another one called RONA—rate of return on net assets. It causes you to reduce the denominator, assets, because the fewer the assets, the higher the RONA.
“We measure profitability by these ratios. Why do we do it? The reason the finance people have preached this almost like a gospel to the rest of us is that, if you describe profitability by a ratio, you can compare profitability in different industries. It ‘neutralizes’ the measures so that you can apply them across sectors to every firm.”
In other words, “we have discovered the problem and it is us.” Thus behind the problem of competitiveness lies a concept of management based on short term profits and the stock price that these business leaders learned when they were MBA students at Harvard and elsewhere.
This concept of management, that measures results in terms of short-term performance and the stock price, is still the core of what is taught in the business schools across the country today. To see it play out in detail, just read any of the “consulting casebooks” that business schools use. In case after case, the “right answer” to the business problem at hand is to go for short-term profit, and pay less attention to long-run consequences for the firm or the economy. It is this fundamental thinking that drives the business decisions that Christensen calls “just plain wrong” and that are killing U.S. competitiveness.
Shareholder value morphs into C-suite capitalism
Even worse, this concept of management has morphed into something else: C-suite capitalism. Thus the focus on short-term value and the stock price gained traction in the 1970s and 1980s, supposedly as a way of advancing the interests of shareholders and protecting them against the greed of self-serving managers. It was called shareholder value. But the approach had the opposite effect of what was intended. Maximizing shareholder value turned out to be the disease of which it purported to be the cure.
In his book, Fixing the Game, Roger Martin, Dean of the Rotman School of Management at the University of Toronto, notes that between 1960 and 1980, CEO compensation per dollar of net income earned for the 365 biggest publicly traded American companies fell by 33 percent. CEOs earned more for their shareholders for steadily less and less relative compensation. By contrast, in the decade from 1980 to 1990, CEO compensation per dollar of net earnings produced doubled. From 1990 to 2000 it quadrupled.
Since 2000, the situation has further deteriorated. According to Professor Mihir Desai, the Mizuho Financial Group Professor of Finance at Harvard Business School, over-compensation of the C-suite has produced a giant financial incentives bubble that is inexorably pushing the US economy into decline. His 2012 HBR article shows how it is having disastrous business consequences, including a serious mis-allocation of capital and talent, repeated governance crises, rising income inequality and a lack of international competitiveness.
Fiddling with symptoms while ignoring root causes
One might have expected that this new report on competitiveness, having identified a focus on short-term results and the stock price as a root cause of the loss in competitiveness, would explore with the business leaders whether they recognize this to be the case, and if so, what they are doing to change it.
Instead, the focus of the conversation with the business leaders was on fixing the symptoms of the loss of competitiveness—particularly rebuilding the talent pool (through training, apprenticeship, community colleges), improving the business context (participating in initiatives like regional clusters, research, startup incubators, or political advocacy) and exploring more local sourcing of products.
Not surprisingly, given the failure to address the root cause of the competitiveness problem, not many firms are actively pursuing these issues. Only 8 percent of respondent firms are “heavily involved”.
In the overall scheme of things, this result is discouraging but perhaps not so important. Even if those measures were being implemented more energetically by business leaders, they wouldn’t resolve the loss of competitiveness. As Professor Porter has reminded us for several decades, if a strategy is misconceived, more talent or more research won’t help: the talent and the research will end up being wrongly directed on short-term gains, not redressing competitiveness.
Not surprisingly, reshoring—which requires rethinking the very basis of competition—was the least-supported action by these business leaders.
What government must do
Consistently with the business leaders’ own viewpoint that the loss of business competitiveness is not the fault of business, the main thrust of the Harvard report on competitiveness is less about what business leaders themselves should do, and more about “the general consensus about what Washington must do”, including controlling federal spending, reforming the tax code and streamlining regulations.
The issue here is not that the report’s recommendations for government are misguided. They are important and necessary. The issue is that they will do little to resolve the problem of competitiveness, so long as business leaders focus on the short-term and the stock price. They are contributory issues, not root causes of the problem.
Missing in action: the customer
Yet the most staggering aspect of the Harvard report on competitiveness is the total absence of the customer. The word “customer” never appears in the entire report. Even once. The report thus gives no recognition to another key issue underlying the loss of competitiveness: the fundamental shift in the balance of power in the marketplace from seller to buyer. This shift flows from globalization and customers’ access to reliable information on the Internet.
The shift is critical because it short-circuits the current business focus on the short-term and the stock price: if firms don’t delight their customers with continuous innovation, their customers vanish and the firms die. Several decades ago, being just a bit more efficient than the local competitor might have been enough to get by. Not any longer. Now in order to survive, firms have to excel with their customers on a global basis.
The only solution to the new dynamic of the customer-driven global marketplace is to adopt a different kind of management with a new corporate bottom line in which value-adding innovation is a necessity, not an option. Instead of focusing exclusively on short term gains and efficiency innovations, the very goal of the firm has to shift to delighting customers through continuous value-adding innovation.
The only valid purpose of a firm: creating customers
As it happens, this thinking isn’t entirely new. Back in 1973, Peter Drucker showed us the way to dealing with competitiveness, by getting back to first principles and addressing the question: why do we have private sector firms in the first place? He wrote:
To know what a business is, we have to start with its purpose. Its purpose must be outside of the business itself. In fact, it must lie in society since business enterprise is an organ of society. There is only one value definition of business purpose: to create a customer…
More recently, Roger Martin writes in Fixing the Game:
We must shift the focus of companies back to the customer and away from shareholder value. The shift necessitates a fundamental change in our prevailing theory of the firm… The current theory holds that the singular goal of the corporation should be shareholder value maximization. Instead, companies should place customers at the center of the firm and focus on delighting them, while earning an acceptable return for shareholders.
If you take care of customers, writes Martin, shareholders will be drawn along for a very nice ride. The opposite is simply not true: if you try to take care of shareholders, customers don’t benefit and, ironically, shareholders don’t get very far either. In the real market, there is opportunity to build for the long run rather than to exploit short-term opportunities, so the real market has a chance to produce sustainability and competitiveness.
Similarly in Reorganize for Resilience, Harvard Business School professor Ranjay Gulati writes:
Those companies built around an inside-out mind-set—those pushing out products and services to the marketplace based on a narrow viewpoint of their customers that looks at them only through the narrow lens of their products—are less resilient in turbulent times than those organized around an outside-in mind-set that starts with the marketplace, then looks to deliver creatively on market opportunities. Outside-in orientation maximizes customer value—and produces more supple organizations. Embracing an outside-in perspective—focusing on creatively delivering something of value to customers instead of obsessing over pushing your product portfolio—builds an inherent flexibility into organizations.
A paradigm shift in management
Achieving continuous innovation and customer delight lies outside the performance envelope of firms that are built on hierarchical bureaucracy and focused on short-term gains and the stock price. It requires a fundamentally different way of leading and managing—in effect, a paradigm shift in management. It means:
- a shift from controlling individuals to self-organizing teams;
- a shift from coordinating work by hierarchical bureaucracy to dynamic linking;
- a shift from a preoccupation with economic value to an embrace of values that will grow the firm; and
- a shift from top-down communications to horizontal conversations.
Dealing with competitiveness thus implies a revolution in the way private sector firms are run. To be sure, improvements in the tax code and streamlining regulations will help. But “business leaders” need to start acting like business leaders and draw on the long tradition of “can-do” management on which the country was built.
Fortunately there are many firms already showing the way. In addition to prominent instances like Whole Foods, Amazon and Salesforce, there are thousands of lesser-known firms on the same track. They have shifted the bottom line of the firm so that the very purpose of the firm is to add value to customers. Thus experimentation and innovation become an integral part of everything the firm does. Companies with this model of management have shown a consistent ability to innovate and compete internationally.
The responsibility of business schools
It’s not just business leaders who need to embrace the paradigm shift in management. Business schools, business journals and consulting firms must also join the revolution. In the age of customer capitalism, should it be surprising, when the customer is totally absent from the thinking of leading business schools, that competitiveness has become an issue? Business schools must stop disseminating obsolete management methods, spend less time blaming the government for the private sector’s inability to compete and instead teach management thinking that is relevant to the 21st Century.
The crisis identified by the competitiveness report is real. The diagnosis of the problem and proposed remedies discussed in the report are not. As Professor Rivkin has said, “the ability of firms in the United States to be competitive in the world economy and to support living standards in America is in doubt.” It will continue to be in doubt unless and until business leaders and business schools deal with root causes.
Obviously, there are brilliant thinkers in business schools who have spoken out on these root causes, including Clayton Christensen, Mihir Desai, Rakesh Khurana, Ranjay Gulati and Roger Martin. But their voices are still on the fringe of business school thinking. They are not yet centrally reflected in the business school curricula. Their thinking needs to move from the margins to the the mainstream. Courses need radical change to reflect the new business context. Research needs to focus on knowledge that is useful to the challenges facing managers today.
One can only hope that the next report of the Competitiveness At The Crossroads initiative will be built on this new thinking and deal with the root causes of the competitiveness crisis and not merely fiddle with symptoms.
A new world is unfolding before our eyes, with new goals and new ways of managing. The only question is whether America’s business leaders and business schools are going to be part of it.