A �Good Business� Decision Framework

Systematic management approach is necessary in both bad times and in good

Published: May 15, 2010 06:59:08 AM IST

Updated: May 14, 2010 05:46:03 PM IST

The current economic downturn has focused managerial attention on and fostered a spate of articles about how to manage effectively in difficult economic circumstances. A recent and particularly good -- possibly iconic -- example of advice about managing in a downturn is provided by David Rhodes and Daniel Stelter in a recent Harvard Business Review article. Their approach is positive, comprehensive and considers both the immediate exigencies and future potential. Their key recommendations include immediately focusing on:
•   Monitoring and maximizing cash
•   Optimizing financial structure
•   Reducing cost and increasing efficiency
•   Aggressively managing the top line
•   Rethinking product mix and pricing strategies
•   Shedding unproductive assets and divesting non-core businesses.

Reviewing these recommendations reveals three fundamental truths:
1.   Each of these recommendations applies equally well in good times and in bad. The only difference may be that in bad times, managers facing the prospect of ruin bring a renewed intensity and focus to these basic and essential business practices.

2. There is no magic bullet or single answer to effecting a turnaround or improving declining business performance. A comprehensive, systemic approach is necessary to improve subpar business performance. This truth has been known, though often overlooked, for a long time.

3. It is important to pay attention to both immediate operational concerns and enduring strategic issues.

So, if the same focused but systematic management approach is necessary in both bad times and in good, what role does ethics or ‘good business’ have to play? The answer, I believe, is that ‘good business’ criteria are the key to identifying and prioritizing the actions to be taken. These criteria also serve as the basis of a framework for ensuring systematic comprehensiveness and strategic consistency in the actions being taken, and they are especially valuable in the context of a downturn.
The question remains, how do managers identify priorities and also ensure systematic, comprehensive and synergistic decisions and actions?

Rhodes and Stelter offer clues in their article. The “snags of implementation” they identify include:
•   Failure to see how individual initiatives are part of a comprehensive plan; and
•   Lack of attention to the human element.

By using the ‘human element’ as a guiding principle, I will present a framework that promotes the development of both comprehensiveness and consistency of managerial decisions.

There are three bases and motivations for the framework for ethical or ‘good business’ decision making in a downturn that is being proposed here:
1.   The dysfunctionality of accounting profits for managerial decision making in crises or when innovating strategy.
2.   The short- and long-term economic and strategic advantages of ‘humaneness’ in managerial decision making.
3.   The imperative of recognizing ‘humankind’ in innovating strategy.

I will examine each in turn.

1. The Dysfunctionality of Accounting Profits
The dysfunctionality of accounting profits as a basis for guiding managerial decision making is quite evident, but is largely ignored. The use of accounting profits for decision making can be likened to searching for a lost object at a street corner because of the street lamp being located there, rather than searching for the object in the nearby dark alley where it was lost. Some of the fundamental failings of accounting profits are:

• They do not map well onto economic or ‘true’ profits. Accounting profits are based on historical costs while economic profits are based on opportunity costs.

• They are substantially defined by rules and regulations that seek to ensure consistency but often cannot capture the realities of the situation. Rules for depreciation and amortization charges, for example, are just a mechanism that promotes consistency across companies as opposed to reflecting the true economic and profit-generating potential of tangible or intangible assets. Occasionally, these rules are driven by political expediency rather than economic rationality. The debate in the U.S. about the ‘mark-to-market’ rule is a topical illustration of this unfortunate reality

• Accounting profits often treat period or time-driven costs such as salaries and rent as product or volume-of-activity-driven costs leading to distortions. For instance, in full- cost accounting systems that allocate period costs to products, reported profits are positively affected by increases in finished goods inventories even when sales levels are stagnant.

• Accounting-based measures, especially ratios such as return on investment (ROI) are easily manipulated and such manipulation usually involves actions that hurt companies’ competitive and value-generating abilities. In an economic downturn, the pressure and temptation to engage in such untoward manipulation may prove irresistible.

• Accounting profits do not reflect the objectives and expectations of all the entities with a stake in how the organization does business and how it performs. Some of these stakeholders such as government, customers, creditors, NGOs and the communities in which businesses operate can significantly impact their economic performance. Ignoring these stakeholders’ expectations and concerns can be costly.

So, if accounting profits are not an ideal basis for decision making in the best of times, and are potentially even less helpful in difficult economic times, what is the alternative?

2. ‘Humaneness’ in Managerial Decision Making
One intriguing and perhaps surprising answer to this question has been evident for decades and has, in recent years been generating considerable attention. ‘Humaneness’ in decision making has been found to have both immediate and long-term impacts on the economic performance and viability of businesses. Considerations such as ergonomics, good design, quality, diversity and gender equality in the workforce, safety, and environmental and social sustainability have all been found or logically presumed to have a positive impact on the economic bottom line.

Take quality for instance. Three decades ago, American automobile companies viewed investments in quality improvement as hurting the bottom line. This changed when they observed the example and experience of Japanese industry that embraced the American prophet of quality – Edwards Deming – who had initially found no favour in his own land. The first mantra that resulted was ‘quality is free’, which then evolved through total quality management (TQM) programs into Ford’s assertion that “Quality is Job 1.” Today, motivated by Motorola’s creation of and Allied Signal’s and General Electric’s popularization of Six-Sigma quality management processes, business has learned that focusing on quality can enhance the economic bottom-line immediately and in the long run.

There is also a long-standing appreciation of safety – the critical importance of which was tragically brought home by Union Carbide’s Bhopal disaster and the company’s subsequent economic diminishment. Alcoa is an example of a company that gives critical importance to safety, more than any other consideration, with positive economic results.

A similar understanding is developing about environmentally-responsive decision making. The many positive consequences of such decision making have been catalogued – ranging from government subsidies, support from NGOs, favorable consideration by regulatory agencies, stimulation of technological innovation, enhanced customer loyalty, premium pricing possibilities, potentially lower energy and operating costs, and significantly lower life-cycle costs. European companies have a decades-long history of ecological sensitivity leading to economic sustainability, and the economic advantages of going green are now attracting profit seekers worldwide.

Businesses have realized the economic importance of the well-being of employees and customers, and one consequence of this realization is that ergonomics in manufacturing processes and product design has taken on growing importance. The automobile industry is a convincing example of the importance of ergonomics for the well-being of customers and employees as well as of the bottom line. The disastrous consequences of the sub-prime lending practices in the U.S. have highlighted the necessity to take into account the impact on the consumer’s well-being of financial instruments such as mortgages.

It is often argued that primacy among the three traditionally recognized stakeholders -- shareholders, customers and employees -- which has shifted from shareholders to customers, should now be given to employees. Employees embody the knowledge and competitive capabilities of the organization which are the basis for creating value for the customer and returns for the shareholder. Accounting profits do not provide guidance as to how best to earn the loyalty and creative contribution of the employees, but ‘humaneness’ does.

For instance, in a downturn, ‘humaneness’ suggests that laying off employees, which is often an instinctive and early cost-cutting response of managers, is not in the long-term or immediate interests of the organization. Shared cuts in pay, with the senior management taking proportionate or greater reductions, is one alternative that is more likely to engender a sense of loyalty and commitment to the organization. Experience has shown that layoffs, on the other hand, result in disastrous drops in morale compounded by survivors’ guilt.

The time horizon that is relevant to decision making that is oriented to the qualitative criteria falling under the rubric of humaneness tends to be longer. This, consequently, raises economic considerations that would be ignored in quarterly, EPS-driven decision making. For instance, safety and environmental regulations emanating from OSHA (Occupational Safety and Health Administration) and EPA (Environmental Protection Agency) in the U.S., and, in Europe, regulations such as WEEE (Waste Electrical and Electronic Equipment) and RoHS (Restriction of use of Hazardous Substances) change the economics of businesses. They force consideration of product life cycles from R&D through disposal and of industry life cycles from emergence through maturity and decline. This focuses managerial attention on economic implications that may otherwise be given short shrift.

3.   ‘Humankind’ as a Basis for Decision Making
The arguments related to ‘humankind’ are at least as well known and accepted as the qualitative considerations related to humaneness. Two obvious ones are:
1.   Managerial decisions today require a global perspective. Markets, competition, sourcing, knowledge generation, technological innovation and human resources are all increasingly global in nature.
2.   There is value in serving the large populations of low-income families and individuals that exist throughout the world, particularly in developing countries, who have been largely ignored.

The second argument has been powerfully made by C.K. Prahalad. The cell phone market in India is a good illustration. Every month, several million cell phones are sold in India; a staggering number that rivals the entire population of small countries. The reason is that companies are producing inexpensive, functional phones that can be purchased by relatively poor people. Airtime in India is the cheapest in the world, so now the rural farmer when negotiating with a middleman can call to find out what price his crops should bring in distant markets and the housewife can rent her phone to neighbors, which increases their income and their ability to buy more goods to improve their lives.

By serving the needs of an often-forgotten population, smart businesses are making billions, and case studies show that companies that seek to serve these markets foster technological innovations that enable them to attain very low price points. As they seek to better understand and serve these markets’ needs, further technological innovation results that stimulate new and better products that then can be targeted to higher income segments. The Tenet Group in IIT Madras, a collaboration formed of electrical engineering and computer science professors, is a good example of such aspirations and resulting innovation. Started with the intent of bringing broadband communications to rural India, the venture’s initial strategy was to reduce the cost of the broadband communication technology by an order of magnitude and to make the technology viable without connection to an electrical grid. An epiphany of understanding of the customers’ basic needs changed the initial and quite successful strategic focus from reducing the price point of existing technology to developing broadband technology, both hardware and software, to meet the three essential needs of rural India – health, education and livelihood, as the professors phrased it. The resulting breakthroughs in technology have created the potential of global billion-dollar businesses.

A ‘Good Business’ Decision Framework
The ‘good business’ framework that is motivated by the construct of humanity is illustrated in Figure One.

Figure 1
“Humanity” as the Integrating Construct for “Good Business” Decision Making

Ford Motor Company offers a powerful example of ‘good business’ decisions guided by the touchstone of ‘humanity’. Of the three major U.S automobile companies, only Ford has managed to avoid bankruptcy and to not ask for a government bailout. The conventional view is that Ford’s recently-appointed CEO, Alan Mulally, presciently sold off parts of Ford and mortgaged other assets, which resulted in a strong cash position that has enabled it to avoid bankruptcy and eliminate the need for a government bailout. However, this is only part of the explanation for Ford’s relatively better situation compared to the other two major U.S. automobile companies.

Ford adopted the policy that “Quality is Job 1” in the early nineties, and this was more than an advertising slogan. Ford’s commitment to quality has now brought its cars to the same level as those made by Toyota and Honda, which have long dominated the quality charts. When Ford acquired Jaguar in 1989, the quality of Jaguar cars was abysmally low. When Ford sold Jaguar to Tata Motors in 2008, the Jaguar line had, amazingly, achieved the highest quality of any car line. This undoubtedly made Jaguar more valuable and enabled Ford to obtain a higher price than if quality had remained at its original dismal level.

Chairman Bill Ford made a similar commitment to environmental sustainability, raising it to a mission-critical level of importance. As a consequence Ford’s manufacturing processes are among the greenest and Ford has designed and built what is by far the best mid-sized, hybrid gasoline-electric car in the world.

Ford’s emphasis on diversity and gender equality has also been notable. Women are divisional presidents and head corporate functions. The beneficial consequences have been evident at all levels. For instance, Ford’s women car designers introduced significant safety innovations such as moveable pedals that can be adjusted to the driver’s physique. This ergonomic improvement not only enables better and more comfortable driving but also reduces injuries to shorter drivers caused by exploding airbags in front-end collisions.

In Brazil, Ford has recently built its finest assembly plant on a greenfield site in the rural, non-industrial, underdeveloped northeast region of the country. It has closely and very successfully partnered with local government to build needed infrastructure including a dedicated harbor. It trained and developed a very large and totally inexperienced workforce.

Women constitute fifty percent of the workforce. Its manufacturing processes and even the sanitation system are the greenest of any automobile plant. It has integrated suppliers’ operations under its roof. The cars designed and built at this plant in Camaçari are uniquely and demonstrably well-suited to the needs of Latin (Central and South) America. Ford’s Camaçari plant has also become the benchmark for industry-government cooperation and economic development of less developed regions.

Ford’s commitment to the humanity-based criteria of quality, environmental and social sustainability, diversity and gender equality have undoubtedly played a large role in enabling it to withstand the recession and positioning it for robust, long-term viability.

John Camillus is the Donald R. Beall Professor of Strategic Management at the University of Pittsburgh’s Joseph Katz Graduate School of Business.

[This article has been reprinted, with permission, from Rotman Management, the magazine of the University of Toronto's Rotman School of Management]