The rate of profit does not, like rent and wages, rise with the prosperity and fall with the declension of the society. On the contrary, it is naturally low in rich and high in poor countries, and it is always highest in the countries which are going fastest to ruin.
Adam Smith, “The Wealth of Nations”
If you live and work in the U.S. today, you don’t need to read Adam Smith to know that something is out of synch in our economy. Corporate profits and stock prices are breaking records. At the same time real wages for most workers are flat or declining. Mass layoffs are the headlines of the day: 10,000 at GTE Corp. 40,000 at AT&T Corp. 50,000 at Sears Roebuck and Co.
Corporate executives say the pain is inevitable because firms today operate in a chaotic world of global competition and fast-changing technology. They speak in terms of “shifting paradigms” and creating “virtual organizations.” At AT&T, for example, no bones are made about the goal of developing an entirely new employment culture. James Meadows, the firm’s vice president, told The New York Times that AT&T is trying to “promote the whole concept of the work force being contingent.” He called it part of a larger move to a society that is “jobless but not workless.”
As a business professor, I hear the same themes from managers with whom I have contact. They want to have as little tied to the firm as possible, be it permanent employees or fixed assets. The firm must float free to seek new opportunities-in new geographic markets, new technologies, even new lines of business.
Thus the need to cut bureaucracy and shuffle people: The goal is a lean, flexible organization of empowered employees, working in teams to be innovative and responsive to changing customer needs.
But if you look inside American firms, as I and other researchers have done, you find a disturbing paradox. The very qualities that many executives say their firms need in order to compete-flexibility, teamwork, innovation, etc.-are in fact being destroyed by the organizational culture they’re creating.
Advocates of this new culture of “permanent restructuring” and “contingent workers” see great savings but don’t count the costs. And here I am not talking about the well-documented human costs, such as employee dislocation and financial distress. Real damage is being done to the ability of our business firms to compete and succeed over the long run.
This paradoxical behavior inside the firm is connected to the larger paradox in our economy-the boom in the stock market while other measures of economic prosperity lag. It should come as no surprise that the stock market has been booming, since that’s where managers have focused their attention. For a variety of reasons, our firms recently have emphasized maximizing returns to the shareholder.
The typical U.S. firm, much more than a firm in, say, Japan or Western Europe, now views itself primarily as an investment mechanism-a sort of free-floating entity that seeks to maximize profits, adding and dropping people as needed. This view has been emphasized to such a degree that it amounts to a basic redefinition of what the firm is. And this new definition, with its narrow and short-term focus on today’s stock price and this quarter’s earnings, is bad not only for the long-term interests of the “restructured” firm but also for our larger society.
The investment-mechanism view ignores the fact that a business firm is a social organization. A firm is social first in the sense that it is a complex network of ties between people. It runs on intangible factors like continuity and trust. Current restructuring efforts, based on the investment-mechanism model, give little thought to such factors. This puts our firms at a disadvantage against many foreign competitors, which give great care to harnessing the “social capital” of their companies.
The firm is also a social organization in the sense that it is a dominant institution in our society at large. Indeed, with the possible exception of churches, it is the most pervasive form of social organization we have. Business firms, and our places within them, are the sources of livelihood and personal identity for most of us. Not only is the work of America done within corporate firms, but firms decide what kinds of work shall be done here-what kinds of widgets to make, or whether to make widgets at all.
Business firms play a key role in shaping our future, especially now that government funding for scientific research is being cut back and more research and development is corporate-funded. They play a growing role in many areas, as government services are privatized. Business firms now run prisons. And grade schools.
In short, we are giving business firms a larger role in society while they are defining themselves more narrowly than ever. And we are counting on them to be healthy institutions while they’re behaving in ways that threaten their long-term health.
In the current investment-mechanism model of constant restructuring, jobs are cut even when the firm is wildly profitable. More work is contracted out as an ongoing policy. The fundamental view is that people are interchangeable and the ties between them fungible.
Oddly, this model is being imposed at a time when experts agree that the quality of the work force is more important than ever to the success of the firm. The business consultant Peter Drucker talks of the growing importance of “knowledge workers”-people who work with and “add value” to information, instead of (or along with) handling material things. And as management professor Jeff Pfeffer at Stanford University has noted, technology and investment capital are eroding as sources of competitive advantage. Technologies are more transferable than ever before, shortening the period of advantage the investing firm realizes from them. Many crucial technologies such as new business software are quickly out there on the market for any firm to buy and use. Capital is more widely accessible, too.
That leaves human resources-the possession of a group of smart, skilled people who work well together-as a prime source of competitive advantage. “People are our most important asset,” business firms declare in their public relations campaigns, and current thinking among management scholars affirms it.
But how do we reconcile this with an employment philosophy that views people as disposable, interchangeable parts? Firms aspire to a knowledge-worker model, yet they’re operating by a cheap-labor model. I call it Japan aspirations with Guatemala work practices.
The new culture is at odds with the realities of daily life inside the corporation. According to Charles Heckscher, “All of this restructuring and downsizing has actually reinforced corporate bureaucracy instead of eliminating it.” Heckscher, chairman of the labor studies department at Rutgers University, spent five years studying corporate empowerment programs. He found the efforts negated when downsizing wipes out the informal communication channels that evolve in any large organization and that are often the real channels for getting things done. As a result, people “no longer have the network of trusting relationships so crucial in the past,” Heckscher said. “They cope by withdrawing into a narrow world, putting their heads down, getting by, waiting it out.”
Despite the lip service paid to employee “empowerment,” extensive field observation has confirmed what employees already know: No one feels empowered with an ax over his head. Last year, International Survey Research Corp. of Chicago conducted a poll of 350,000 workers nationwide. The poll found that 49 percent worried about losing their jobs, up from 20 percent in 1990.
All this worry is creating a “me-first” culture that impedes employees’ abilities to work cooperatively and creatively. And the me-first attitude carries beyond the company that is restructuring. It gets exported along with the people who are let go. In my research over the last 10 years, my colleagues and I have tracked professionals and middle managers who were laid off, then subsequently re-employed. These are the supposed success stories of restructuring-the ones who found new jobs and landed on their feet. We found that even through they were re-employed, they continued to spend an enormous amount of time looking for new jobs. They had learned to look out for No. 1, not for the company.
Managers also like to think restructuring creates a high-energy atmosphere that will spur innovation and creativity. But mostly it creates a high-stress atmosphere, and the notion that “people do their best work under pressure” is true only to a point. Numerous studies have shown that each person has an optimum level of stress. Up to that level, thinking is stimulated as the juices begin to flow. Beyond that level, cognitive dysfunction sets in. People make simple errors in reasoning. They fall back on reflexive patterns of thought and behavior that may not be appropriate and are anything but creative in nature.
If your business, like most, requires satisfied customers in order to be successful, downsizing poses very real risks. “What your customer experiences in your bank is directly related to the way you treat your employees,” Alan Silberstein, executive vice president at Midlantic Bancorp, told American Banker last year. The magazine went on to note that Silberstein “should know. A bad loan portfolio pushed Edison, N.J.-based Midlantic to the brink of failure. The bank laid off 2,000 employees as part of a major restructuring in 1993. Employee morale sank, and customer runoff was rampant.” Midlantic now has been acquired by PNC Bank; more layoffs are expected.
Contract workers in a “jobless but not workless” economy may provide a ready pool of just-in-time talent for a corporation to tap into. But in many knowledge-worker functions, a good deal of benefit accrues from having people with “firm-specific” knowledge-people who really know the products, the customers, the way the firm operates and the other people in it. It takes time and money for a firm to impart this kind of knowledge. It takes time and effort for people to acquire it. And much of this knowledge is not transferable. You can’t walk into the First National Bank of Chicago and start doing things the way you did them at Nation’s Bank; you’ve got to learn your way around.
In an economy such as ours is becoming, firm-specific knowledge is constantly being acquired and dissipated. In American firms today, people spend a lot of energy adapting, as distinct from working and innovating. Then they go out to compete against a world where business is practiced very differently.
At my management school, part of my job is to teach working executives in a variety of professional-education programs. Many of the students are mid- or high-level managers from overseas firms, who come for the special programs we’ve designed to teach them about American culture and business methods. They are enhancing their firm-specific knowledge with country- specific knowledge. They will then use this knowledge to sell their products here in the U.S., to negotiate strategic partnerships here in the U.S. and to manage plants that their firms locate here in the U.S.
A single overseas firm may send dozens of its people to my school for a program of this sort that lasts for months, and we are only one of many U.S. business schools offering such programs. These overseas firms are making a tremendous investment in their employees, actively developing human resources for competitive advantage. It is rare for a U.S. firm to do the same thing in reverse-to send dozens of its executives to a school in Asia or Europe for an extended educational program.
The overseas executives I teach do not question the value of investing in employees. Nor do they hesitate to commit their own time to learning what the firm wants them to learn; they plan to be with the firm for a long time. As one Korean manager told me, “we do things differently; we stay in one place.”
The American executives I teach are often quite different in their approach. They’re looking for skills they can apply immediately. They tell me that “we need our answers today.” And they like skills that are transferable. They believe that anyone can manage anything, a message they get straight from the top: The CEO of Westinghouse Electric came from Pepsico; the new marketing director at General Motors came from Bausch & Lomb. If you can sell contact lenses, surely you can sell cars in a fiercely competitive global market.
The MBA students, our next generation of executives, are well attuned to the “new realities” of the job market. Many expect to have multiple careers. The new state-of-the-art MBA curriculum at my school is loaded with options, so they can learn a lot of different things, to facilitate hopping around.
What is not in this mix-either in the management schools or out in the workplaces-is a focus on developing people who are going to look out for the long-term good of the firm. And that may be the greatest cost of all.
It is easy for executives to ignore the hidden costs of restructuring because there is an immediate reward: Their firms do well in the markets. But not necessarily in the markets in which they trade their goods and services. Instead, restructuring means success in what has become the “real” market: the stock market, which frequently rewards layoffs with a boost in the stock price. When AT&T announced its massive cuts in January, its stock shot up nearly three points in one day. James River Corp. announced 4,400 job cuts last July and its stock price jumped 25 percent overnight. Ameritech’s stock rose five points within a week of its announcement of 1,500 layoffs.
The traditional view of the firm says that corporations have many constituencies: the stock owners or shareholders, the customers, the employees and the community (or communities) in which it does business. These groups are typically called “stakeholders”-people who have a stake in the firm-and as recently as 10 years ago, when I started teaching MBA students, there was a great deal of talk about how firms could serve all of them.
But that has all changed. Now we have Albert J. Dunlap, former CEO of Scott Paper Co., telling Business Week: “Stakeholders are total rubbish. It’s the shareholders who own the company.” Today, as Labor Secretary Robert Reich complains, firms tend to view themselves as “the agent of the shareholder alone.”
The pressure to boost stock performance, and do it quickly, has grown for several reasons. For one thing, shareholders don’t hold their shares as long as they used to. More than half of the stock of an average U.S. firm now changes hands in less than a year. Much of this churning is because a larger proportion of stock today is held by mutual funds, which compete with one another for investment dollars. Constantly pressed to seek high returns, fund managers buy and sell large blocks of shares-using modern computer-based analysis and trading systems to do so-and their impatience gets passed along to the managers of the firms whose stocks they are trading.
The “shareholder rights” movement of the 1980s and ’90s is another factor. Every firm is overseen by a board of directors elected by the shareholders. In the 1980s, large investors began a push to make it harder for the CEO to pack the board with his or her supporters, and generally demanded more attention to shareholders’ interests. The movement emerged at a time when labor unions were waning and government was taking an increasingly “hands-off” approach to business; thus shareholders became the squeaky wheel that got greased.
Defenders of the focus on short-term share price reject the concern that playing to the stock market hurts companies in the long run. They argue that market analysts value a stock based on the firm’s potential performance over the long term, so rising stock prices must mean that our firms are building fundamental strength. They argue that there is a trickle-down payoff for the whole economy: By keeping the firms’ shareholders happy, Scott Paper’s Dunlap explains, “We’re encouraging them to invest, to build new plants and create new products. At the end of the day, that will mean more and better jobs down the road.” Mutual funds and pension funds, moreover, have become the access point for people who would not otherwise invest in the stock market. Thus, more of us benefit from rising stock market returns.
The problem with these arguments is that they do not always describe the real behavior of firms or investors. Although in theory stock prices reflect a reasoned judgment of future prospects, they can jump about wildly in response to auguries and opinions. Last year, the stock of Weirton Steel Corp. lost about one-fourth of its value in a few days after one steel-industry analyst, Peter Marcus, lowered his rating of Weirton from a “buy” to a “hold.” Had the company been grossly overvalued before? Or was it now grossly undervalued?
We don’t seem to be realizing the presumed trickle-down value of soaring stock prices either. Firms seem to be making more of their new investments in offshore ventures or in buying and selling one another rather than in building new facilities with new jobs here in the U.S. Moreover, few of us have enough invested in stocks to carry us through a period of joblessness or to make up for years of stagnant wages. And when an employee’s defined-benefit pension plan does well, it’s the corporation rather than the employee who realizes the gain; Polaroid hasn’t contributed to its pension plan for years because its stock portfolio is doing so well.
And as to the whole arrangement leading to wise long-term planning, the growth in the power of the fund manager may be having the opposite effect. Fund managers are starting to personally sway decision-making by corporate CEOs. As Michael Useem of the University of Pennsylvania’s Wharton School of Business has noted in his research on the “shareholder value” movement, executives must now answer to fund managers after-and often before-strategic decisions are made. Now we have the spectacle of a CEO-who in some cases has been recruited, at high salary, from another industry, and may not know his firm very intimately-being advised by someone committed only to maximizing short-term performance.
And this is the essence of the problem. When the stock market is the “real” marketplace, it becomes the primary arena of competition. Other measures of the health of the firm become secondary, if not irrelevant. A firm like Westinghouse Electric, for example, used to consider itself as competing with other electrical-equipment makers such as General Electric, and it gauged its performance accordingly. On the stock market, though, it also “competes” with the stocks of any other kinds of companies an investor might buy, such as entertainment companies and financial-service firms. Some of those industries, due to their nature, have typical profit margins that can’t be achieved in electrical manufacturing.
So what emerges is a business that is left “competing” with the types of business that happen to be most profitable. The only alternatives are (a) to cut costs drastically to try to drive up your operating margins or (b) to go into those lines of business yourself.
Westinghouse has tried both. It sold off most of its manufacturing businesses-electrical transmission equipment, transportation systems, defense electronics and more-while moving to high-margin businesses such as dfinancial services (a move that nearly sank the company when a speculative loan portfolio went bad) and television.
Some of the moves no doubt were motivated by sound business reasoning. But the end result is that a firm that just a few years ago was hailed on the cover of Fortune magazine as a paragon of our new industrial strength is now a shadow of its former self.
Strategies like these create a situation where acting in the interests of one stakeholder-the shareholder-means acting against the interests of others such as employees. And when one stakeholder dominates the attention of managers, as shareholders now do, the old aphorism that “what’s good for General Motors is good for America” no longer applies.
Too many discussions of corporate restructuring are permeated by an air of inevitability and resignation. When executives announce layoffs, for example, they often say they are only “responding to market forces.” It is not that they want to ruin people’s lives, much less endanger the productive capability of the firm. Rather, they say that forces beyond the control of the individual employer have made it necessary (and profitable, at least in the short term) to undertake drastic restructuring. In a variation on the old Flip Wilson line: The market made me do it.
Some of this, of course, is mere blame-shifting, and as public anger grows, the blame-shifting becomes more ingenious. Perhaps the classic “what’s-a-poor-company-to-do?” argument came recently from re-engineering consultant Michael Hammer. In a Wall Street Journal essay titled “Who’s to Blame for All the Layoffs?” Hammer blamed the customers. By demanding higher-quality goods at lower prices, he said, customers leave corporations no choice but to restructure. One paragraph began, “It is Ralph Nader who bears some of the responsibility for the triumph of the customer at the expense of the employee.”
Hammer concluded his essay by pointing out (correctly) that each of us is both a customer and a worker, and writing, “We are at war only with ourselves.” This is true, but only in the sense that it is always true. Each of us always has conflicting needs and desires; there are always conflicting agendas in society at large. These conflicts are to be managed. It is wrongheaded to assume that the only way a firm can see fit to take care of one constituency-be it customers or shareholders-is at the expense of another.
Corporations sometimes unfairly blame markets (or Ralph Nader) as an excuse for their actions. But corporations are not charities. They are self-interested, profit-making institutions. All the hectoring in the world about the costs of downsizing and the legitimate needs of stakeholders other than Wall Street means nothing unless the corporation’s managers view addressing those concerns to be in the firm’s self-interest. This is not a criticism of corporations or a denunciation of their spirit. That is how a free-market system works and how it is supposed to work.
This does not mean, however, that corporations must remain captive to the logic of Wall Street, which seems to applaud every time stiff restructuring methods are undertaken. Corporations make their self-interested decisions, whether wise or foolish, in the context of the society in which they operate. If Wall Street or any other single stakeholder has acquired a monopoly on the allegiance of corporate America, we must structure the rules and incentives so that business firms will behave in ways more suited to the broader social interests they serve.
There is nothing radical about this. At other times we have moved to limit the power of other stakeholders-and to free corporations from their undue influence-when a political majority deemed it necessary. In 1947, for instance, the ability of labor unions to engage in crippling secondary boycott strikes was sharply limited by the Taft-Hartley Act after the perception arose that labor could use this weapon to unduly influence the decision-making of corporations. A current example is the call for tort reform, which, if enacted, would protect corporations from one of the consumer’s most potent weapons: the punitive damages lawsuit.
We take steps to change the laws, to regulate the context in which business is done, because we believe it is good for us collectively-not because it is good for the corporation. The free-market system works by permitting self-interested entities to seek profits. But self-interest is not society’s goal; it is the means. The goal is the collective good of society. The wealth of the nation.
It is because society is supposed to benefit from the dynamism of a free-market economy that we have corporations at all. As Secretary Reich pointed out, “The corporation is, after all, a creation of law; it does not exist in nature.” We pass laws to allow for very unnatural concepts such as limited liability and bankruptcy-which permit individuals to invest money, fail to meet their obligations to others and yet protect their personal assets from creditors-because we believe these regulations of the marketplace serve us all. When self-interest is leading corporations to harm themselves and neglect the interests of their many stakeholders, it is time to rethink the context in which they operate.
For too long federal policies and proposals have actually worked with the trend toward a fragmented economic structure tilted to favor the stock market. An example is the Clinton Administration’s recent push, under the banner of health care reform, to make employee benefits “portable.” It is a good-hearted proposal, meant to protect those who lose their jobs, but it is an acquiescent adaptation to the supposedly immutable reality of the new “jobless” economy. The federal government ought to be trying to reverse this tide, not aid it.
There are signs that government leaders sense the crisis and are moving in a new direction. Reich, earlier this year, suggested the idea of using corporate tax incentives to encourage firms to invest in U.S. facilities and retain U.S. workers: A firm that did enough of these things would pay no corporate income tax. Other critics of the current system-such as consultant Frederick Reichheld, the advocate of “loyalty-based management”–suggest that more firms should escape the pressures of Wall Street by taking themselves private. Still others point to employee ownership as a way of breaking Wall Street’s hold. When employees own a controlling interest in the firm, taking the long view, rather than looking only at the short term, can become not just possible but also desirable.
Such ideas are a step in the right direction. It may well be time for a redesign of the corporate charter. Our corporations-the greatest social instruments we have, the source of the wealth of this nation-are in crisis, and it is time to reshape them. The real restructuring is at hand.
