Highlights
At Issue
What makes some firms successful? So far, economists mostly looked at the amount of inputs - capital and labor - or at the quality of workers and managers. Management gurus, on the contrary, advocate the importance of good management. Is the adoption of best management practices a source of competitive advantage? If these practices do indeed enhance performance, then why do managers not always adopt them?
Approach
The paper exploits an ambitious survey on 732 medium-sized firms in the United States, the United Kingdom, France and Germany. The survey collected data on firms’ management practices, workforce characteristics, ownership, and top management succession procedures. Advanced econometric techniques are employed to derive the results. Its clearness of exposition makes the paper a pleasure to read, some technicalities notwithstanding.
Findings
Adoption of best practices is positively related to firms’ performance, growth, and survival. However, best management practices are not widely diffused yet - not even in leading industrial economies. Country and industry factors partly explain the adoption of best practices, but this is not the full story. There are two other factors which are far more important. One is the degree of product market competition: survival and success are harder in competitive industries, and this leads to better management practices. Second, inheritance of top managerial posts in family-owned firms results in less competent and less professional management.
Novelty
There is much talk about the effectiveness of best management practices, but their effects are rarely analyzed rigorously. This is the first paper that thoroughly analyzes best practice adoption and also tackles its consequences. The paper therefore opens the black box of the firm, looking at how firms are actually managed, as well as at the black box of management, addressing and explaining the reasons of poor management.
A recent study conducted by McKinsey indicated that one of the ten business trends in the near future will be that “management will go from art to science”. Scientific management will quickly become a necessary condition to survive rather than a source of competitive advantage. How are companies currently placed to face this challenge?
To tackle this issue a useful approach is to assess the extent to which best management practices are diffused among companies. This is what the authors do in the paper, relying on a sample of 732 medium-sized firms (i.e., firms with 50 to 10,000 workers) in the United States, the United Kingdom, France, and Germany. The underlying idea is that the firms first adopting state-of-the-art management practices are the better managed ones.
Over the last few years, a number of practices have come to the forefront of business. The management practices taken into account by the authors in their survey may be grouped into four areas. The first group refers to operations, and includes practices such as lean manufacturing and the documentation of process improvements. The second group focuses on monitoring and on practices that have to do with individual performance appraisal, controls, and rewards. The third group considers targets and the practices related to goal setting within organizations. Finally, the last group includes incentives-related practices, i.e. promotion criteria, bonuses, etc.
It should be stressed that the considered practices are widely recognized as important and display an average level of sophistication; that is, we are not dealing with high-tech, highly specialized and complicated practices, rather, with well-tested, mature practices.
A first - somewhat surprising - result is that there is wide variance in practice adoption, with several firms adopting just a few of the management practices considered. In particular, US firms are more likely to be run through these practices - i.e., seem to be better managed - than European firms. At the same time, there is also substantial variation in management practices across firms within each country. Moreover, while different industries are characterized by different patterns of adoptions, the majority of variation can still be observed at the country and firm level.
One may criticize this approach at its core and argue that these practices - and management practices in general - are not necessary to achieve superior performance. Moreover, management practices may also be the result of fashions, which come and go like the swing of a pendulum. In order to properly check for this possibility and to validate their study, the authors investigate whether there is any correlation between practice adoption and firm performance. They find that adopting best management practices has a strong positive effect on performance, and that this positive effect holds for a variety of performance measures: profitability, productivity, market value, sales growth and survival.
But then, if these practices do enhance performance, why do managers not always embrace them? The paper allows for two explanations. First, managers turn to state-of-the-art management practices only when facing fierce competition. Firms operating in industries where product competition is low display a lower propensity to adopt best practices. In other words, product market competition provides a strong incentive to perform, thus fostering better and more accurate management. Furthermore, economics argues that in competitive environments inefficient firms are driven out of business. Therefore, we are less likely to see badly managed firms when product market competition is stronger simply because those firms no longer exist.
The second explanation for the observed patterns rests on the nature of family firms - i.e., firms that are primarily owned by one family. A consistent pattern the data reveal is that family businesses are managed worse. Family businesses constitute the backbone of several economies: according to the Family Firm Institute, they comprise 80% to 90% of all business enterprises in North America. Similar figures may be observed in European countries such as Finland or Italy.
This analysis shows that family ownership per se does not influence the adoption of management practices. It is the decision to designate the founder’s eldest son as the firm’s CEO that has a strong negative effect on the propensity to adopt best management practices. Why is it so? First, usually genius and talent are not inherited, and there may be professional managers with better skills than the founder’s heirs. Second, anticipating that they will have an easy career path young heirs may choose not to invest much in their education and training.
Lack of competition and inefficient succession practices explain about half the observed number of firms which do not adopt best management practices.
Overall, three messages stand out from the paper. First, management practices do improve companies’ performance. They are not sufficient to outperform rivals - nor can they be, by definition, as anyone may implement them - but they seem to be necessary to survive and do well. Second, not only does competition benefit consumers - who enjoy lower prices and better quality - but it also promotes good management and therefore ultimately it benefits firms too. Any policy fostering product market competition is thus to be welcomed.
Finally, though family ownership may at times be beneficial for business, alleviating as it does the conflict of interest between managers and owners, family management through direct succession into the position of CEO actually destroys value. Given the widespread diffusion of family businesses, this observation is fundamental for the very survival of business, and a careful reflection on the different roles of family, management, and ownership is necessary.
Report Source:"Measuring and Explaining Management Practices Across Firms and Countries", a Working Paper by: Nick Bloom (Stanford University), John Van Reenen (London School of Economics).
LSE-CEP Discussion Paper No.716, March 2006, pp.72