An economist is someone who knows the price of everything and the value of nothing.
Old joke based on Oscar Wilde?s quip about a cynic.
If, as William James wrote in 1906, that the Olympics are ?the moral equivalent of war?, then is the decision to make the US Olympic uniforms in China the moral equivalent of treason?
Not surprisingly, the discovery?in an election year?of the place of manufacture of the uniforms has unleashed a blizzard of jingoism. Democrat Senate Leader Harry Reid said that we should ?burn? the uniforms. Republican House Speaker John Boehner said, ?They should have known better.?
A lost PR opportunity?
Whatever else it is, the decision is clearly a PR disaster for the US Olympic Committee and for Ralph Lauren. What were they thinking? Peggy Noonan at the Wall Street Journal sees it as a communication problem?a lost opportunity for PR: making the uniforms at higher cost in the US could have been a heart-warming PR triumph.
Hey, we could do a nice commercial to run during the games, with American women and men making the uniforms, looking up from their sewing machines as the camera goes by and saying, ?Good luck America.?? As if we?re all in this together, and what we?re all in is actually bigger than the games.
Instead?sigh?China.
Perhaps it?s just as well that such an ad wasn?t made, as the pitch that those textile workers are ?all in this together? with the athletes and corporate America would have been a considerable stretch for most viewers. It would have infringed the first principle of good PR: tell the truth.
Resistance to globalization
Others have suggested that the outcry is an example of unthinking resistance to globalization. Why can?t we see that globalization is good for us? Thus Micheline Maynard, fellow Forbes contributor, boldly proclaims that ?Ralph Lauren has nothing to apologize for?. Someone should tell these folks that if you want to have exports, you also have to have imports.? In effect: grow up, you people: that?s the way the global economy works.
In a similar vein, John Bussey at the Wall Street Journal thinks we should actually celebrate having the uniforms made in China. The complaints, he says, reflect ?a lack of understanding of comparative advantage and how trade works?the Chinese are really good at producing low-cost uniforms, the U.S. is really good at innovative technology and advanced manufacturing?which would you rather be??
In any event, Bussey says, Chinese imports constitute only a tiny insignificant sliver of the US economy? only 1.2% of total US personal consumption expenditure. No big deal.
How whole industries have disappeared
Well, those Chinese imports might be a tiny sliver, but it happens to be a sliver that matters. What economists often miss is what is happening behind the numbers of dollars in the real economy of people.
Decades of outsourcing manufacturing have left U.S. industry without the means to invent the next generation of high-tech products that are key to rebuilding its economy, as noted by Gary Pisano and Willy Shih in a classic article, ?Restoring American Competitiveness? (Harvard Business Review, July-August 2009)
The economy as a whole has also suffered. Decades of outsourcing manufacturing have left U.S. industry without the means to invent the next generation of high-tech products that are key to rebuilding its economy.
Pisano and Shih continue:
The decline of manufacturing in a region sets off a chain reaction. Once manufacturing is outsourced, process-engineering expertise can?t be maintained, since it depends on daily interactions with manufacturing. Without process-engineering capabilities, companies find it increasingly difficult to conduct advanced research on next-generation process technologies. Without the ability to develop such new processes, they find they can no longer develop new products. In the long term, then, an economy that lacks an infrastructure for advanced process engineering and manufacturing will lose its ability to innovate.
The economists? reckoning of the impact of outsourcing production overseas misses the point. Americans are left with shipping the goods, selling the goods, marketing the goods. But the country is no longer able to compete in the key task of actually making the goods.
Pisano and Shih have a frighteningly long list of industries of industries that are ?already lost? to the USA:
?Fabless chips?; compact fluorescent lighting; LCDs for monitors, TVs and handheld devices like mobile phones; electrophoretic displays; lithium ion, lithium polymer and NiMH batteries; advanced rechargeable batteries for hybrid vehicles; crystalline and polycrystalline silicon solar cells, inverters and power semiconductors for solar panels; desktop, notebook and netbook PCs; low-end servers; hard-disk drives; consumer networking gear such as routers, access points, and home set-top boxes; advanced composite used in sporting goods and other consumer gear; advanced ceramics and integrated circuit packaging.
Their list of industries ?at risk? is even longer and more worrisome. The result? Amazon couldn?t make a Kindle in this country, even if they wanted to.
Outsourcing as the pursuit of efficiency
David Brooks suggested last week that Mitt Romney might justify his outsourcing activities at Bain Capital as a kind of personal trainer for the economy.
?Let?s face it, [Romney] is not a heroic entrepreneur. He?s an efficiency expert. It has been the business of his life to take companies that were mediocre and sclerotic and try to make them efficient and dynamic. It has been his job to be the corporate version of a personal trainer: take people who are puffy and self-indulgent and whip them into shape. That?s his selling point: rigor and productivity. If he can build a capitalist vision around that, he?ll thrive. If not, he?s a punching bag.?
Yet it?s not obvious that the personal trainer analogy will be persuasive. If you look at the firms that Bain Capital invested in, some prospered, some sputtered and some went bust, while Bain Capital always came out ahead. By a combination of management fees, special dividends, and loading up the companies with debt, the house always won. Who wants a personal trainer who always benefits himself while killing some of his clients?
Moreover the other participants in these deals did not always fare nearly as well as Bain Capital. Sometimes more jobs were created, but often both jobs and benefits were cut. Other shareholders sometimes prospered, but often found themselves owning a bankrupt shell. Creditors also repeatedly found themselves dealing with entities couldn?t repay their loans as a result of the management fees and special dividends that had already been extracted. The reality is that Bain Capital was not so much driven by efficiency as by making money for themselves, whatever the cost to others.
Bain Capital?s track record can be seen as an example of the tendency of capitalism to degenerate into C-suite capitalism, where the firm is run by and for the benefit of the C-suite. To be sure, other parties benefit from time to time from their activities, but those are contingent results, not the goal. The goal is to make money for the managers.
Professor Mihir Desai, the Mizuho Financial Group Professor of Finance at Harvard Business School recently documented the scale of the problem in HBR?s April issue.
?The combination of a foundational myth and absent monitors over the past two decades,? writes Desai, ?gave rise to harmful incentives, asymmetrical payoffs and windfall compensation levels? The result has been the creation of perhaps the largest and most pernicious bubble of all: a giant financial incentive bubble.?? This in turn results in ?the twin crises of American capitalism: repeated governance failures, which lead many to question the stewardship abilities of American managers and investors and rising income inequality.?
Even worse, the skewed incentives and huge unearned windfalls have given rise to righteous but unwarranted belief in entitlement: the individuals ?now consider themselves entitled to such rewards.?
A quarter century of financial capitalism
None of this has happened by accident. For the last quarter century, American business has been pursuing the maximization of shareholder value as the goal of an organization. For a while, it looked as though it was working. Firms prospered by aggressively cutting costs and outsourcing jobs to cheaper economies. The economy appeared to be growing. It wasn?t immediately obvious that real incomes for most working Americans were stagnating. The appearance of prosperity was propped up by unsustainable borrowing: the bottom 80 percent of the American population was spending around 110 percent of its income. This level of indebtedness was enabled by the housing bubble. This led inexorably to the Great Meltdown of 2008 when the housing bubble popped. In the process, many retirement savings were decimated.
It?s not simply that the gains of financial capitalism ended up going to the very few. The consequences for the organizations that were supposedly benefiting from financial capitalism and for the economy as a whole have been terrible.
The effect on the organizations themselves
Financial capitalism has been bad news for the organizations themselves, as the rates of return on assets and the rates of return on invested capital of US firms have steadily declined over more than four decades.
?What does ?success? look like?
Even in those industries that have been successful the quality of the jobs is worth reviewing. Take for instance the biggest success story at Bain Capital?its investment in the startup office products store, Staples. With more than 90,000 employees, Staples is constantly cited to substantiate the claim of large-scale job creation. The jobs created are mainly low-level service jobs, selling products made by someone else.
The service economy with jobs like those of salespeople at Staples is certainly a looming possibility for the US economy, but a service economy alone is unlikely to be an American success story. If all American workers do is sell goods manufactured in other countries, mow lawns, cut hair, and export raw materials, the wealth of the nation is unlikely to be great. The US will in effect have become a Third World economy. It will be unable to support even the current standard of living, let alone an improving quality of life. The question remains whether a service economy with sharply lower incomes and standard of living for most people will be politically acceptable.
Shareholder value: the dumbest idea in the world
The loss of all these jobs and industries is not an accident: it?s the result of aggressively pursuing shareholder value. Jack Welch the CEO of GE from 1981 to 2001 was often cited as the heroic exemplar of maximizing shareholder value, but he came to be one of its strongest critics. On March 12, 2009, he gave an interview with Francesco Guerrera of the Financial Times and said, ?On the face of it, shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy? your main constituencies are your employees, your customers and your products. Managers and investors should not set share price increases as their overarching goal. ? Short-term profits should be allied with an increase in the long-term value of a company.?
Ralph Lauren?s decision to have the US Olympic team?s uniforms made in China is thus just a symptom of the pervasive unthinking decision-making of American business. ?Outsourcing has become a self-destructive bad habit that is pursued even when, as here, it makes no business sense.
The shift to delighting the customer
What to do? Given the numbers of the people and the amount of money involved, rescuing capitalism from these catastrophically bad habits won?t be easy. For most organizations, it will take a phase change. It means rethinking the very basis of a corporation, the way business is conducted and even the values of society.
What is occurring is a transition from a factory economy to the Creative Economy. The Creative Economy is one in which both manufacturing and services play a role. It is an economy in which the driving force is innovation. It is an economy in which organizations are nimble and agile and continually offering new value to customers and delivering it sooner. The Creative Economy is an economy in which firms focus not on short-term financial returns but rather on creating long-term customer value based on trust.
Customer capitalism focuses the true source of business value?the customer?and devotes all its energies to that goal. Once firms make that shift, suddenly, firms need to inspire their employees? full talents and the employees start having meaningful jobs. Suddenly, the firms are not so dependent on business cycles and sputtering demand. Suddenly firms are able to create their own demand. Suddenly firms start making a lot more money. It means running companies in a radically different way. When they do that, a whole lot of good things start to happen.
What is to be done?
With such a complex societal problem, it?s hard not to start from Albert Einstein?s insight: ?The significant problems that we have cannot be solved at the same level of thinking with which we created them.? Many actors will have to play a role.
- Company leaders: Business leaders need to recommit themselves to continuous innovation and the values and practices that are necessary to accomplish that. i.e radical management. As Pisano and Shih write: ?Whether you?re the US firm IBM [IBM] with a major research laboratory in Switzerland or the Swiss company Novartis [NVS] operating in the biotech commons in the Boston area, sacrificing such a commons for short-term cost benefits is a risky proposition.?
- Accountants: Accountants need to get beyond the mental prison of cost cutting and embrace thinking that focuses on how companies can add new value, not just cutting costs.
- Investors: Investors need to realize that the companies of the future are those that practice continuous innovation. Investors need to realize that short-term financial gains are ephemeral: the companies that will generate real value are those that do what is necessary to continuously innovate.
- Government: Government has a role to play in protecting and promoting fields of expertise or what Pisano and Shih call ?the industrial commons?. Thus: ?Government-sponsored endeavors that have made a huge difference in the past three decades include DARPA?s VLSI chip development program and Strategic Computing Initiative; the DOD?s and NASA?s support of supercomputers and of NSFNET (an important contributor to the Internet); and the DOD?s support of the Global Positioning System, to mention a handful.?
- Politicians: At a time of poisonously divisive political debate, in which candidates recite anti-government mantras and call for ?getting government out of the way of the private sector?, it is time for serious politicians to step up and examine which parts of the private sector are fostering, and which parts are destroying, the economy of the country. They must stop embodying e.e. cummings definition of a politician as ?an ass upon which everyone has sat except a man.?
- Economists: Economists need to realize that merely adding up the numbers is not enough. They have to look at the meaning behind the numbers. When they trumpet their finding that ?Chinese goods are only 1.2% of the U.S. economy?, it?s akin to saying ?we kept the house but gave away the keys.?
And read also:
Why Amazon Can?t Make A Kindle In The USA
The Dumbest Idea In The World: Maximizing Shareholder Value
The Phase Change To The Creative Economy
HBR Blows The Lid Off C-Suite Compensation
The Five Big Surprises of Radical Management
________________________
Steve Denning?s most recent book is: The Leader?s Guide to Radical Management (Jossey-Bass, 2010).
Follow Steve Denning on Twitter @stevedenning
Source: http://www.forbes.com/sites/stevedenning/2012/07/23/why-are-the-us-olympic-uniforms-being-made-in-china/
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