CHAPTER 4
How Democratic Capitalism Works
But what if there were another
way, one that engages people in the business and leverages rather than destroys
their energy, knowledge, and talent? In
fact, such an alternative exists, a system that aligns the interests of
employees, managers, and shareholders for the mutual benefit of all.
And the best part of it is that it actually works.
Charles A. O’Reilly III and Jeffrey Pfeffer[1]
An understanding of how freedom and mutual respect make democratic capitalism work can be extrapolated to an understanding of how the world could work, were society based on the same values. Society grows from the exchange of goods and services by people seeking to improve their lives. Experience shows that cooperation and trust facilitate the exchange, competition assures the best products and services at the lowest prices, and the system is energized by individuals free to improve through an interdependent effort. Some would say that the system based on trust and cooperation is natural to humans; many would say that, empirically, it works best. O’Reilly and Pfeffer described specific companies that were able to release the latent power of ordinary people because they were “able to align their purposes with the spirit of their employees, capturing their emotional as well as intellectual energies.”[2]
In democratic capitalism, the broader mission of commerce is to eliminate material scarcity, elevate spirits, and unify people. Government’s mission is to protect life and property, and support the best commercial system. Education’s mission is to equip the individual to participate by developing both individual and social skills. Religion’s secular mission is to support this moral commercial system in order for society to become all that it can be.
The
In contrast, ultra-capitalism,
called the “American Model,” treated wage earners as a cost commodity, and
made short-term earnings the exclusive mission.
By the 1990s, conventional wisdom in
The model that could be called
“American” ought to be the economic system that succeeds through the
synergistic coupling of democracy and capitalism.
Service industries in information, computing, and telecommunications
generated many of the new jobs in the
In 1997, Fortune analyzed the
“100 Best” companies to work for. In
following years, many of the “100 Best” positions shifted, not because
companies were abandoning their principles but because the competition was
heating up. The question of which
policy maximizes profits for the stockholder, whether ultra-capitalism that
demands instant profits or democratic capitalism that elevates the workers as
the source of productivity and innovation, was answered in the Fortune study:
Investors might like to know whether a
corporate culture of mutual respect also provides a competitive advantage.
Last year we determined that the publicly traded companies on the list
did deliver higher average annual returns to shareholders than the companies
making up the Russell 3000, the index that best mirrors our list.
This year’s group demonstrates much the same: The stock of the 55
companies on our list that have been publicly traded for at least five years had
an average annual appreciation of 25% in that period, compared with a gain by
the Russell index of 19%.[4]
The charts accompanying the year 2000 Fortune report were just as impressive: The total stock market return of the public “best companies” compared to the S&P 500 was 35.5% versus 17.6% over ten years, 33.3% versus 18.3% over five years, and 29.8% versus 11.4% over three years.[5]
Fortune did not draw the line between democratic capitalism and ultra-capitalism in the article, but a reading of the particulars of these “best” companies shows that they are democratic capitalist enterprises whose common denominators are freedom for their employees to produce and innovate, performance bonuses, ownership opportunities, job security, meritocracy, training, and education.
While Fortune’s “100 Best Companies to Work For” in 2001 was a new
study, the conclusions were not different from the 1990 Fortune study of the most admired companies.
Many names are prominent on both lists, such as Merck, 3M, Wal-Mart,
Hewlett-Packard, Johnson & Johnson, and Berkshire Hathaway.
The world’s best known investor, Warren Buffet, head of Berkshire
Hathaway, had not changed his message about long-term value:
“Invest forever and look at stock prices about every six months.”
Policies of some of the most admired companies in 1990, however, now seem
quaint: “At 3M, researchers spend
15% of their time on projects that will pay off only far down the road.”[6] A
decade later, the CEO of 3M was criticized in the financial press for not laying
off enough people to improve short-term earnings. Subsequent downsizing provoked
the witticism that the company had become “2M.” Wal-Mart,
on the other hand, did not change its mind about involvement.
In 1999, Fortune reported:
The nation’s largest employer, Wal-Mart, engenders loyalty and enthusiasm by investing heavily in training and by promoting workers from within. Sixty percent of
management started as hourly associates.
It does not hurt that the profit-sharing plan is heavily invested in
Wal-Mart stocks.[7]
Container Store of Dallas, Texas,
was rated #1 again in 2000. The
democratic spirit of this company was confirmed because “97% of the employees
say that people care about each other here.”[8] TD
Industries, also of
People at this plumbing, heating, and
air-conditioning company are called “partners”—they own the company
through ESOP and 401(k) plans. No
surprise that 91% agree that they are treated as full members regardless of
position.[9]
At the beginning of the 1990s,
profits of American companies were proportionate to
The economic logic of investing in
people, illuminated by the Fortune
articles, runs contrary to conventional wisdom of the 1990s.
Collins and Porras challenged this wisdom, describing the common view of
the most successful companies that build on vision and core values:
Contrary to business school doctrine,
maximizing shareholder wealth has not been the dominant driving force or primary
objective through the history of visionary companies.
Visionary companies pursue a cluster of objectives, of which making money
is only one—and not necessarily the primary one.
Yes, they seek profits, but they’re equally guided by a core
ideology—core values and sense of purpose beyond just making money.
Yet, paradoxically, the visionary companies make more money than the more
purely profit-driven comparison companies.[10]
Frederick Reichheld added another
dimension when he traced superior performance through building the interrelated
loyalties of customers, employees, suppliers, and shareholders.
He encapsulated his conclusion in his subtitle, stating that mutual
loyalty is “The Hidden Force Behind Growth, Profits, and Lasting Value.”
Within this culture, profit is recognized as indispensable, but “it is
nevertheless a consequence of value creation.”[11]
Integrity is a repetitive theme: “Loyalty leaders tend to ignore modern
management theory in favor of a code of behavior that is close to the Golden
Rule, or in the case of several hugely successful companies, the Golden Rule
itself.”[12]
The
first element of the democratic capitalist template is integrity.
On a foundation of mutual trust and cooperation, minimum structure
and maximum freedom become attainable, and these are the second
and third elements of the template. The fourth element of the template, competence,
embraces a proper balance between task and resources, and the capacity for
decisive, effective action. These four elements of the template of democratic
capitalism underlie the following common denominators in most democratic
capitalist cultures.
Reichheld affirmed: “New theory sees the fundamental mission of a business not as profit but as value creation. It sees profit as a vital consequence of value creation—a means rather than an end, a result as opposed to a purpose.”[13] Collins and Porras described the mission statement thus: “A well-conceived vision consists of two major components—core ideology and an envisioned future. It defines what we stand for and why we exist.”[14]
For the second half of the twentieth century, Hewlett-Packard was one of
the most admired American companies. Its
co-founder, Bill Hewlett, remarked after the death in 2001 of his partner, David
Packard:
The greatest thing he left behind him
was a code of ethics known as the “
Hewlett-Packard followed this code from its founding in 1938, and in 1998 it was number ten of Fortune’s 100 best companies to work for. H-P’s revenues were seven times greater than any of the other top ten, and it ranked #1 among design and manufacturing companies. Even H-P is not protected from the conflicts in capitalism, however. The merger with Compaq Computer Corp. in 2002 became a battle between family members and the new CEO.
Reichheld pointed out the natural human values inherent in democratic capitalism: “Work that is congruent with personal principles is a source of energy. Work that sacrifices personal principles drains personal energy.”[16] Reichheld’s observation is consistent with my experience: Trust and cooperation, teamwork, and individual ambition in a harmonious whole produce results superior to the combination of excessive individualism and the exclusive money motive; moreover, it is more fun.
The mission statement is not a
one-shot effort to be looked at occasionally; it has to be a living, breathing
part of the work culture. This can
be done by integrating it into management speeches, team meetings, and training
programs. Visual materials used to
merchandise the mission can be effective by coupling integrity with meritocracy
because the unencumbered opportunity for promotion gets people’s attention and
helps give meaning to integrity. The
commitment to integrity needs repetition in the face of a prevalent cultural
perception that either immorality or amorality is the capitalistic norm.
Unfortunately, many capitalists reinforce this negative perception with visible
evidence of their greed and lack of principle.
Customer Loyalty: The mission statement can be complete about the value system and company vision, but if it does not emphasize the company’s purpose in understanding and serving customer needs, it is committing the error of internalizing. The external democratic capitalist culture works extraordinarily well with customers and suppliers because the ability truly to listen, trust, and cooperate is as important in building customer and supplier loyalty as it is in building the loyalty of associates.
The work culture has to be constantly sensitized to relate to the customer and to fight this tendency to internalize. An example of internalizing would be engineers who become excited about all of the bells and whistles that can be added “for free” because of chip technology. A company’s analysis might reveal that the added features would be of interest to fewer than 5% of the customers, and that complication of the learning curve and user manual would make the product less user-friendly for 95% of customers. A customer-sensitive company would either eliminate the confusing features or package them as separate, higher-priced, optional add-ons.
Just as workers become more profitable as they mature, customers also become more profitable. Customer retention becomes a passion with good companies. Some calculate the NPV (net present value) of customers by comparing the selling cost to win a new customer with the lower maintenance cost of an existing customer, someone already familiar with the products and business protocols. Most accounting systems do not reflect the costs of losing customers, even as they do not reflect the costs of worker turnover. Accurate reporting of these costs would further demonstrate the greater profitability of democratic capitalism.
Lexus, the automobile company, has set new standards for customer loyalty. An astounding 68% of its customers continue to buy Lexus. Mercedes is in second place at 42%, while other auto companies retain only 30% to 40%.[17] Lexus accomplishes this through technology and involved people. Headquarters monitors all of its dealers online, full-time, and any dealership that has customer-retention problems is soon blitzed with tested remedies. Their online monitoring is a version of the revolution in electronic commerce in which source data on defects is automatically entered into a computer and instantly becomes widespread knowledge throughout the communications network.
“Nothing happens until someone sells something” is a typical
marketing-company slogan. Evangelistic
sales meetings are peppered with anecdotes of heroic efforts to help out a
customer. This, however, is the easy
part; the hard part is educating everyone, not the salespeople only, to
understand their personal impact on customer relations. For example, some
companies spend generously on advertising, but they allow people, or computers,
to handle the phones. Companies put
the least trained at the front desk or on the phone, the first to meet customers
and, therefore, the first to alienate them.
Similarly, it is painful to have produced an elegant product only then to
suffer serious customer dissatisfaction because of sloppy billing procedures.
The
measurement and analysis of customer loss or retention is an important addition
to the analysis of sales growth and market share.
Companies can spend heavily on improving market share without realizing
that they are adding new, less profitable customers at the same time they are
losing old, more profitable customers. To
avoid the tendency to internalize, customer attitudes need to be routinely
sampled, this effort backed with sufficient resources for quick follow-up.
This discipline must be centralized because any slippage needs early
feedback and may be in areas of product design or billing procedures, not within
a branch’s responsibility.
Worker
Ownership:
Associates in the democratic capitalist culture are involved and contribute
individually and as part of a team to maximize the surplus.
Sharing financially in the improved performance can be accomplished
through profit-sharing plans and various ways to accumulate ownership.
Whatever the formula, the cycle is continuous:
Because associates think and act as owners, they make the surplus bigger,
and then they are rewarded as a result of the improved performance that they
themselves have helped produce. Employee
ownership, a common feature among the 100 best companies, is the subject of
chapter 5.
Training: Good training is impossible in an environment of distrust and friction but good attitudes will not last without good training. Morale surveys invariably mention better training as a priority. Since poor training and poor management go together, “poor training,” mentioned in a job-satisfaction survey can be a code word for “poor management.”
Democratic capitalism is built on the assumption that the potential of every individual is enormous when provided with the proper motivation and training. Most individuals function at well below their potential. Companies, schools, the government, and society as a whole function at an even lower rate because their realization of overall potential is held down by the lowest common denominator.
In democratic capitalism, training is a continuous priority, and it
includes the following:
·
Formal skills training.
·
The use of interactive computer
training that provides self-development opportunities.
·
Informal training that results from
team environments in which all share in the benefits of improved performance.
·
Continuous leadership training that
anticipates and prevents managers under pressure from reverting to top-down
management by fear.
·
Formal education that improves
associates’ cognitive, communication, economics, and other forms of learning
skills that contribute to individual development.
·
Good companies contribute to the
continuous education of citizen-workers, an aspect of personal development upon
which any democracy depends.
Intensity, the Secret Ingredient: Although the emphasis in democratic capitalism is on consensus, cooperation, and human values, effective action still requires leadership with authority, capable of decisive action. Leadership policy in democratic capitalism needs to be preceded by the involvement and cooperation of all, but ultimately it cannot be a democratic process in the political sense. A good leader, whether top management or a supervisor, will help build consensus and then merchandise the agreed-upon plan, but success depends on the leader’s capacity to “make things happen.” This sounds like a business slogan because it is one, and a good one, too!
When someone promoted into a position of greater responsibility based on a record of achievement and perceived qualities then fails to perform, everyone is disappointed. Knowledgeable and respected, the person in the new job may fail at leadership for lack of intensity. What is intensity? Energy? Desire? Fire-in-the-belly? Hard to define, intensity is easy to recognize when you see it, and you see it over time.
When a leader is held accountable to a three-year plan, first failure will provoke analysis and retraining, but successive failure must result in the appointment of a new leader. In some cases, a manager most sympathetic to human values may lack the required intensity to act. This can become a weakness in democratic capitalism, if managers assume that good people working diligently is all that is required. In addition to good will and hard work, intensity is critical to continuous improvement.
Emphasis on leadership does not contradict the concept of self-supervised worker groups; it makes them possible. The leader remains invisible until the exception principle triggers his or her involvement. The communist dream of unsupervised work groups is a confession of ignorance about how people really function. After all have been given equal opportunity, extensive training, and profit-sharing motivations, significant differences in talent will nevertheless become apparent. Wealth-creation depends on meritocracy, continually moving those with the capacity to make things happen into positions of greater responsibility and authority. In an environment where all are owners, meritocracy works
partly because most of those not
promoted come to understand that the process was fair and that they still have
opportunities for further development.
Productivity: Increasing productivity over the long term is the basis of rising wages and economic growth; consequently, it is the solution to social problems. With rising productivity, better products at lower cost are delivered to consumers; this attracts more consumers who can afford the lower prices, and this adds still more wage earners to produce the additional volume. This is a compressed version of Adam Smith’s dynamic for building and spreading wealth (see chapter 6).
The last quarter of
the 20th century witnessed productivity improvement stimulated by a
technological revolution more profound than the late-18th-century Industrial
Revolution powered by the invention of the steam engine or the late-19th-century
Second Industrial Revolution powered by electric motors.
This recent revolution was made possible not only by new technology but
also by unprecedented participation of the workers.
Here are some of its features:
·
The microprocessor became
ubiquitous after 1970, making decentralization and empowerment easier because
information could be processed at the working level; as a result, performance
standards and accountability were improved.
·
Microchip technology opened large
markets for products that could do new and useful things at very low cost.
·
The amorphous slogan “the search
for excellence” became an effort at rigorous truth searching, finding out how
to “do it right the first time.” Standards
of performance were developed, measured, and subjected to continuous
improvement. These techniques
allowed “employees to establish goals, spot failures, use standard
financial-analysis techniques, evaluate trade-offs—and learn from the
results.”[18]
·
The new standards of performance
could not be met without worker participation.
·
Technology and involved workers
extended productivity improvements to the growing service industries.
The critical-mass effect from increasing volume has always been fundamental to lowering manufacturing costs, but it is now driving costs down in the service industries that represent over 80% of the United States economy. Productivity is a result of investment in both equipment and people, but the two kinds of investment are significantly different from each other: With training, education, and motivation, people get steadily better at what they do, whereas machines wear out.
The Japanese pioneered the application of continuous-process principles to inventory control with their JIT (just-in-time) programs. They applied the same searching examination that had resulted in quantum improvements in the quality of the product and cost to produce in the uses of cash. “We’ve always done it that way” became a joke in companies, no longer a rationale for mindlessly perpetuating the status quo. The leading companies learned to improve the “productivity” of cash in their operations dramatically.
When the revolution in applying new technology to cash management came to
retailing, I was on the Board of a large company that took more than $600
million out of inventory by rethinking its whole distribution and warehousing
program, and then investing millions in the hardware and software, including a
satellite network, required to do the job. The
key to success, however, was capital investment combined with long-term
associates eager to be trained in use of the new technology.
Job Security: A sense of job security is crucial to the democratic capitalist culture. Job security gives substance to the concepts of trust and cooperation, and it neutralizes the old industrial fear: “If I help the bosses do it better, then they will reduce the hours needed and fire me.” Conversely, commitment to workers’ secure future encourages involvement and participation. Worker-ownership plans are built on the basis of stable employment over a long period of time.
The introduction of new technologies and world competition are legitimate reasons for reduction of personnel. With a reasonable investment, however, workforce reduction can be accomplished through attrition, retraining, relocation, or in limited cases, generous severance. In contemporary mercantilism, the worker is still treated as a disposable cost commodity, and Wall Street celebrates this tough, soulless capitalism that fires people by the tens of thousands. The rationale for downsizing is that decisive cost-cutting management is needed in the face of world competition, although much of the downsizing is done to benefit short-term earnings.
The argument that downsizing validates Marx’s theory of the inherent contradiction in capitalism, namely that pressure on profits is relieved by firing workers or suppressing wages, is partly true. An additional argument is that Wall Street analysts and the financial media have made downsizing an executive manhood check. Many large layoffs are capricious. They excite Wall Street and almost guarantee, through accounting tricks, a cosmetically better financial year following the layoffs, a higher stock price, and gains on options. Wall Street does not like attrition because it knows that immediate downsizing includes a big-bang accounting treatment that produces artificially good profits for a few years. Government policy at the turn of the century favored the large immediate write-off rather than attrition over a period of several years. This is bad accounting because it distorts true profits, and it is bad fiscal policy because it deliberately favors short-term and greedy ultra-capitalism.
Large
layoffs are frequently weak in the analysis of short-term benefits versus
long-term growth. R&D (Research
and Development), product improvement, new markets, maintenance, new equipment,
training, and community involvement are frequently sacrificed.
Layoffs do not address management’s failure in having added so many
unnecessary employees in the first place. Layoffs
also beg the question: “What will
the company do for an encore?” Major
cost reduction of administrative expense is a one-time improvement in profits
that approaches the problem from the wrong end.
A continuous-process program for sales growth approaches the problem from
the correct end. Only sales growth
can assure job security by assuring a profitable future for companies and a
rising standard of living for countries. Finally,
layoffs force unions to revert to zero-sum bargaining, in which the argument is
about “more” but not about the fair share of improved performance. Reichheld
pointed out the destructive effects of downsizing:
Most companies think
layoffs are a great way to raise productivity. It’s true, of course, that the
ratio of revenue to people will go up if you throw some of those people out on
the street. But in most cases, the
relief is momentary. The truth is,
layoffs lower productivity; in some cases, they decimate it.
Granted, some situations require layoffs for the sake of survival, and
some require the short-term accounting gains that a layoff brings.
But the ultimate price of a layoff is always high.[19]
A study by the American Management Association revealed that fewer than half of the firms that downsized during a five-year period in the early 1990s subsequently increased their profits, and that only one-third reported higher productivity.[20]
According to the Fortune article, the wisdom of the “100 Best” companies to work for runs contrary to conventional wisdom that “job security is a thing of the past.” Job security is “a recurring perk among the 100 best companies. Several have no lay-off policies, 37 have informal policies against layoffs, and 74 have never had a layoff.”[21] The language in the Fortune article is instructive: Job security in ultra-capitalism is described as a “perk,” whereas abandonment of any loyalty to workers is called the “conventional” view. The Wall Street Journal was even more
emphatic: “The social contract between employers and employees, in which companies promise to ensure employment and guide the careers of loyal troops, is dead, dead, dead.”[22]
These purveyors of “conventional wisdom” are wrong, wrong, wrong.
Long-term profitability depends on the associates’ desire to innovate
and produce. This is possible only
in an environment of trust and cooperation in which the wage earner feels
secure. This has always been true,
but it is even more compelling in the Information Age.
Meritocracy: Democratic capitalist companies are managed by the best and the brightest because all of the associates believe that they can go as far and fast in their careers as their talent and energy can take them.
The commitment to integrity assures meritocracy; meritocracy reaffirms integrity. In democratic capitalist companies, meritocracy is proactive, for the company’s best interest is served when individual potential is identified early, and when opportunities and training are provided for its development. The company wins two ways: It gets superior managers and it keeps the best from leaving the company. The very best people are motivated by self-development, and unless they enjoy opportunities to learn and grow, they will leave.
After Jack Welch took over GE in 1981, GE’s sales and profits went up
seven times. By the turn of the
century, GE was the ninth-biggest company in the world and the second-most
profitable. Meritocracy is a passion
at GE and the key to the company’s effective participation by all.
There’s nothing egalitarian about GE’s human resource philosophy. It finds the best and culls the rest—period. Sophisticated HR systems make sure that no sharp knives stay in a drawer. These include annual self-evaluations and feedback as well as a yearly, company-wide review of talent.
Welch himself reviews some
3,000 people. It’s not pretty, but
Welch thinks a merciless push to upgrade human capital is vital.[23]
Part of Welch’s genius in running GE was his ability to talk like an ultra-capitalist for the benefit of Wall Street, while, in fact, acting like a democratic capitalist in the development of GE talent. His alleged practice of firing those at the bottom, however, is overkill, in my opinion.
By contrast, I had good experience with a “Reverse Peter Principle,” the principle being the theory that people are eventually promoted beyond their ability to perform. In many cases, this is the fault of the person doing the promoting; for that reason, I found that reversing the process worked well by reassigning people to jobs comfortably within their ability. Such moves need the environment of trust, but with the pride factor involved, it may not work in all cases.
The best companies promote
from within as part of their culture. Promotions from within provide new
management with a detailed understanding of the business, a factor easy to
underestimate. Business plans are
built from the bottom up with the participation of all providing opportunities
to evaluate individual performance in both planning and execution.
As all wage earners are owners, they are more disposed to support the
leaders who have been promoted by meritocracy.
The Continuous Process for Quality: A commercial example of the benefits of rigorous truth searching is the evolution of quality levels in manufacturing companies that are striving to be world class. Production rejects at one time were measured in parts per thousand, then in parts per million, but now world competition has pushed quality to such precision that rejects are measured in parts per billion. One who pioneered in this effort was W. Edwards Deming. His emphasis was on quality, and his method was Socratic, probing to get beyond superficial answers. Deming concluded that root problems usually cannot be discovered with fewer than five questions, digging ever deeper for final answers.
Andrea Gabor
described Deming as “the man who discovered quality,” and she summarized his
philosophy as follows:
A holistic vision of
how companies can anticipate and meet the desires of the customer by fostering a
better understanding of “the process” and by enlisting the help of every
employee, division and supplier in the improvement effort.
A process-obsessed management culture that is capable of harnessing the
know-how and natural initiative of its employees and fine-tuning the entire
organization to higher and higher standards of excellence and innovation.[24]
Deming had a single-minded mission to attain perfect quality. While oriented to quality, his organizational philosophy was one of decentralization and empowerment, in fact, democratic capitalism. His search for excellence took him to Japan, after the Big Three motor companies in Detroit decided that they did not need him. Years later, after the Japanese had taken huge chunks of market share away from American companies with cars that took far fewer hours to produce and had dramatically fewer defects, the Big Three got serious and adopted Deming’s principles. GM’s Saturn plant now runs TV ads that show the assembly-line worker empowered to identify a problem affecting quality, hit the button, and shut down the line.
Deming’s “Fourteen Points” call for a new philosophy that breaks down barriers among departments; empowers and trains people to think and act; and encourages cooperation, leadership, and pride in workmanship. Underlying this approach is the premise that a company will invest anything required in training, production equipment, test equipment, and supplier training, assuming an excellent eventual return. Short-term earnings are ignored; customer loyalty, not satisfaction only, is the goal. Deming’s philosophy and specific advice are a significant addition to the library of democratic capitalism. Deming’s points are as follows:
1.
Create constancy of purpose toward improvement of product and service,
with the aim to become competitive, to stay in business, and to provide jobs.
This is captured in the
popular phrase “continuous process.”
2.
Adopt the new philosophy. We
are in a new economic age. Western
management must awaken to the challenge, learn their responsibilities, and take
on leadership for change.
This challenge from Deming was offered years before the extent of the Information Age revolution was recognized. The “new philosophy” refers to the new relationship among associates, management, and capital.
3.
Cease reliance on mass inspection to achieve quality.
Eliminate the need for inspection on a mass basis by building quality
into the product in the first place.
In Deming’s operations, inspectors are not needed because everyone
builds quality into the product.
4.
End the practice of awarding business on the basis of price tag.
Instead, minimize total cost. Move
toward a single supplier for any one item, based on a long-term relationship of
loyalty and trust.
This is the “stakeholder” philosophy, in contrast to
“shareholder” philosophy, that builds a two-way long-term commitment from
the company to the supplier and from the supplier to the company.
Loyalty and trust are synonyms for integrity, the first element in the
template of democratic capitalism.
5.
Improve constantly and forever the system of production and service, to
improve quality and productivity, and thus constantly decrease costs.
This is Deming’s restatement of Adam Smith’s economic dynamic in
which the growth of free markets is self-perpetuating.
6.
Institute training on the job as the prerequisite to empowerment.
The routine elements of the job must be disciplined by training in order
to free individuals to innovate.
7.
Institute leadership. The aim
of supervision should be to help people and machines and gadgets do a better
job. Supervision of management is in
need of overhaul, as well as supervision of production workers.
Deming’s call is for a rejection of the traditional hierarchical,
top-down, feudal organization to be replaced by leadership in a bottom-up
environment.
8.
Drive out fear so that everyone may work effectively for the company.
Leaders, not bosses, drive out fear; full participation through worker
ownership removes the basis of fear; a sense of job security drives out the
greatest fear of losing one’s job.
9.
Break down barriers between departments.
People in research, design, sales, and production must work as a team to
foresee problems of production and in use that may be encountered with the
product or service.
A harmonious whole sounds simple, but many companies engage in internal
turf wars that increase costs and lower quality.
10.
Eliminate slogans, exhortations, and targets for the workforce, asking
for zero defects and new levels of productivity.
Such exhortations only create adversarial relationships, since the bulk
of the causes of low quality and low productivity belong to the system and thus
lie beyond the power of the work force.
The responsibility for improvement of the whole process through
investment in people and things belongs with management, not the workforce.
11.
Eliminate “management by objective” and numerical goals.
Substitute leadership.
Fads like “MBO” targets posted on the bulletin board become jokes
with the workers if the process investment is limited.
12.
Remove barriers that rob hourly workers of their right to pride of
workmanship. Remove barriers that
rob people in management and in engineering of their right to pride of
workmanship.
Superior performance is coupled with elevated spirits of the workers, a
fundamental of the democratic capitalist culture.
13.
Institute a vigorous program of education and self-improvement.
The opportunity for individual self-development through adult education
makes for better worker-citizens.
14.
Put everybody in the company to work to accomplish the transformation.
The transformation is everybody’s job.
Deming completes his advice by coupling individual development with the team environment.
Six Sigma: What is Six Sigma? Is it a statistical measurement system that employs new technology to make every operation measurable and accountable? Or is it a management philosophy that believes in the involvement of all associates to produce dramatic and continuous improvement in the quality of the product and the cost to produce? It is both.
The positive impact on the quality of the product delivered to the customer, and the cost to produce that product, has been in the billions of dollars at companies such as Motorola who pioneered Six Sigma, and
companies such as Allied Signal and GE who adopted it. Led by the two men who developed it at Motorola, Six Sigma is becoming an important part of Information Age business education.[25]
When Motorola pioneered Six Sigma in the 1980s, many thought that Deming
had been made obsolete by a more sophisticated system.
More careful examination, however, shows that Six Sigma depends on the
principles of democratic capitalism and most of Deming’s “Fourteen
Points.” Six Sigma applies
Deming’s simple rule: “Do it
right the first time,” but notably it extends the concept to the large and
growing service industries. The
pioneers of Six Sigma made the following claim:
Most
companies operate at three to four sigma level where the cost of defects is
roughly 20% to 30% of revenues. By
approaching Six Sigma—fewer than one defect per 3.4 million
opportunities—the cost of quality drops to less than 1 percent of sales.[26]
This extraordinary level of performance is dependent, consistent with
Deming’s philosophy, on the corporation’s willingness to spend whatever is
required on training and capital equipment, but Six Sigma is ultimately
dependent on each individual’s participation
in the development of the measurement criteria, and cooperation in
producing superior performance.
Wage Earner Compensation: Profit-sharing, stock purchase, stock bonuses, dividends, and capital appreciation are all additional benefits that accrue to associates when they become democratic capitalists and company owners. Through performance improvements, most wage earners can become wealthy because the potential for improvement is so great. Compensation must be competitive and sufficient to motivate workers to produce and innovate, thereby maximizing surplus. Benefits, including conventional pension plans, must also be competitive in the job market and in addition to the rewards from worker ownership.
If government fiscal policies were aligned to favor
dividends, most worker-owners could receive 6 % annual dividend on their stock.
Dividend income would grow each year from additional stock from payroll
deduction purchases, and from stock awarded as performance bonuses.
Besides this steady dividend income, wage earners could build wealth from
the accumulation of stock with an annual total return of over 10%, a realistic
expectation for a company in which all are involved and contributing to the
improvement of performance. Associates
who use all of their opportunities to build ownership over a career-long period
could become relatively wealthy by retirement, as well as having received
substantial dividends during their work years.
Instead of the traditional zero-sum battle between management and labor,
all gain in a collaboration among all worker-owners. The plan that I designed
and implemented while CEO of ADT, Inc., Care
and Share, demonstrates this premise (see chapter 2).
With this philosophy, management’s job changed from worrying about
whether the workers were working hard, to concern for training and cooperation
among workers. This is the core of
self-supervised groups: Workers help
each other, and as everyone feels responsible for performance, peer pressure is
continuous. The Compensation
Committee of most corporate Boards addresses management compensation only.
Compensation for all employees, particularly performance bonuses and
stock-ownership opportunities, should be a Board and Compensation Committee
responsibility. Compensation
practices will continue to lack internal logic until this governance
responsibility is accepted.
Executive Compensation: CEO compensation is a visible statement of a company’s philosophy, whether of democratic capitalism or ultra-capitalism. To build trust and cooperation, CEO compensation must both be fair and be perceived as fair.
Compensation professionals
grade jobs in a company based on working conditions, skill, financial
responsibility, and educational requirements, as well as potential impact on
performance. Besides the skill and
responsibility criteria, an internal logic should include empirical evidence of
how much of a financial increment is necessary to motivate a person to move up
to the next level. For example, would a machine operator with leadership
potential give up overtime pay and piece-work to take the foreman’s job with
all of its responsibilities for only a 5% or 10% increment in compensation?
Most would not.
The combination of this logic and pragmatic judgment resulted in a structure of job grades with as many as 36 levels. The logic of this structure at the top levels worked well in democratic capitalist companies in which all felt themselves to be parts of the whole, and senior executives were respected. The internal logic of compensation has been abandoned by ultra-capitalists, however, and it has been replaced by the logic of external comparisons to other overpaid CEOs.
Ultra-capitalists care little about a harmonious whole because in ultra-capitalism excessive individualism dominates. The contribution to corporate success by the CEO and a small group of executives is assumed to be greater than the potential contribution of the whole team. Starting in the late 1970s, the multiple of base salary from the lowest wage to the highest went up from twenty-five into the hundreds. Inordinate executive compensation in the United States has resulted in unfavorable comparisons to executives in Japan or Germany, but these comparisons were based on base pay alone. Even more extreme levels of compensation were fueled by the various bonus and stock-option plans that raised CEO compensation to 300 times, or more, of that of the lowest paid.
Compensation consultants rationalized this by upgrading the CEO to “match the market” in order to “attract and retain” top-quality management. Compensation committees were an easy sell: “Matching the market” was a more compelling argument than “internal logic.” Inflation was a reason for large increases when it was double-digit, but when the workforce increases were later held at around a 2% increase because of world competition and low inflation, the top group continued receiving 12% increases because “the universe has shifted,” according to the compensation consultants.
Hundreds of articles addressing the subject of CEO compensation carried such titles as these: “The Boss as Welfare Cheat,” “The Way CEOs Overpay Themselves Hurts the Firms They’re Supposed to be Leading,” and “Executive Pay Compensation at the Top Is Out of Control. Here’s How to Reform It.” A leading executive compensation critic, Graef Crystal, summarized his argument in his title and subtitle: “In Search of Excess, The Overcompensation of American Executives: In the Last 20 Years, the Pay of American Workers Has Gone Nowhere, While American CEOs Have Increased Their Own Pay More Than 400%. This is How They’ve Done It.”[27]
To keep CEO compensation in context within the organization, a plan
should be designed by working backwards from the Board’s agreement about what
the CEO ought to make over a long period for sustained excellent performance.
The CEO of a very successful large company could make up to $1 million a
year in salary and stock bonuses based on a CEO’s earning $500,000 a year,
with a bonus that for top performance could match the base pay in stock. During
a successful term of over ten years, the CEO can add up to $10 million to his or
her net worth. Compensated this way,
the CEO’s interests are congruent with stockholders’ interests, including
those of the worker-owners.
If the stock pays a 6% dividend, the CEO can
reinvest in more stock that is assumed to make steady returns in income and
appreciation over 10% a year. With a
pension of 60% of base pay, this CEO could retire with an annual income of
several hundred thousand dollars and leave his family or charity millions of
dollars in the value of accumulated stock. The congruence of the executive with
the shareholders must be demonstrated by the executive’s not selling company
stock while managing the company. For the average person, this annual salary,
build-up of net worth, and pension on retirement are astronomical numbers. They
can pass the fairness test, however, if all wage earners are becoming wealthy,
the design is based on professionally developed internal logic, and all
associates are part of the same performance improvement plan.
Compare this scenario to the compensation history for the CEO of Bankers Trust. In the 1980s, Bankers Trust had been a proud bank, making money from prudent loans to businesses, and the competent CEO’s compensation averaged less than $1 million in pay and bonuses. The next CEO moved the bank towards ultra-capitalism, tried to make money by trading in futures, and hurt the company with losses and practices that provoked lawsuits by customers like Proctor & Gamble. The CEO after that lost money in 1998, and Bankers Trust was sold to Deutsche Bank AG. This last CEO received a guarantee of bonuses of $10.1 million for each of the next five years.[28] This $55 million reward for failure is not extraordinary in ultra-capitalism; in fact, it is modest by many comparisons.
The greed infection started on Wall Street in the
1970s when the compensation of investment bankers was changed from an annual
advisory amount to a percentage of deals. Merger
and acquisition lawyers copied the investment bankers and departed from an
hourly charge to enormous fees, with no methodology other than their wish to
share in the plunder with the investment bankers.
In time, corporate executives involved in mergers and acquisitions,
encouraged by Wall Street, learned how to reward themselves with
millions-of-dollars, whether as acquirers or acquired.
Analysts responsible for providing an accurate examination of a
company’s performance, were rewarded by investment banking deals with the
company studied. In two decades,
analysts contributions to ultra-capitalism moved their compensation from five
figures up to seven figures. Similarly,
auditors responsible for insuring the quality of earnings were compensated for
selling non-audit services. Partners’
salaries moved up to the millions of dollars-per-year category.
Ultra-capitalism’s demand for a rising stock price soon led to rationalizing CEO compensation on the basis of comparing it to a small percentage of increased market value of the whole company. In most cases, the market value accrued more from “irrational exuberance” in the bull market than from management performance. When the CEO’s compensation is tied to the interests of Wall Street through enormous stock options, the mantra becomes: “Maximize shareholder value and pay for performance,” which translates to “Get the price of the stock up.”
Executive compensation consultants frequently propose new programs that
have been provoked by new tax laws passed by Congressional efforts to do remote
engineering of executive compensation. The
result is a proliferation of new compensation instruments designed to thwart the
intent of the new tax laws. This
contributes to the feeding frenzy at the compensation smorgasbord: base salary,
short-term cash bonus, long-term cash bonus, stock grants, stock options,
phantom stock, stock appreciation rights, performance units, and restricted
stock. Some Board Compensation
Committees love being Santa Claus and want to award their executives all of the
above; most struggle to understand how all of the elements can be integrated
into a fair plan.
A plan for senior executive compensation consistent
with the environment of democratic capitalism would have only three standard
compensation elements: base salary, bonus in stock, and stock grants.
Bonuses in stock instead of cash make the executive a true owner.
Stock options, by contrast, are freebies that are usually piled on top of
cash plans, and they are painless to give because they cause no profit-reducing
effect on the company and no tax consequence to the executive at the time of the
grant. Because corporate executives are not obliged to buy stock with their own
money and hold all stock until retirement, they have little sense of true
ownership. The proposal that executives buy stock, take all bonuses in stock,
and hold all their stock until retirement causes some to complain that the
executives would then be “cash poor,” but cash poor is exactly how a
capitalist should feel, for the willingness to sacrifice in order to invest is
part of an owner’s psyche, particularly if all the other associates are buying
stock through the payroll deduction plan.
Global competition has stimulated the rise in standards of quality and productivity. Many union officials recognize a congruent interest with management in improving quality and productivity, and they cooperate in modifying work practices and converting to performance-based compensation. Excessive executive compensation, however, coupled with no concern for the workers’ job security, is eroding this common ground. Union cooperation is being undermined, and this forces bargaining back to the zero-sum battle. Worker wages and benefits may improve, but worker productivity and innovation suffer.
Executive compensation is influenced by government tax laws lobbied by
Wall Street in cooperation with big companies.
Tax policies need to be corrected in the following ways that will
democratize capitalism:
·
Tax
policies need to encourage executives to buy stock and take all bonus money in
stock.
·
Tax
policies, more than they already do, need to penalize the sale of stock in the
short term but favor long-term holdings.
·
Tax
laws need to encourage the replacement of stock options with stock grants that
require a charge to earnings, that is, a reduction in profits.
·
Tax
laws need to encourage distribution of surplus in increased dividends by
elimination of double taxation on dividends primarily for low- and middle-income
wage earners.
Distribution
of Surplus: A company’s surplus can
be distributed in four ways: investment in more growth, dividends, stock
buy-backs, and acquisitions. The
decision on how to distribute surplus intersects private motives and public
policy. The democratic capitalistic
distribution of surplus is reinvestment in growth and large dividends.
The ultra-capitalistic distribution of surplus for short-term personal
gain is stock buy-backs and non-strategic acquisitions. Why, then, do tax laws
favor stock buy-backs and non-strategic acquisitions? Too many hints have
already been provided: The answer is that public policy is determined not for
the general welfare but based on the lobby power of Wall Street.
Although
the tax laws clearly need to be changed to align them with the public interest,
the distribution of surplus should also be an important part of corporate
governance. The Board of Directors as representatives of the shareholders need
to review the policy regularly and approve this distribution.
Management is responsible for maximizing profits, but they should not
have exclusive authority over use of the surplus.
Evidence in support of this proposal can be found in the hundreds of
billions of dollars wasted during the last quarter of the 20th
century on stock buy-backs and non-strategic acquisitions by ultra-capitalists.
Institutional
investors have a fiduciary responsibility to influence both corporate governance
and government fiscal policy in order to move from the stock buy-backs and
non-strategic acquisitions of ultra-capitalism to the reinvestment in growth and
large dividends of democratic capitalism. This simple clarification of mission
will have a profound effect on economic growth and the ability of the government
to provide consistent assistance for good education and health because it will
replace the boom/bust economic cycle with strong, steady growth.
Measurement and Accountability: A company’s long-term performance is most accurately measured by adding sales growth and cash flow to earnings per share. Sales growth measured against a three-year plan demonstrates how well a company is managing its future. Cash flow measured against a three-year plan demonstrates how well resources are being managed and is an early indicator of trouble. Strong cash flow distributed in dividends also demonstrates good management in both fast- and slow-growth companies.
Enron demonstrated, among other things, the damage caused by concentrating exclusively on quarterly and annual e.p.s. (earnings per share). Companies have been rewarded or penalized in the billions of dollars by Wall Street for producing, or not producing, a few cents in e.p.s. This simplistic passion for this imperfect measurement has driven ultra-capitalism, and, with the help of institutional investors, it has extended Wall Street’s domination of the economy.
The accountability period needs to be at least three years to encourage innovation. An annual budget tends to extrapolations because time is too short to reflect the subsequent profit benefits from aggressive first-year investment. Annual budgets reflect overt or covert guidelines that contradict the philosophy of decentralization. In ultra-capitalism,
budgeting guidelines in public companies are affected by Wall Street analysts’ expectations, and they tend to limit investment in long-term growth.
A company’s budget for multi-location operations is frequently imposed in a more top-down fashion than managers like to admit. Budgeting instructions to the “decentralized” units are frequently contradictory, asking for “your plan” but with an 8% profit-improvement “guideline.” Sponsors of new products or markets, sensing limited funds for expansion, tend to understate the resources needed in order to push a project ahead. The negative result of this is the failure of many growth programs, not because the idea was bad but because the resource allocation was inadequate.
In ultra-capitalism, the original mantra was “Just give me the numbers,
dammit,” with the implication that the senior officer did not care how it was
done. Financial officers became
heroes for their “creativity.” At the beginning, they had their
“drawers” in which they hid extra reserves taken from such items as bad
debts and inventory write-offs to be dipped into to “smooth” earnings in a
quarter that was below expectations. In time, the pressure for constantly higher
e.p.s encouraged creative CFOs and managers to increase sales and profits by
shipping products to a warehouse, or special deals for customers to take
material they did not need until later. The only constant was the necessity to
meet e.p.s. expectations, and when that could not be accomplished by more
traditional tricks, many resorted to illegality.
By contrast in democratic capitalism, the control system is based on integrity and decentralization. The first three elements of the template—integrity, maximum freedom, and minimum structure—are the guidelines for designing a management control system that provides freedom for associates to make their maximum contribution. The control system is simple because it is designed for and by worker-owners to measure the vital aspects through cooperatively established standards, that is, the agreed-upon benchmarks against which performance is measured. The planning process is reiterative, starting with sufficient freedom to encourage independent and creative thinking, then proceeding through the negotiating stages among levels of management, concluding with a demanding but realistic plan.
Budgeting control systems have evolved from management information systems (MIS) into information systems (IS) that recognize worker involvement. With workstation computers, IS provides online information that affects scheduling, workloads, inventory, staff availability, and machine capacities, allowing teams to supervise themselves. Information technology is a powerful tool for decentralization and empowerment but only when integrated within the democratic capitalist culture.
Democratic capitalism’s control system begins with a belief in people
and their enormous potential to do better, not with the “gotcha!” principle.
Most control systems are not built on the assumption of integrity.
Instead of operating on the exception principle, that is, identification
of deviations against an agreed-upon norm, top-down systems try to micromanage
with over-designed control methodology. An
over-designed control system contradicts the philosophy of democratic
capitalism, it can fail to control from the information overload, and it can
suffocate individual productivity and innovation.
A minimum, decentralized structure is based on the assumption that
well-trained and involved people with competent leadership are pursuing a clear
mission and need a minimum number of reported deviations over the longest
possible time. The control system, however, must be sophisticated enough to
protect against significant risk, that is, while the people are individually and
team responsible, an audit process, both financial and operational, is also in
place that regularly reviews and confirms the integrity of the process.
Decentralization: The broad-based control philosophy of democratic capitalism is to delegate responsibility, authority, and accountability to the level closest to the work. In a decentralized structure, people are responsible for performance and results, measured by a plan that they have helped to formulate. They are neither suffocated by detailed rules and regulations nor measured by standards imposed top-down. This is an essential difference between industry and government, and it spells the difference between high productivity in commerce and the unmeasured and unaccounted for high cost and repetitive errors of government.
The environment of integrity makes fact assimilation easier, but it must
still be supported by effective fact-assimilation. In complex, fast-changing
circumstances, facts can be assimilated more easily in a decentralized structure
than in a centralized one. During
the second half of the twentieth century, clarifying this phenomenon was one of
the many contributions of Friedrich Hayek (1899-1992)
[29] who
persistently argued the superiority of “spontaneous order” over central
control, although the momentum towards centrally planned society was so great
that Hayek’s argument
was treated as heresy. In his last book, written in 1988 when he was 89, Hayek
restated his argument for spontaneous order:
To
the naive mind that can conceive of order only as the product of deliberate
arrangement, it may seem absurd that in complex conditions, order and
adaptations to the unknown can be achieved more effectively by decentralizing
decisions, and that a division of authority will actually extend the possibility
of overall order, yet that decentralization actually leads to more information
being taken into account. This is
the main reason for rejecting the requirements of constructivist rationalism.
For the same reason, only the alterable division of the power of disposal
over particular resources among many individuals actually able to decide on
their use—a division obtained through individual freedom and several
property—makes the fullest exploitation of dispersed knowledge possible.[30]
At the turn of the century, the benefits of decentralization were a
starting premise in books on “continuous process,” as Michael Hammer
described:
The
transition to process-centering does not occur in the rarified atmosphere of
corporate boardrooms. The real
action is on the front lines, where people who do the real work of the business
redirect their thinking and change their behavior.[31]
Aided
by Information Age technology, decentralization not only is necessary for
empowerment of the people but also is the most effective way to assimilate
complex, fast-changing information. Because much of the information in play is
used at the working level and stays there, only a minimal amount need be chosen
to be reported to another level.
A Supportive Finance Capitalism:
Adam Smith specified that the success of free markets depends on money that is
ample, low-cost, non-volatile, and patient. Smith also warned that speculators
would deflect capital away from growth, and make money scarce, high-cost,
volatile, and impatient. Smith defined the mission of finance capitalism as
helping companies grow, offering advice, and lending money that meets Smith’s
criterion of neutrality while avoiding damage from speculators.
Investment bankers
traditionally helped with long-term financing, providing new equity by offering
stock or long-term bonds. Commercial
banks also provided short-term, working-capital loans for seasonal needs.
British merchant banks took ownership positions in companies as well as
lending them money. Had a similar
policy of coupling short-term loans with long-term equity investment been in
place in 1997, the Southeast Asian disaster might have been prevented
because banks would have protected their long-term investment by limiting their
risk on short-term loans.
The mission of finance capitalism changed during the last quarter of the
twentieth century when commercial bankers and investment bankers alike converted
from banking the old-fashioned way to trading in futures, making deals for
enormous fees, and offering easy credit for hedge funds and high-risk projects.
The money made from these activities dwarfed advisory fees and moved supportive
finance capitalism towards dominant ultra-capitalism.
With hundreds of billions of dollars of pension and 401(k) money pouring
in, Wall Street became the leading
edge of ultra-capitalism. The
bankers were energized by deals and speculation, and the institutional investors
felt that their fiduciary responsibility was emphasis on short-term earnings
and, in effect, support of ultra-capitalism.
Corporations split into two groups: those few companies, big and small,
that were so good that they could both grow the business and keep Wall Street
happy, and the majority who were forced to subordinate business plans to the
expectations of Wall Street (see chapter 8).
Some companies have reintroduced retainers into their relationship with
investment bankers, instructing them that the scope of their annual advisory fee
covers all potential deals and is related to hours spent on task. Advisory fees
have an expectation of creativity and, occasionally, long working hours, but
they are premised on a willingness to pay for good service.
Many companies disenchanted with Wall Street, however, have now decided
that investment bankers frequently add little value, and that in-house company
staffs can do the work as well and save money besides.