Measuring the contribution of good management
Fri 16 Apr 2010 by David Grimmond.

A recently published paper provides insights into how management practices contribute to variation in business performance between countries.1Nicholas Bloom and John Van Renan have conducted a study that investigated the relationship between management practices and business performance in 5,850 middle sized firms (100 to 5,000 employees) in 17 countries.   Although their study did not include New Zealand it still offers a number of insights that are likely to be relevant here.   Bloom and Van Reenen construct a measure of management performance based on firm responses to interviews that rated the sophistication of management practices in three broad areas:

Monitoring how well do managers monitor what goes on in their firm and to what extent do they use this information for improving operations?

Targets do managers set challenging but achievable targets for implementing their medium-term strategies?

Incentives are managers promoting and rewarding employees based on performance, and trying to hire and retain good staff?

These results were then used to generate numerical management scores for each firm and then compared with independent information about firm performance.   They found that firms with "better" management practices typically also have better performance on a wide range of dimensions: they are larger, more productive, more profitable, have faster sales growth, and have higher survival rates.

Management practices varied considerably between firms and countries.   On a cross-country basis, United States based firms had the highest management practice scores on average.   This was followed by Germany, Sweden, Japan, and Canada, which had similar scores.   Then came a middle block of mid-European countries (France, Italy, the United Kingdom, and Australia).   At the bottom of their sample were southern European countries like Portugal and Greece, and the emerging economies of Brazil, India and China.

The ordering of these countries is also similar to the ordering of their relative incomes.   The graph presents a cross plot of the Bloom-Van Reenen country average for management performance (vertical axis) with estimates of each country’s GDP per capita in 1999 (horizontal axis). [2] There seems to be a strong correlation between average management performance and overall economic performance.   Based on New Zealand’s per capita GDP this correlation would suggest that New Zealand management performance is likely to be in the middle cluster of countries with France, Italy, the UK and Australia (as marked by "NZ" on the graph).

So what lies behind differences in management performance?   Interestingly Bloom and Van Reenen concluded that most of the difference in the average management score of a country was due to the number of badly managed firms.  For example, relatively few of the US firms studied had very low management scores, but Brazil, India and the southern Europe countries had many firms with very low scores.   Poorer countries seem to sustain a larger proportion of poorly managed firms.

One contributing factor seems to be competition.   Bloom and Van Reenen found that strong product market competition was associated with higher management scores through a combination of the competition driving out the poorer performing management teams and pushing the survivors to improve their practices.

Ownership also appears to be an important determinant of management performance.   Firms with publicly quoted share prices and private-equity owned firms were typically well managed.   Government-owned, family-run businesses, and private businesses run by the company founder were more likely to be poorly managed.   The size of the businesses studied, employing at least 100 workers, is an important aspect in understanding the impact of ownership.   The firms studied were generally well established.   This means that for a number they have outgrown the skill set of the founder.   The creativity and entrepreneurial flair of the founder are less important at a more mature stage.

Family firms have their own set of problems, where selection of management based on descent is no guarantee of managerial talent.   Indeed, family firms that hire an external CEO tend to be managed as well as publicly listed companies.   Another issue with family owned firms is that they typically have less debt, thus competition may not be as effective in encouraging management improvements.   Without debt, firms only need to cover operating costs (wages and materials) but not capital costs like the rent on property or equipment as these could have been bought outright many years ago.   Such family firms can continue to generate positive cash-flows while generating economic losses, because the family owners are effectively subsidising the company through cheap capital.

It would be interesting to see how the management of New Zealand firms compare with other countries, but this international study indicates that policies that promote competition, encourage the progression of firms into corporates, and that promote the dissemination of information about good management practices are all likely to be positive for New Zealand based businesses and the economy in general.

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