Hybrid Models of Capitalism

An article in the November 29 issue of The Economist caught my attention.  Titled “Going Hybrid”, it is the lead article in a special report on business in Japan.  It examines the changes taking place in Japanese companies in the past decade as they are developing a new industrial model that combines elements of the old Japanese way of doing things with some carefully chosen bits of American capitalism.  The result is a new hybrid model of capitalism that aims to achieve the best of both worlds.

The old model was founded on three main elements:  lifetime employment, seniority-based pay and close cooperation between unions and management.  This model was well suited to the times, and formed the basis for the Japanese miracle in the second half of the 20th century, which helped Japan become the world's second biggest economy.  But as we know, the old model ran into trouble in the early 1990s, and the Japanese economy has stagnated ever since, during a period when the American economy took off, practicing a more dynamic form of Anglo-Saxon capitalism, including performance-based pay, stock options and pursuit of shareholder value.

In the late 1990s the American model seemed to have all the answers that the Japanese model was missing, but then came the dotcom crash and the series of corporate scandals and unethical behaviors that continue to this day.  Anglo-Saxon capitalism, or at least its most extreme forms, has lost some of its luster in Japan and other countries around the world.

I am fascinated by these discussions because they go to the heart of a very important question: What objectives should ultimately drive a company or business organization?  At one end are the owners or shareholders, whose main objective is typically to grow their personal wealth.  At the other are the stakeholders, including the employees of the company and the communities in which it has facilities and conducts business.  It would be quite rare - perhaps even dysfunctionally so - to meet employees who would put an abstract concept like shareholder value ahead of their personal well being, as well as that of their families, colleagues and friends.

Everything works best when the shareholder and stakeholder objectives are in harmony with one another.  But as we know, this is sometimes not the case, especially when companies face financial problems.  One of the top jobs of the senior management and boards of a company is to find the proper balance between shareholder and stakeholder value for their particular business.  In addition, local and national governments have a major role to play, helping to balance the needs of business - so it can flourish, create jobs and help raise the overall standard of living - with the needs of individuals, communities and nations, who ultimately are the ones elected officials are supposed to serve.

These are incredibly complex subjects.  In spite of claims from demagogues at both ends of the political spectrum, there are no easy answers.  Finding innovative business models that properly serve the needs of shareholders and owners, as well as those of individuals and communities, is perhaps one of the most important challenges we face.  It has a direct impact on any attempt to re-invent the enterprise and the very notion of what a company is in our increasingly global and fast-changing knowledge economy.  My own feelings on the subject have significantly evolved over time.  Let me offer some personal thoughts.

For a long time in its history, IBM resembled the old Japanese model, in particular its practice of lifetime employment.  This goes back to the days of Thomas J. Watson, Sr., who was so confident in the eventual success of the company that he refused to fire IBM employees, even in the face of the Great Depression.  Instead, he continued to manufacture and warehouse tabulating machines until the New Deal and especially the Social Security Act of 1935 - which became the biggest accounting operation of all time - suddenly created the demand for IBM's products. 

This core part of IBM's culture fused over time with the company’s Basic Beliefs, which were codified by Thomas Watson, Jr. in A Business and its Beliefs, which was published in the early 1960s.  One of those three core beliefs was “Respect for the Individual”:  "Help each employee develop his potential and make the best use of his abilities; pay and promote on merit; maintain two-way communication between manager and employee, with opportunity for a fair hearing and equitable settlement of disagreement."  While “Respect for the Individual,” as written down by Tom Watson, Jr., never mentioned the right to lifetime employment, that is how it came to be interpreted within the company for the next 25 years or so.   

This culture, including its benefits and entitlements, helped IBM attract top talent and achieve its leadership position in the IT industry.  But by the second half of the 1980s, the technology and market environments in the industry changed dramatically, and IBM was no longer able to compete effectively with the meaner, leaner and faster moving young companies that were rising all around it.  IBM had well over 400,000 employees at the time, and was as well known for its bureaucracy and numerous processes as for its excellent technologies and sales force.  As profit margins eroded due to the intense competition in the marketplace, financial analysts kept pointing out that IBM had to restructure and significantly cut its expenses, including reducing overlapping products and services, consolidating manufacturing as well as many of its corporate functions, and reducing its workforce through massive layoffs. 

I remember that at the time - twenty years ago or so – I thought that those financial analysts were really cold-blooded because all they cared about was financial results and the price of the stock, with little concern for IBM's employees and the IBM culture.  I was naive and clearly wrong.  IBM had indeed become bloated and internally focused.  Its business model and personnel practices had worked well when it was growing fast and had a dominant market position that enabled it to set its own prices and achieve high profit margins.  But given the increasingly competitive IT industry of the late 1980s, IBM had to change drastically and embrace more realistic marketplace practices or we would simply go out of business.  The very survival of the company was at stake.

In the subsequent years, IBM did what it had to do to adjust to the new market realities.  It was very painful for all involved - the employees being laid off, as well as those that remained with the company.  But looking back at those times, just about everyone who left IBM ended up doing very well in the open marketplace, quite a few doing significantly better than they would have had they remained at IBM.  This is not surprising.  IBM attracted very talented people and provided them with excellent training and work experiences.  Playing the game in the open marketplace proved to be good not only to IBM but to most of its employees and former employees as well.

But if a model based on a highly paternalistic company and a highly loyal workforce is not appropriate for a highly dynamic marketplace, how far in the other direction should a company go?  The danger at the other end of the spectrum is an undue emphasis on short-term wealth creation and the self-interests of a transient investor base, over the strategic value creation that benefits stakeholders and long-term investors alike.  These are the more extreme forms for American and Anglo-Saxon capitalism where companies, including their employees, customers, products, services and assets are just abstract entities to be played with like chips in a casino. 

A number of recent studies have pointed out that "the obsession with short-term results by investors, asset management firms, and corporate managers collectively leads to the unintended consequences of destroying long-term value, which decreases market efficiency, reduces investment returns, and impedes efforts to strengthen corporate governance.”  These same studies have found that currently many companies encounter significant short-term pressures from a more transient investor base which imposes costs on companies and their investors, not the least of which are internal trade-offs against long-term strategic investments.

In fact, such so-called investors value volatility over everything else, since their objectives are to maximize their near-term gains.  They have little interest in the future of the company.  What obligations does a company have to such traders?  What happens when these market players, especially powerful ones, game the system with perfectly legal schemes that may not be in the best interests of the communities and societies those systems were put in place to support?

I am a strong believer in open, free markets and in Adam Smith's notion of the Invisible Hand, not out of ideology but out of pragmatism.  While free markets are often chaotic and unrestrained, they generally produce the right results - certainly a lot more often than any one individual or small group of people could.  Even though greed often guides the actions of individuals, the benefit of competition will usually overcome the detriment of greed.

We have, however, seen what happens when greed becomes extreme, such as with the illegal actions of executives at companies like  Enron and WorldCom.  This is clearly intolerable, which is why we need governments and regulatory bodies to temper our bases impulses.  But even without such clearly illegal behavior, an obsession with near-term profits and personal enrichment over everything else can cause management to push the limits of sensible behavior, as we have recently seen with subprime lending and with the use or lead-based paints in children’s toys.

The proper management of a company requires constant attention to these issues.  You go too far in one direction, as IBM and the Japanes companies did, and you run the risk of being unable to keep up with more aggressive competitors and innovators.  You go too far in the other direction, and you run the risk of destroying the brand of the company and the personal reputation of its executives, let alone running afoul of the law and ending up in jail.  My belief is that those companies around the world that find the proper balance, and are able to attract talented employees as well as long term investors will be the ones that ultimately prevail.

Comments

[Jim]

When referencing Worldcom, Enron, or even the recent subprime lending issues, I wonder what your thoughts are on the various compliance mechanisms employed by government to combat the "excessive" or "extreme" greed issues. I have read a fair bit about how the U.S.'s ever-increasing web of compliance regulation is onerous on small and medium-sized businesses and that some/many (depending on who you talk to) companies are setting up formal shop outside of the U.S. in order to avoid the worst of it. Here I am thinking about such initiatives as Sarbanes-Oxley, which some people say is an important component of enforcing corporate responsibility and other people say wouldn't even have addressed the core problems going on at Worldcom or Enron.

Some days I wonder whether the concept of a corporate entity, which is a government creation in and of itself, isn't a part of the problem. I understand why they were created in the first place, but the corporate entity is used so much as a shield and smokescreen that many time I find myself wondering whether any system based on the corporate model can properly address these issues.

[Makio Yamazaki]

In 1980s, I noticed that many U.S. companies pursued a return in the short span.
Tom Peters said in his book, "excellent leader".
The company follows an "experience-curve " in the most case. In other words,
it is the trap of the "mind-set ".
It puts differeciations on not attracting a rival, but also making the facilities
to produce products with the lower prices to win share.
To become a successor in the company, they follow an "experience-curve".
Simply, it isn't possible to become a quality prank and a service prank.
When the speed and the competition of the change is remarkable,
the operation would be different from the "experience-curve".
I also read the following report, "Winning the Global Challenge"
(IBM: http://www-935.ibm.com/services/us/gbs/bus/pdf/winning-podcast.pdf ).

[Chris Ward]

When I joined IBM, it was explained to me that the overall business model was to spend (of the money that our customers gave us)
30% on marketing and selling
30% on manufacturing
30% on taxes and dividends
9% on product development
1% on basic research

That was in the days when IBM did more manufacturing (disk files, displays, personal computers) and the Global Services business wasn't identified as such; so the balance is probably different now, but the principles are roughly the same.

IBMers in different 'walks of life' within this have different measures of success; and different timescales to work on. The '100% club' for salesmen/women is definitely 'quarterly'. Development is roughly 'annual', and Research can extend maybe up to 5 years.

I'm not sure if you view it as 'One research scientist supports 99 other IBMers'; or 'It takes 99 regular IBMers to support one scientist'; but there's a certain symbiosis.

Without the Research core, IBM would still be manufacturing typewriters. Very good typewriters by this stage, but typewriters nevertheless.

So, we'll see. OS/2 is over, just like typewriters. I think for mass market it's all 'IBM value add on top of a collaboratively-developed shared open-source (Linux) base'.
Lotus SmartSuite is on the glide-path down to land; get your Lotus Symphony here http://symphony.lotus.com/ .

IBM (and therefore IBM's customers) seem to be taking advantage of all the academically-developed software, built in universities over the 25 years since the dawn of the PC era. And why not ? That's what it's there for.

The future may be radically different from the past. And that's good.