SO FAR the credit crunch has only affected the UK financial sector. But as the squeeze tightens and the ripples spread, there is likely to be a sharp rise in corporate failures among companies in the wider economy whose management shortcomings have been disguised by the loose credit conditions of the past few years.

This is the diagnosis of risk consultancy Kroll, which as business’s enforcer, as it were, is well placed to spot early signs of distress. With its businesses in risk management, security, investigations and forensic accounting, Kroll is a company ‘you come across on a bad hair day’, in the words of its founder Jules Kroll, and in a recent report, ’20:20 vision: Boom, bang or bust’, it highlights some of the impending hangovers from the UK’s years of easy money.

Thus, the counterpart to the long period of stability the UK has enjoyed since the early 1990s is that managers are much less well equipped to deal with volatility and failure than their forebears. Managers (and shareholders) of weaker companies have certainly benefited from generous credit, but they have only put off the day of reckoning. ‘When the music stops and the bright lights come on,’ says Kroll, ‘it’s a bit frightening what you see… the party’s over, and there will be significant fallout as a result.’

Among a number of things becoming scarily clear as liquidity dries up is that in the more challenging times ahead, managers will no longer be able to rely on their – and the City’s – preferred method of improving perceived performance: doing deals. They will have to do it the hard, old-fashioned way: through operations.

However, not only is there no sign that managers have conquered their traditional weakness in operations, the refinancings of recent years may have made improvement more difficult by lumbering companies with soaring debt levels. Kroll calculates that the ratio of corporate interest payments to operating surplus is at its highest for 15 years. If profitability dips, for some companies these levels will not be sustainable.

Moreover, the fact that corporate (as opposed to individual) insolvencies are at an all-time low may not be the good news that it first appears. The low insolvency rate is likely to be the result of lenders’ willingness to allow firms to refinance themselves out of trouble rather than a product of good management. In other words, there may be a corporate sub-prime bubble out there waiting to be pricked.

Vulnerability is only increased by two other main trends of the past 20 years: technological advance and globalisation. Information technology has certainly played an important role in London’s success as a financial centre, enabling deregulated institutions to invent dizzying new financial instruments and lend ever more aggressively. But it also has downsides that are now becoming apparent, in complexity and lack of transparency that make it hard to estimate the magnitude of risk or where it finally lies. They are also contributing to the mushrooming of white-collar crime.

By multiplying complexity and interdependencies, globalisation adds another dimension to risk. Are UK companies agents or principals for the wall of money passing through London from rich but murky emerging economies such as Russia? Most may be agents, but it’s hard to know. The combination of globalisation and complex debt structures makes restructuring, disposals and debt recovery a harder (and more expensive) job than ever before. Kroll describes one corporate refinancing that involved simultaneous restructuring in 11 different jurisdictions.

One of the big questions now is whether languishing companies will go to the wall or will continue to be propped up. With refinancing more difficult, the likely outcome is a wave of distress selling at every stage and size of the corporate food chain as firms try to unwind rash mergers and bring debt levels down to manageable levels. These will be bargains for sounder corporate citizens with the resources and confidence to undertake industry consolidation.

Although to some extent today’s conditions can be viewed as a natural correction to past financial exuberance, there is unlikely to be a swift and easy way out. The management weaknesses – resistance to change, lack of information, poor rationale and implementation of mergers and acquisitions – that Kroll’s report identifies as a persistent handicap and cause of business failure are likely to become more evident, not less, as capital markets continue to contract.

‘We’ve been nervous for a while about the direction,’ says Kroll. In the interconnected, globalised world, predicting where and in what shape the next bout of turmoil will occur is impossible. But that it will happen is almost certain. ‘Are we seeing more insolvencies yet? No,’ says Kroll. ‘But is the telephone ringing more? Yes.’

The Observer, 9 Decemberr 2007

LAST SUMMER, the International Journal of Production Research devoted an entire issue to the Toyota Production System. The TPS is probably the most influential manufacturing model since Henry Ford’s moving assembly line of the early 1900s. It figures among the ‘giant steps in management’ described in a new book of the same name, and is also part of strategy guru Gary Hamel’s ‘management of the future’. The TPS has generated a model of ‘lean production’ not only for the rest of manufacturing but also, increasingly, for the service sector; it has been applied to jurisprudence, house repairs, benefits processing and even the NHS. Its inventor, Toyota, is perhaps the most successful large manufacturing firm in the world.

Why is the TPS so important? Because it’s the nearest thing there is to a learning organisation. It is not strategic brilliance (Toyota makes mistakes just like anyone else) but manufacturing prowess that has turned the company from a joke in the 1950s into the equal largest, by far the most profitable, and the most advanced car maker in the world.

It has managed this through 50 years of problem-solving that has abolished conventional production trade-offs and recast manufacturing economics. Textbooks used to teach that manufacturers had to chose between quality or low price, volume or flexibility. The TPS was among the first to show that built-in quality (‘right first time’) was cheaper, not more expensive. Today, the same lines handle different models and specifications without missing a beat. Tomorrow, Toyota aims to demolish the final trade-off – by building a car that doesn’t despoil the environment.

Unsurprisingly, Toyota’s capability to solve ever larger problems evokes deep envy. Yet the TPS’s success is matched only by its elusiveness. Despite the best (or worst) efforts of consultants and academics, no other large organisation has managed to replicate it. While the component principles are understood, how they work together remains, in the phrase of the article in IJPR , ‘a continuing puzzle’. ‘We don’t really understand what the TPS is,’ admits author Steve New, ‘and it is possible we never will.’

Why not? Because the TPS is a complex self-organising system, the irreproducible product of the interplay of a few simple principles that derived from the particular circumstances of its origins.

At Toyota, the fixed cost is in effect the labour force, whose ingenuity is used to minimise the variables. Thus from the Toyoda Automatic Loom Works, where the firm originated, came the notion of jidoka , or ‘automation with a human touch’. By inventing a machine that automatically stopped when a fault was detected, founder Kiichiro Toyoda prevented the waste of faulty production, allowed the workforce to concentrate on solving problems rather than supervising the looms, and hugely boosted productivity.

With a premium on space, raw materials and capital, Toyota devised frugal production methods that, by ‘pulling’ supplies only when they were needed, minimised inventory, space, capital investment and all kinds of management overhead. The principles were turbocharged by what has come to be called kaizen , ‘continuous improvement’, but in fact could equally well be termed ‘obsessive tinkering’: trial-and-error shopfloor experimentation whose lessons are incorporated into highly standardised work routines. That turns the TPS into a learning system. Given that Toyota’s Japanese workers alone make upwards of 600,000 improvement suggestions a year, most of which are adopted, it’s hardly surprising that the production system in front is Toyota’s.

But while it has evolved into a formidable organism, the TPS is not the product of a grand design. Rather, notes industry observer Takahiro Fujimoto in a new book, the Japanese car makers’ systems emerged through improvisation – ‘piecemeal, ad hoc measures for addressing needs and issues that arose’. Toyota, he believes, would remain formidable even if it abandoned the hallmark practices of the TPS, since its strength resides not in any particular method but in an extraordinary ability to develop new ones.

The TPS, then, is not a blueprint it is organic and emergent, a living thing. Hence the impossibility of replication: other companies can only reinterpret it in the light of their own contexts. This is also why would-be copiers often fail. The commonest mistake is to assume that the essence of the TPS is the tools rather than the purpose for which they have been devised. As many organisations have discovered, in the hands of command-and-control managers, TPS-inspired ideas can do as much harm as good.

Now the TPS faces its biggest challenge: accommodating the results of its own success. Can it maintain its integrity while the company is expanding globally faster than any other firm in the motor industry’s history? It is not just Toyota’s future that is riding on the result.

The Observer, 2 December 2007

THE REAL British disease is the unerring talent for putting together entities that are less than the sum of their parts. The comical inability to think in systems terms – call it management dyslexia – was on dazzling display last week, all over the front and back pages.

First up, the England football team. Management is supposed to amplify effort by providing a creative framework for individual expression that benefits the team. But defeat against Croatia was the reverse, the culmination of un management that over several matches has diminished team effort and turned good players into turnips.

It was the opposite of management that left players individually and collectively bereft. At least the England rugby players, in the World Cup, took the initiative to create their own playing system that, although limited, suited the available talent and took them against the odds to the very brink of triumph.

England’s Premiership is the wealthiest football league in the world. Its consistent failure to generate a satisfactory national team is deeply rooted and reflected in other systemic shortcomings. Only one of the top teams, Man chester United, has a British manager the starting line-up of the Premiership leader, Arsenal, contains just one, sometimes no, English player. Oh, and the new pounds 800m Wembley stadium can’t even produce a decent surface to play on. From grass upwards, English football is a system for growing anti-synergies.

Second up, a performance by HM Revenue & Customs that makes it hard to know where to begin – with the IT outsourcing that makes it an expensive extra to separate bank details from other personal data, to senior management’s decision to dispense with encryption to Gordon Brown’s repeated use of the ‘one bad apple’ excuse: the leak was the result of one individual’s failure to carry out procedures – at the dispatch box.

The spectacle of a general blaming his troops is always distasteful, but in this case is also bankrupt. The HMRC leak is primarily the result not of human error, but poor or non-existent systems design which failed in at least three respects: not segregating sensitive from insensitive information, allowing the two to be sent out together, and omitting to encrypt it. If any of those steps had been followed, the further error, of leaving a junior to decide to put it in the post, would have been harmless. This is called fail-safeing – part of any good systems design.

And by the way, don’t bother with a witch-hunt or a full-scale investigation to find out what went wrong: with the help of readers and the junior HMRC official, this column offers to find the root cause in a day, using a basic problem-solving technique called the ‘five whys’ (asking ‘why’ five times over) – and apply the answers to prevent the problem happening again. The five whys are at the heart of continuous improvement which, in turn, is the motor of systemic performance enhancement.

Last week’s third outbreak of British anti-synergy syndrome centred on Norfolk and Norwich Hospital. On Wednesday, the hospital went into ‘major incident’ alert because it was chocker. At one stage, 10 ambulances (nearly half Norfolk’s total) were immobilised waiting to unload their patients.

So the hospital’s too small, right? Well, hang on a minute. Why was the hospital full? Because of high demand, coupled with high bed-occupancy rates. Why are bed rates so high? Partly because the hospital is ‘efficient’, operating at occupancy rates of more than 90 per cent. But also because 60 beds are occupied by patients who have finished treatment but can’t be discharged. Why can’t they be discharged? Because, for financial reasons, the Norfolk Primary Care Trust is busy closing down the community hospitals that would traditionally have taken recovering patients, and social care, as almost everywhere in the country, is utterly inadequate to cope.

And why is demand so high? An epidemic or major accident? Nope. The extra demand comes from within. It is largely generated by NHS Direct which, terrified of making mistakes, routinely directs callers to A&E or their GP – but since GPs are no longer available out of hours, as a result of the government-imposed contracts, that means A&E.

In other words, the Norfolk NHS crisis, like that of HMRC and team England, was self-generated, the result of complete and continuing system-blindness. ‘Problems in organisations,’ points out Russell Ackoff, one of the first and best systems thinkers, ‘are almost always the product of interactions of parts, never the action of a single part.’ Treating a single part destabilises the whole and demands more fruitless management intervention management becomes a consumer of energy, rather than a creator.

Unfortunately, that’s the hallmark of 21st century UK management. As last week demonstrated, it still shows no sign of recognising it.

The Observer, 25 November 2007

THE OLYMPIC-SIZED rewards for failure notched up in the last month by Merrill Lynch’s Stan O’Neal ($8bn write-downs, $161m payoff) and Citigroup’s Chuck Prince ($11bn write-downs, up to $100m payoff, with the use of office, car chauffeur and administrative assistant for five years, plus consultancy) have caused the usual bout of handwringing – and the usual resignation.

Even before the discovery of these performance black holes, US bosses had the grace to acknowledge they were being paid too much. Four in six of them, and 80 per cent of outside directors, admitted in a survey last month that CEOs were overpaid. But while the payoffs pocketed by the deposed bankers may have increased the embarrassment, there is little sign of a correction. On the contrary: instead of proving that the system is broken, each failure is used to justify still greater incentives to get the leaders facing in the same direction as shareholders.

But supposing it could be shown that there was a correlation between the composition of CEO pay and the size of the losses? We’re not quite there yet, but some intriguing US research suggests there is an indirect link – and one that could have considerable implications for the way shareholders think about CEO compensation in the future.

In brief, a study in the influential US Academy of Management Journal finds that the way top managers are paid does influence a firm’s performance – but not in the way the textbooks indicate. The article, by academics Gerard Sanders and Don Hambrick, focuses on the role of stock options, which still constitute the largest proportion of CEOs’ ever-growing pay, and whose effects are surprisingly little researched.

Stock options, you recall, were supposed to stir top managers out of their assumed default mode of cautious self-serving and spur them to become bold, buccaneering entrepreneurs. So they do. CEOs loaded with options do indeed invest lots of shareholders’ money in research and development, new ventures and acquisitions, and the result is extreme performance. What wasn’t envisaged, however, ‘was that the extreme performance delivered by option-loaded CEOs was more likely to be in the form of big losses than big gains’. Like Andrew Flintoff or Ian Botham, option-padded CEOs go for the big hits – but they usually get caught on the boundary rather than score sixes.

In a complicated formula, the professors looked at the performance of 950 US companies across the size range and related it to the stock-option content of the CEOs’ pay. They found that the more executives were paid in options, the more the company invested and the more extreme its financial performance. It wasn’t high investment that generated extreme performance, but, with stock options, it created a ‘combustible combination’ which encourages executives, the authors say, to take on big bets at long odds, with predictable consequences.

Why CEOs should do this is fairly obvious. If, as is their nature, options carry no downside, then CEOs will simply go for the projects with the largest potential payoff. ‘If we accept the common-sense idea that the projects with the biggest possible upside are likely to also have the biggest possible downside, and then couple it with the assumption that option-loaded CEOs have little concern with the size or probabilities of downside outcomes, it is straightforward to expect that option-loaded CEOs have a relatively high likelihood of delivering big losses,’ the authors say.

In the case of Merrill Lynch and Citigroup, O’Neal and Prince certainly had plenty of options. And although this is not part of the professors’ case, if they don’t have an option downside and, in addition, are certain to benefit from a lucrative exit payoff if they are fired, how much more likely are they to take on big, long-odds bets without fear of the consequences? If the numbers are life-changing enough – which they are – there is not even any danger to a future job, since neither of them will need ever to work again.

The Hambrick and Sanders findings are important because unlike other criticisms of stock options they strike at a feature that is at their heart: it is not that they fail to foster managerial aggressiveness, they do it only too well. They also take a swipe at agency theory, which has allotted options an important role in combating the supposed managerial tendency toward shirking, short-sightedness and risk aversion.

In the professors’ perspective, the problem is fundamental and can’t be fixed by tinkering with the way options are administered. The solution is simple: stop giving so many, or don’t give any at all. ‘These findings may help put the nail in the coffin of executive stock options,’ remarks Hambrick. ‘And even if not, they certainly ought to give the corporate world pause in using them nearly as extensively or heavily as they have been in the recent past.’

The Observer, 18 November 2007

It looks like the set of a sci-fi movie: a roomful of dummies lolling disconcertingly on their seats or spilling electronic innards on lab benches under the gaze of white-coated technicians. The dummies are condemned to endlessly reprising the role of crash victims in the high-speed car smashes that are staged five times a day at Toyota’s Higashi research centre in the shadow of Mount Fuji. They are extras in a drama with a plot as bold as any Hollywood movie: a quest to create a car that doesn’t wreck the planet but saves it.

Sound preposterous? It’s the goal of Toyota president Katsuaki Watanabe, who for the past two years has been piling pressure on his engineers to devise a ‘dream car’ that leaves the air as clean as it found it, avoids crashes and improves the health of those who drive it.

Among today’s car manufacturers, only Toyota would dare to air such an ambition in public – and have it taken remotely seriously. As the Economist put it, ‘There’s the world car industry, and then there’s Toyota.’ This year the Japanese phenomenon is on course to churn out 9 million vehicles from assembly lines in 28 countries, in the process probably overtaking GM as the world’s largest car-maker. Its relentless profitability (the last year it fell into the red was 1950, a record matched only by rival Honda) has been rewarded with a market capitalisation as great as GM, Ford and Daimler put together. Over the past few years the company has been growing faster than any firm in the industry’s history, with the possible exception of Ford during the Model-T era a century ago.

As to the technology, at yen 800m (£3.3m) apiece, the dummies are bit players in the yen 900bn research investment that Toyota is pouring into its attempt to marry the conflicting claims of safety, the environment and individual desires, and create what Watanabe calls ‘sustainable mobility’. He refuses to set a deadline for his dream car vision. ‘But the engineers have developed a road map for achieving the goals,’ he says. ‘I am confident we shall get there.’

In fact, the company is already some distance down the track. At Higashi, engineers have reformulated Watanabe’s challenge as simultaneously to ‘zeronise’ and ‘maximise’: systematically eliminating the car’s negatives while optimising its pluses.

Take safety. Like other car-makers, Toyota began by focusing on passive safety – strengthening the car body and devising restraints to protect passengers in accidents. That’s effective up to a point: Toyota says that fatal accidents in its cars in Japan have halved in a decade. But passive safety incurs other penalties in the form of extra weight – requiring more energy for propulsion and meaning greater waste when crashes do happen.

So the emphasis now is as much on ‘active’ and pre-crash safety – preventing the accident from occurring or at least minimising the damage. Anti-lock brakes, traction control and parking aids fall into this category, as do newer systems warning the driver of an unnoticed lane change, getting too close to the car in front, or even drooping eyelids. The driver remains in control – a fundamental Toyota tenet – while the car takes charge to tighten seat belts and apply braking only when an accident is inevitable. But the aim is to extend safety to every driving stage, from parking to rescue after an accident. This, says Seigo Kuzumaki, Toyota’s head of safety development, involves merging passive and active safety measures into a complete ‘integrated safety management concept’ that will eventually link the car to its surroundings – and to other vehicles.

Toyota uses the same problem-solving cycle to overcome trade-offs between the environment and performance. Not everyone shares Toyota’s faith in hybrid petrol-electric technology, as implemented in its Prius model, believing it to be a distracting half-way house on the road to hydrogen-powered fuel cells. But Toyota insists there is no contradiction, since the issue in both cases is not the propulsion system but obstinately lagging battery technology. It is therefore pushing ahead with both hybrid systems and fuel cells, the twin research teams sitting alongside each other to spur development and share advances.

On the hybrid side, Toyota is testing a second-generation Prius that can be plugged into a domestic electricity source overnight, saving a claimed 40 per cent in fuel costs over the original model. It has taken Toyota 10 years to sell a million Priuses after 2010, Watanabe wants that to be a million a year, with eventually a hybrid option for every model, possibly even – provocatively – the company’s Formula 1 car. In the meantime the Prius’s popularity with Hollywood stars such as Leonardo DiCaprio and Kirsten Dunst can surely do no harm.

Fuel cells, even the impatient Watanabe admits, will take longer. Although, like rivals Honda, GM and others, Toyota has made considerable advances in range and durability, daunting obstacles remain: not only the battery bottleneck, but a hundredfold cost reduction for production viability. Watanabe concedes initial ambitions for production were over-optimistic. ‘But we are doing everything we can to speed development up,’ he says. ‘We have to do it for the planet.’

Can Toyota pull it off? Systematically making light of trade-offs that defeat others has always been its trademark, a powerful reason it has pulled ahead of the rest of the pack. Yet Toyota already has its hands full with issues larger than any it has faced before. One is maintaining quality in the face of headlong growth; although for now it retains its high rankings in consumer surveys, over recent years the company has been obliged to recall unprecedented numbers of vehicles, a sequence that has continued this year in Japan.

It also needs to continue to cut costs, both by further simplifying manufacturing (through its fabled kaizen or ‘continuous improvement’ process) and, just as importantly, by improving sales and service. At the same time it must preserve the integrity of its all-important culture as it moves into new territories. It also needs to reinforce both its luxury Lexus brand and what to international buyers remains, despite the success of the Prius, a slightly stodgy Toyota name.

Watanabe makes no bones about it: Toyota must improve on all fronts at the same time, he says. In the face of stern competition, growth will continue only if the company offers high quality, environmental responsibility, service and driving pleasure at the best cost – the right car in the right place at the right time, everywhere in the world.

Being number one in the world for size is irrelevant, he insists. It is important only as a measure of how far Toyota is getting the other things right. If it meets those tests in the years ahead, then at some point, he reasons, the dream car will no longer be a distant ideal – but simply the logical next step.

The Observer, 11 November 2007

FIRST THERE were the truly gruesome events at Maidstone and Tunbridge Wells hospitals where, according to an official report, at least 90 patients died of the superbug Clostridium difficile because of deficiencies in the cleaning regime. Second was the strange embarrassment of the Surrey police chief at his force’s top place in the performance league tables – an achievement, he confessed, that was undeserved. Third, the saga of the National Treatment Agency, which has been rewarding drug addicts who present clean urine samples with bonus drugs, and which last week revealed that a pounds 130m budget increase had resulted in just 70 extra patients kicking the habit.

What do these cases have in common? While the consequences were unintended, they were also no accident. Each was the unerring product of the management regime that ministers have propagated throughout the public services – and for which they, as much as the executives involved, should be in the dock.

At Maidstone, a report by the Health Commission said that the trust had been under such pressure to cut costs and waiting times that it took its eye off the job of cleaning. The drug administration regime is driven by the need to demonstrate that it is getting addicts into treatment, rather than getting results.

Most tellingly, Surrey’s chief constable explained that, to meet government objectives to boost numbers of offenders brought to justice, his coppers were focusing on soft targets such as handing out warnings to shoplifters, instead of more serious and difficult cases. The result, the chief constable said, was that ‘we are at risk of claiming statistical success when real operational issues remain to be addressed’.

Together these cases illustrate once more just why and how top-down target regimes have such baleful effects.

Targets, claim their defenders, are simple, they provide focus, and they work. Yes, they do. Unfortunately, these are also their fatal flaws. The simplicity is a delusion. As Russ Ackoff put it: ‘The only problems that have simple solutions are simple problems. The only managers with simple problems are those with simple minds. Problems that arise in organisations are almost always the product of interactions of parts, never the action of a simple part.’

To focus on the individual parts and ignore the whole always makes things function worse at a system-wide level. Thus, to meet financial and waiting-time targets, Maidstone drove up bed occupancy rates. But that compromised cleaning. At the system-wide level, the cost was making the hospital more dangerous to patients than staying at home.

And if enough pressure is applied, people will meet targets – even if they destroy the organisation in doing so. As quality guru W Edwards Deming put it: ‘What do ‘targets’ accomplish? Nothing. Wrong: their accomplishment is negative.’

These are systemic faults, which is why such regimes can’t be refined by setting ‘better’ or fewer targets. Deming added: ‘Management by numerical goal is an attempt to manage without knowledge of what to do’. This is what makes it so attractive to bad managers. Unfortunately, in absolving them from the effort of thought, it is also junk management, which has the same effect on the consumer as junk food: obesity, flatulence, discontent and demoralisation.

Lack of method explains why the public sector absorbs so much resource for so little return. It also explains the stop-go, curiously disembodied experience of engaging with it: it’s not reacting directly to you, the individual citizen, but to management’s abstraction of you, as embod ied in the target. Hence the obsession with ‘choice’, which simply transfers the question of method to you.

Here’s what I mean. On holiday near Aix-en-Provence in September, my mother had a fall. At the small, busy local hospital she was seen, X-rayed and discharged within two hours.

One phone call produced home visits by a local doctor and a nurse to administer a daily injection. On the last day, she showed my mother how to inject herself – a smart move, because the logistical feat of getting a nurse out for an immobile 90-year-old in Primrose Hill subsequently proved beyond the NHS. She also needed a blood test. Several days after the request, a nurse turned up without tourniquet, cotton wool or plaster. She severely bruised the arm, failed to take any blood and said someone would return with a ‘longer needle’. Several weeks later, still no test.

So when Camden Primary Care Trust sends out a document on ‘Improving Health in Camden’ and asks for feedback, this is my reply. Stuff the targets and fancy extra services. I don’t want ‘choice’. I want competent professionals to give objective advice based on medical, not financial, considerations. What use is a health service that isn’t personalised? If it functions properly, as in the wilds of Provence, it doesn’t need personalising. If it works there, why not here?

The Observer, 4 November 2007

FOR MORE than a decade, BP was Britain’s proudest corporate monument – a financial colossus with global reach and brand, which yet managed to be the first oil company with credible green credentials. Its CEO, Lord Browne, was the UK’s most respected businessman.

All that changed overnight with an explosion at a US oil refinery. BP wasn’t a great company, after all: in fact, it was a very bad one. Browne’s achievement likewise went up in the smoke of the accident, and he left in unfortunate circumstances. The transformation was completed last week when Tony Hayward, Browne’s successor, said in an interview that (in effect) the company was a bloated, overcomplicated mess in need of a root-and-branch makeover that would take years.

This extraordinary turnabout needs explanation. How does a company go from great to gruesome overnight? And if it wasn’t overnight, why didn’t anyone step in to stop it? Of course, the company was probably never as good as the hype made out, just as it is now not as bad. Both company and CEO were to some extent victims of a ‘halo effect’ – financial excellence imparted a rosy glow to its management processes up to the refinery accident the same processes are now made self-evidently awful by the bad news. Even so, a central question remains: why even at ‘excellent’ companies – think Marks & Spencer, IBM and Sainsbury as well as BP – does it take a crisis to provoke change? Why can’t firms adjust incrementally, avoiding the need for the trauma, job loss and all-round heartache?

The conventional answer is it’s a failure of leadership. While true, the implication drawn from it (find better leaders) is diametrically wrong. The underlying truth is that the current management model makes failure inevitable.

As management thinker Gary Hamel recently noted, ‘Few people would want to live in a planned economy, but almost all of us work in one’. Corporate dictatorships (as 99.9 per cent of companies are in the last resort) are quite good at getting people to carry out orders. The downside is that the dictator, however brilliant, is too far removed from what’s happening at ground level for the orders to be reliably timely or right: 99.9 per cent of what we call management (planning and scheduling, budgeting, market research, performance management) consists of measures to compensate for this basic connection failure, with results that can never be better than mediocre.

Companies, perversely, compound the inbuilt shortcomings of central planning by their much vaunted alignment arrangements. While CEOs boast of their alignment with shareholders, notes Hamel, this is exactly the wrong way round. It’s not shareholders who create shareholder value but customers buying products and services. Alignment should logically go the other way. This is why progressive companies put employees first (because it is they who perform the all-important contact with customers) customers second and shareholders third. ‘To be sure, shareholders have residual rights,’ says Hamel, ‘but to put those first runs the danger of mistaking the scorecard for the game.’

The real enemy of timely corporate change is therefore not poor leadership, but poor design. The corporate change dilemma is not, or shouldn’t be, about finding a superhuman leader with perfect foresight (there is no such thing) but designing an organisation that is capable of thriving without perfect leadership, harnessing instead leadership distributed around the organisation. As another guru, Warren Bennis, wisely put it: ‘None of us is as smart as all of us.’

Averting the need for palace coups and disruptive 180-degree change is in part a matter of setting up feedback loops that allow corporate ecologies to adapt automatically to changes in the environment. Former Intel CEO Andy Grove recounts how when the firm’s top brass were agonising over whether to phase out production of memory chips in favour of the newer microprocessors, he was astonished to find that salespeople dealing with customers had already anticipated the decision. With US memory prices being undercut by Japanese manufacturers, they had had no option but to switch to processors.

Another strategy, suggested by intriguing long-term research undertaken at the Advanced Institute of Management Research, may be tolerance – or even fomentation – of alternative power coalitions to the dominant one at the top, allowing for the emergence and airing of different scenarios and strategies.

The ideal changeover at the top, of course, is one that is so seamless that no one even notices. One study of the motor industry found that the only manufacturer where a change in CEO had no effect on performance was, as you will probably have guessed, Toyota. Its system is so robust and so focused on continuous improvement that appointing a charismatic individual is not only unnecessary: it would wreck it.

The Observer, 21 October 2007

YOU WAIT years for a chink of light in the management gloom, and suddenly flashes of illumination go off all over the place. After From Higher Aims to Hired Hands (reviewed last week), Rakesh Khurana’s magisterial survey of how management drove itself into its gloomy cul-de-sac, strategy guru Gary Hamel starts waving a sat-nav showing the way out.

As one of the most influential of today’s globetrotting academic consultant-thinkers, Hamel is a guide who commands respect. He describes his new book, The Future of Management , as an attempt to ‘speed up’ the discipline’s snail-like evolution, and, not coincidentally, he is also a leading light in London Business School’s pioneering ‘M Lab’, or management labs, a kind of incubator for new management breakthroughs.

Direct action of this kind is a novel ploy for management researchers. They generally think of their job as firstly describing what currently passes for best practice and then teaching it to executives. ‘We rarely challenge the underlying paradigm or world view, and we don’t do practice either. Too often we’re stuck in the middle, neither profound nor practical,’ Hamel notes. His book is, therefore, to be seen as ‘a call to arms’: a double challenge to managers to dispense with the obstructive baggage of the past, and to the research community to engage with something that matters: devising methods of amplifying and aggregating effort for the internet age.

Hamel’s core contention is that ‘you can’t solve new problems with old principles’. Industrial-age management, designed 100 years ago to socialise docile employees and tame problems of repeatability and control, doesn’t cut it with today’s issues of resilience and adaptability: in short, innovation.

The achievements of ‘management 1.0’ are considerable but, Hamel points out, its cost is high and getting higher. The overhead of control, planning, specification, standardisation, and motivation by material reward is not just an increasing financial burden. Far more serious is the cost in terms of demotivation and disengagement, critical disablers of innovation and creativity. Equally crippling is the deficit in resilience and adaptability. The more decision-making power is concentrated, the less adaptable the organisation. This explains why corporate change can often only be accomplished by crisis and palace coup, as in a dictatorship – which most companies are.

In short: attempts to make today’s management paradigm work better are just ‘putting lipstick on the pig’. Management is a drag on success – the problem, not the solution. But ‘management’ in itself is not inevitable. It is a creation of the industrial age, engendered by the need to control the new class of employees who made scale possible. Yet ‘human beings weren’t born to be employees’, Hamel reasons. ‘If we invented management, we can reinvent it’.

This is a profoundly liberating thought. And Hamel’s book suggests that a new technology of co-ordination is out there. In conventional theory, there are two means of achieving co-ordination: hierarchies and markets. Markets are good at competition and resource allocation but don’t do innovation; hierarchies are fine for control and planning but poor at nimble adaptation.

But internet-enabled networks offer a credible third way, Hamel believes. The prime exemplar is Linux, the open-source operating system developed by a self-selecting band of volunteers linked only by the web and their motivation to contribute. There are now 150,000 open-source projects using the freely given energy and initia tive of 1.6 million people, according to estimates. While many of these are not-for-profit enterprises, the lessons that they embody have wide application, Hamel argues. They use peer review by many rather than control of the few, the intrinsic motivation of work rather than monetary reward, self-selection rather than fiat for resource allocation, and perpetual, continuous improvement. ‘The internet is the most important new social technology since writing, perhaps ever,’ he says. ‘The idea that it will change everything else but not management is simply naive.’

Even if the shortcomings of management 1.0 are glaring, however, getting to version 2.0 will be anything but easy. The inertia of today’s vested interests is huge. And the consequences will be momentous – particularly for those in power. ‘It’s hard to stand up and say that ideas can come from anywhere, that leadership must be distributed, that accountability flows downward, and then justify paying one person 400 times more than another,’ Hamel points out.

Yet while the full paradigm will take time to configure, companies like W L Gore, Whole Foods, Semco and Google, as described in the book, are already successfully trying parts of it. And the agenda for action is clear, as laid out in this essential and timely manifesto. So what are we waiting for?

The Observer, 14 October 2007

BY WHAT right do managers run companies? Daft question: because they have the knowledge and skills to do it. That’s the accepted line – managers are the visible hand that takes over where the writ of the market doesn’t run, using the technologies of organisation to gain economies of scale that the market can’t match. This version is now so taken for granted that it is effectively ‘invisible’.

But in the late 19th and early 20th centuries, as Rakesh Khurana shows in a masterly new survey, conquest of the industrialising economies was as bloody as that of the Wild West. That large companies and managers came out on top was not inevitable or ‘natural’, but the result of a fierce institutional battle largely decided in favour of the winners by a marriage of convenience between management and business schools.

From Higher Aims to Hired Hands (Princeton) charts in compelling detail a symbiotic and often perverse relationship in which management and business schools decisively shaped the purpose of the corporation, which has then fed back to alter the theory and practice of management. It’s a remarkable and uncomfortable story.

As suggested by the subtitle – The Social Transformation of American Business Schools and the Unfulfilled Promise of Management as a Profession – Khurana, a Harvard academic, views management as not only an unfinished but a crippled project. His case is that having failed to establish a ‘grand narrative’ of management as a profession with a claim to moral leadership, business schools were an easy prey for outside influences that bounced them into adopting a much narrower role. First supplying technocratic organisation men to run the conglomerates of the Fifties and Sixties and, latterly, even further from the founding ambitions, simply supercharging the career prospects of their graduates.

By a supreme irony, the theories currently elaborated and taught in business schools, notably agency theory and transaction cost economics, de-skill and de-legitimise management by turning managers into the hired hands of the title. They exactly reverse the professionalisation project. Small wonder that those taught that self-interest drives everything take the doctrine at its word. As Khurana notes, the corporate scandals of the past few years are ‘bitter fruits’ of business school developments in the Seventies and Eighties.

Now, while apparently at the peak of their power, business schools find themselves in full existential crisis, impaled on a painful prong of their own making. If management is not a profession but sim ply a means of amassing private wealth if, as the theory suggests, management gets in the way of the efficient functioning of markets and is thus the problem rather than the solution – what are business schools for? And why should management studies be taught in publicly funded universities?

How did it happen? Khurana leads us through the institutional twists and turns with nary a false step. He shows that, subverted both from without and within, the professionalisation project – ‘so to broaden the minds and raise the ideals of its graduates that it will do something to elevate the business community above the plane of mere money-getting’, as the Tuck School put it – never even approached completion. Lacking a critical mass of moral or factual authority, management has never defined itself in the terms called for by an early Harvard dean: ‘While 2+2 in mathematics may always be 4, 2+2+ the X of human relations… is never 4… A new conceptual framework was required.’ With business academics beavering away in deep furrows increasingly unconnected with actual business practice, it still is. The mission of instilling ‘leadership’, now desperately invoked as a new business-school role, is also undermined by the glaring lack of an accepted fact base.

Meanwhile, theoretically and in practice, business schools are in the grip of a market logic which, as Khurana points out, doesn’t even allow consideration of the questions being asked of them. The interests of academics, students and business continue to diverge, and MBA grades are on the decline. Why should students work when the point of an elite degree is not to gain practical knowledge (unnecessary for a career in financial engineering) but access to networks and to signal to employers that they are the elite? Maybe Oxford’s long resistance to a business school wasn’t so unreasonable.

Khurana’s meticulously researched account ends with a call for renewal of the idea of management as a profession – otherwise, it will find its privileges regulated or forcibly wrenched away. Coming as it does out of Harvard, the most iconic of business schools, From Higher Aims… could hardly be a more provocative and timely intervention. It’s no beach read (500 pages, 100 of them notes), but anyone remotely interested in management and its future should get hold of it – and ignore its lessons at their peril.

The Observer, 7 October 2007

WHEN AS a young journalist I first started writing about business, my total lack of experience was saved by two pieces of advice that I have blessed ever since. Robert Heller, my first editor, dispatched me on an initial assignment for Management Today with the words: ‘Don’t believe anything until you see it with your own eyes.’

And a shrewd City PR punctured any remaining gullibility by pointing out that whatever people like him said for public consumption, there was little in business that hadn’t been seen before. Wait long enough and the cycle will come around: what goes up almost always ends by coming down. As well as sparing me acute personal embarrassment (well, mostly), these common-sense lessons have a wider application to business generally – as events of the past few weeks demonstrate. If companies had paid more attention to such hoary basics and less to the blandishments of City and Wall Street slickers, the world economy wouldn’t be in the mire it is wading through now.

The visibility test ought to be a basic one for any investor or manager, particularly when bubbles are in the air. In the internet boom of the late Nineties, the inflated valuation of web start-ups was the direct result of investors taking the business model – how they would make any money – on trust. Not trusting their own eyesight, they allowed the internet emperors to convince them that virtual clothes were the same as real ones.

That seems inconceivable now: yet the hedge fund and private equity-fuelled binge just ending was similarly based on an optical illusion. As Warren Buffett, the undisputed Olympic champion of investors, points out, extracting more from the economy than its constituent companies create in value is a logical, physical and financial impossibility.

Yet that’s what the purveyors of today’s modish financial instruments wanted us to believe, and they found many willing buyers who have come to count the cost. The frictional costs charged by financial intermediaries are now a burden of 20 per cent on corporate income, Buffett says – income that otherwise would come straight through to investors and pension funds. One more time: if you can’t see it, you can’t weigh it and you can’t trace an owner, it probably doesn’t exist.

Northern Rock is a good example of what happens when a company succumbs to this kind of voodoo economics, precisely because it is a company that wanted to be, and by its own lights was, ‘good’. Firmly identified with its northeast roots, it is devoted to its community and full of philanthropic and cultural good works. It gained much respect during the miners’ strike of 1984-85 by declining to repossess the houses of strikers unable to pay their mortgages.

Alas (another useful lesson), social responsibility doth not on its own sustainable corporations make. Dazzled by the promise of outsize returns from the thin-air economy, Northern Rock turned itself from a boring old bank lender, requiring a deep knowledge of creditworthiness and asset values, to a trendy retailer of securitised loans and mortgages to hedge funds and CDOs (collateralised debt obligations), requiring a deep knowledge of opaque and arcane financial markets. It wasn’t borrowers that tripped Northern Rock, whether sub-prime or not: it was its own unbounded faith in what it couldn’t see.

Of course, everything is made worse by the failure to remember lesson No 2. Previous cycles have amply demonstrated that borrowing short to lend long can look smart in the short term, but can also turn you into a penniless idiot in the long. Similarly with debt in general. An ‘efficient’ balance sheet in the short term does not necessarily equip a company for success in the long term and, indeed, it may make success more difficult if it squeezes out the resources to innovate and grow. We shall certainly see this point underlined in the near future as one or more debt-heavy private equity chickens comes crashing home to roost.

Of course it’s easy to be wise after the event. But that is exactly what the two precepts are designed to avoid – particularly in financial services, whose products, although companies appear to have forgotten it, were meant to provide security rather than heart attacks. Whatever happened to banking prudence? The queues besieging Northern Rock branches in the first UK bank run for a century and a half tell a visible story of devastating loss of trust: an unfortunately deserved result for an industry that has steadfastly ignored the truism – and its own statutory advice – that what goes up can equally well come down.

It’s no excuse either that when gravity finally reasserts itself, as it always does, the pieces don’t always land in the original location. We ought to know by now that history is cleverer than that. Here’s a third piece of advice for the next time the financial cycle turns around. In Mark Twain’s words: ‘History doesn’t repeat itself, but it does rhyme.’

The Observer, 30 September 2007