Well-managed firms have higher productivity, profits, market value and growth, says award-winning Stanford economist and TNIT member Nicholas Bloom. They’re also more innovative, safer and cleaner. Information technology (IT) has often been claimed to be essential to effective management - encouraging billions of dollars to be spent on IT hardware and software - but it is only recently that researchers have been able to study the relationship between management, IT use and economic performance empirically.
To investigate such patterns, the World Management Survey (WMS) - a Harvard-LSE-Stanford research project - has collected firm-level management data across 35 countries since 2001. Using this survey tool, Bloom and his collaborators have shown management practices - defined in terms of monitoring, targets and incentives - are strongly related to development across countries and that effective management practices are strongly correlated with the intensive use of IT.
IT SOLUTIONS
Management is positively correlated with intensity of IT use
One of the major benefits claimed for the adoption of IT has been its ability to improve management systems. Comparing one basic measure of IT intensity against WMS management scores, Bloom found a clear strongly positive relationship, robust to a full range of controls for country, industry, firm size, age and other demographics. This positive relationship has been shown to be present across manufacturing establishments within the US. It is these types of modern management practices, says Bloom, that enabled US firms to drive the productivity miracle of the 1990s and 2000s.
MANAGEMENT MAGIC
Why some firms, industries and countries outperform their rivals
High-income countries with strong manufacturing sectors - such as Germany, Japan, Sweden and the US - tend to have the best management practices. Middle-income countries - such as Brazil, China and India - have moderate management practices, while those in Africa are really very poor.
Countries typically have management scores in line with their development - few countries are able to achieve substantial growth without improving their management practices. Increased productivity is usually necessary to afford the higher wages that come with development.
Within every country there is also a huge variation in management practices across firms. The wide dispersion of scores suggests that while it is possible to implement formal management practices across firms, they are not being implemented more widely. There are a number of well-managed firms - typically larger multinationals - operating in competitive markets with a highly educated workforce. But there are also poorly managed firms in most countries, typically family owned and managed, operating in protected and highly regulated sectors. Encouragingly, this spread across firms reveals there is significant room for improvement in management for many firms, that can lead to rapid employment and wage growth by adopting globally accepted management best practices.
When we consider three dimensions of management practices (monitoring, targets and people management), it is not surprising to see the top spot claimed by the US, the home of the business school and the plurality of the world’s large multinationals, followed in second place by Japan, the birthplace of “lean manufacturing” (a modern management practice focused on data collection and continuous evaluation).
Within manufacturing, some industries tend to be managed better or worse. High-tech electronics and machine industries seem to be better managed. Lower-tech industries, such as furniture, leather and apparel, have lower management scores. To what extent do better management practices translate into better economic performance? At the macro level, countries with higher management scores have higher GDP.
Meanwhile, firms with higher management scores have substantially higher performance across every dimension analysed: they are more productive, faster growing, more profitable and they have more employees, higher sales per employee and higher stock-market value. In other work looking at US firms, we also see that better managed firms are more innovative.
How robust are these results when controlling for factors such as industry, country and other potential performance-driving factors such as employee skills and firm size? We ran rigorous multivariate regression analysis of various indicators of performance on management scores, plus an increasingly complete set of controls.
Another concern may be that the management practices associated with economic success may differ in some countries. However, this survey evaluates very basic management practices which are generally perceived to be the core of good management practices. Furthermore, in a 2014 experiment, we re-estimated our performance regressions on the samples of firms in Asia, South America, Africa, Europe and North America, finding similar results in all regions.
One could also be concerned that this evidence is correlation based, so maybe rather than better management leading to superior performance, the relationship is reversed. Firms with superior economic performance might hire in good consulting firms to upgrade their management practices. In a 2013 study, we provided free management consulting to some large textile plants outside Mumbai, to help them adopt the modern practices measured by WMS, and compared their performance to another randomly chosen set of control plants. The adoption of these management practices took several months to occur, but eventually led to large increases in productivity.
Interestingly, the Indian experiment also found that firms were more likely to try to upgrade their management practices when facing tough times. If this type of endogeneity was common, it would lead to systematic underestimation of the impact of management on performance.
We also find that measures of work-life balance and family-friendly policies are positively correlated with WMS management measures, as are measures of worker safety such as the use of fire extinguishers and fire drills. By relentlessly focusing on cost minimization, better managed plants also reduce pollution and waste.
WHAT WORKS
How to make better managers
Why is there so much variation in the quality of management practices across firms? Here are five drivers with direct policy implications.
- Competition: Tougher product market competition is strongly related to better management practices. Competition forces badly managed firms to improve or exit the market. It also provides firms with lots of rivals to copy and learn from. Hence, a clear policy tool to improve management practices is increased competition - enabling firms to enter, removing any regulatory barriers on trade, FDI [that is, Foreign Direct Investment] or market entry and vigorously policing anti-trust.
Ownership: Founder/family owned and managed firms tend to be managed significantly worse. The main issue here is not ownership, but control. Founder/family firms that have a founder/family member as CEO have low management scores, but founder/ family firms with an external (non-family) CEO are just as good as other privately-owned firms. Three policy levers can help here. First, minority shareholder protection to allow firm owners to hire professional managers without fear of expropriation. Second, an improvement in the general rule-of-law so that family owners can trust outside managers in their firms. Finally, FDI can play a critical role in spreading modern management practices. Foreign-owned firms are significantly better managed than domestic firms.
- Regulation: Countries with lower regulation - as evaluated by the World Bank’s Doing Business Index - have significantly stronger management practices. This link is likely to be driven by greater competition (international trade is highly competitive) and decision-making flexibility (allowing managers - rather than governments - to determine practices is likely to be more efficient).
- Skills/Education: We found a strong relationship between the share of managers and workers with college degrees and quality of management. This makes sense when considering the importance of not just knowledge, but also implementation, of these best practices. Cultural changes in companies are only successful when there is significant buy-in from the employees, and this is often easier when workers are well educated and can be included in discussions about changes.
So creating incentives for continuing education of managers as well as employees is another policy action point. We can see human capital formation as a longer-term policy strategy in the general sense of the clear benefits accrued from a more educated populace. There are also short-term action points, such as identifying the skills most needed in each sector and offering training and workshops to current managers and employees. Training programs for basic operations across all sectors, such as inventory and quality control for manufacturing, could be a good place to start.
- Information within and across countries: Across countries, the response to the question “How well managed is your firm?” is totally uncorrelated with the actual management score. Firms in countries with poor management practices do not seem to think their management practices are poor - if anything, they rank themselves more highly. But when we evaluate this self-perception across firms within the same country, we see a positive correlation, as better managed firms appear to rate themselves somewhat more highly compared to their local competitors. How can we explain these two apparently contradictory results?
Firms are able to evaluate themselves to a limited extent against their local competitors, but not against international competitors. Information on management practices seems to flow locally to some extent, but not at all across countries. A clear policy implication is that governments should try to expose domestic firms to the management practices of successful multinationals.
WHAT’S THE SCORE?
Measuring best practices
The WMS research team uses an interview-based evaluation tool that scores a set of 18 key management practices from one (“worst practice”) to five (“best practice”). It has focused primarily on collecting data for more than 11,300 manufacturing firms, but it has also surveyed nearly 1,200 retail firms, 1,700 hospitals and 1,900 schools, finding similar patterns.
The WMS attempts to measure management practices in three key areas:
- Monitoring: How well do firms monitor what goes on inside the firm, and use this information for continuous improvement?
- Targets: Do firms set the right targets, track the right outcomes, and take appropriate action if the two are inconsistent?
- Incentives/people management: Are firms promoting and rewarding employees based on performance, prioritizing careful hiring, and trying to keep their best employees?
A firm earns a low score if it fails to track performance, has no effective targets, does not take ability and effort into account when deciding on promotions and has no system to address persistent employee underperformance. In contrast, a high-scoring organization frequently monitors and tries to improve its processes, sets comprehensive and stretching targets, promotes high-performing employees and retrains, rotates or exits underperforming employees.
To collect the data, graduate students who had some business experience were hired and trained from top US or European universities. These students interviewed plant managers who were senior enough to have an overview of management practices but not so senior as to be detached from day-to-day operations. Interviews were conducted in the managers’ native languages.
These managers were not told they were being scored. They were told only that they were being “interviewed about their day-to-day management practices”. To do this, we asked open-ended questions such as, “Could you please tell me about how you monitor your production process?” rather than “Do you monitor your production daily [yes/no]?”. In this double-blind approach, interviewers were not told in advance anything about the firm’s performance.
A variety of procedures were used to obtain a high success rate and to remove potential sources of bias. To obtain performance or financial data, only independent sources such as company accounts were used. A series of “noise controls” were also collected on the interview process itself (such as the time of day), characteristics of the interviewee (such as tenure in firm), and the identity of the interviewer.
For almost three quarters of all interviews, there was a second person listening in on a phone extension as a “silent monitor” to independently score the interview. For these double-scored interviews, the correlation across scores was 0.887, which shows that the two interviewers typically gave the same score.
Repeat interviews were also conducted at 222 firms from the manufacturing sample, using a different interviewer and a second plant manager within the same firm. The correlation between the first and second interview scores was 0.51 (p-value< 0.001). Part of this difference is likely to be real internal variations; no two plants will have identical management practices. The rest of this difference reflects measurement error.
Survey sample
The survey randomly sampled manufacturing firms with between 50 and 5,000 employees. The upper bound of 5,000 was introduced to exclude firms that are too large for us to proxy for the management of their firm from just one plant interview. Nonetheless, in other work on US manufacturers we find similar results extending the size distribution across the whole population.
The WMS tried to cover a range of major as well as smaller economies around the world across all six continents. Firms in the sample typically had around 250 employees, so cross-country comparisons are typically not impacted by large differences in firm size. Interestingly, developing-country firms tend to be relatively young, likely reflecting their rapid recent growth.
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- Management practices are strongly related to development across countries. Most firms in the US, northern Europe and Japan have world-class management practices. Their firms are: (I) continuously collecting and evaluating data to improve production efficiently, (II) setting stretching targets to motivate their employees to excel, (III) rewarding high-performing employees with bonuses and promotions (IV) and retraining or exiting underperforming employees. Firms in middle - and lower-income countries such as Brazil, China and India have substantially less advanced practices.
- Effective management practices are strongly correlated with the intensive use of information technology. One likely reason is that collecting and processing performance data - a key part of modern management practices - is facilitated by efficient IT systems.
- The key policy tools to improve management practices - and thereby raise employment, wages and growth - are competition, FDI, trade openness and workforce education.
The preceding is republished on TAP with permission by its author, Professor Nicholas Bloom, and by the Toulouse Network for Information Technology (TNIT). “The Art of Management” was originally published in TNIT’s April 2017 newsletter.