Why Public Companies Can't Be Lean

        

    There is an article written by Sally Blount, the Dean of Northwestern’s business school, in BusinessWeek that is curiously circular in its logic, but really gets to the heart of why publicly traded companies rarely realize the potential lean principles and philosophy has to offer; and why the few that do rarely sustain.

    On the one hand Ms. Blount argues that the world needs more MBA holders, asserting that “Business has evolved to be the dominant social institution of our age. Business is the cultural, organizational, and economic superforce in human development.” Folks with MBA’s presumably are the experts in this cultural and economic “superforce”. She’s got that right. Business can and does change everything. Sometimes a business brings about great improvement in the quality of the lives of the people connected with it; and sometimes it is the driving force that results in hundreds of Bangaldeshi women burning to death. Business is not inherently good, nor is it inherently evil. It just is, and whether it helps or harms the people it touches depends entirely on the decisions and actions of those in control of it.

    The circularity of Ms. Blount’s argument lies in the fact that, on the one hand she urges more MBA’s, but on the other acknowledges that “Today’s predominant business models drive public companies, for instance, to focus on predictable, short-term shareholder returns that may be detrimental to employees, communities, or the broader social good. They also fail to motivate industries to reduce their environmental impact.” Why she thinks we need more people who are proficient at doing things that are “detrimental to employees, communities, or the broader social good” is a mystery.

    Publicly traded companies are owned by what the Pope referred to as “anonymous funds”, and he is right. They are owned by and large by people who have put their money into the business – or into the fund that, in turn, put it into the business - for the purpose of realizing a short term gain. The sole motivation of such investors is, in fact, a relatively short term return. They have no personal or emotional interest in even the industry, let alone the individual firm in which they invest. They are just as willing to invest in a candy company as they are in a defense contractor. Their investment is based on the timing and probability of the potential return. What happens to the firm after they have realized that return (or not) and withdrawn their money is of no consequence to those investors. For that matter, if the firm destroys itself in order to generate a return for such an investor is perfectly acceptable to that investor because, again, what happens to the firm next really doesn’t matter.

    Of course, people have other avenues for investment. If they wanted to invest for the long term, or if they define their return in terms of broader social benefit, they would invest in something other than a publicly traded firm. They could invest in a local entrepreneur, for instance, or buy a stake in a local, privately held form if such a stake were for sale. Or they could put their money into a non-profit to have it generate social improvements. But no right minded investor puts his or her money into a Fortune 500 firm because they want to save the environment or improve the workaday lives of women in Bangladesh. There are other, better places to put their money to achieve such purposes.

    And even the investor whose goal is to realize long term gains – for retirement, as an example – has no reason to invest it in only one company to reach such goals. Rather, that investor is more likely to engage an expert to continually move the money from one firm to another as economic cycles and the prospects for one company or another rise and fall in an effort to string together a long series of short term gains.

    Because the owners of a publicly traded company at any point in time don’t care whether the other stakeholders – employees, customers, suppliers or the communities in which the business happens to be located – gain or suffer; and, indeed, they don’t even care if the business itself is completely destroyed after their investment is pulled out, the managers engaged to run the business for them have a very well defined objective: to maximize their short term gain. It is certainly not to spend it on the welfare of other stakeholders even if they believe that to do so might actually result in greater returns over the longer term. For those managers to the investors’ money and append it on any other objective than to create the greatest short term returns is at the very least missing the point and actually tantamount to fraud – taking investors’ money under false pretenses.

    The basic economic underpinning of lean is quite the opposite. It is built on the idea that, rather than look for ways to take advantage of stakeholders for short term gain, it is better to engage and support them. While this can and often does harm shareholder returns in the immediate term it will create far greater returns for them over the long haul.

    Keeping employees on the payroll even when there is no work for them is a perfect example. It directly harms the current level of profits, but it avoids having to hire and train new employees when the work returns, and it improves the morale of the employees, driving greater long term productivity levels. The person whose investment interest is the long term success of that particular company is often willing to make such a decision. The person who has invested in stock with an eye toward short term gain is not. They would prefer to lay those employees off and avoid the immediate expense. Any greater cost resulting from such a decision that the company might have to pay down the road when those employees must be rehired or replaced is not their concern since their investment will most likely be elsewhere by then.

    The same is true of partnerships with suppliers or customers. Replacing suppliers with cheap, off shore ones, or pushing price increases on customers may well be destructive in the long term, but beneficial in the immediate term. Those are often unacceptable outcomes for the owner committed to a business for the long term, but actually the preferred courses of action for the owner who will not be around to pay for the long term consequences.

    Privately held companies are very good at creating value and creating wealth. That is normally a long term endeavor. It requires ownership that is willing to be patient and endure short term losses. It often involves breaking even for a long time while the gains of the business are continually reinvested. Publicly held businesses are not good at such wealth creation. Rather, they exist largely to exploit and ultimately consume the wealth created by the founder of the business. Exploiting and consuming wealth is what the owners of those businesses – the short term investors – want the managers of the business to do. Business schools, for the most part, crank out kids with MBA’s trained quite specifically to do this.

    So back to Ms. Blount. She bemoans “We need leaders who fully grasp that markets, while highly efficient, are not fair, kind, or wise. The prevailing market price, while efficient, is not inherently just—it can, in fact, be rather cruel: for example, when a large retail chain comes to a town, forcing small businesses to close. We need leaders who are ready to confront the challenges of growing income inequality, unemployment, environmental impact, and cultural homogenization that current business practices do not yet adequately address.” She is essentially saying that we need leaders steeped in lean principles, but she fails to realize that publicly traded businesses are not at all interested in hiring such people because that is not at all the purpose or mission of those businesses.

    Expecting the manager of a publicly traded company to invest time or investors’ money in the long term greater good of the other stakeholders in the business is akin to expecting the local ice cream parlor to sell you an oil filter for your car. It is silliness, foolishness; it completely misses the point of the business’ existence. And that is why the only time you see a big company embrace anything deeper than lean tools is in those rare instances in which the stockholders of the business are unavoidably bound to it for the long term. When you invest in Toyota – a publicly traded company – you are realizing the gains resulting from forty years of little or no profits while they operated outside of Wall Street. Ford outperforms GM and Chrysler because the family controls the company. GM cannot and will never operate in a similar manner or get similar results simply because it is not designed to do so.

    For the academic, consultant or employee of a publicly traded company: Don’t waste your time trying to convince the owners or management of the company to embrace lean thinking. It’s not their purpose to do so and it is never going to happen.

     

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