Monday, September 27, 2010

ENCOURAGING LAYABOUTS.

You can teach people how to fish. You can give them fishing gear and bait. But you cannot teach or give them a willingness to fish. And you certainly reduce this willingness if you give them fish without holding them accountable for catching their own. This is the simple logic of empowerment: you give people the means, the ability and then hold them accountable for the catch.

Again we see the folly of any system, structure or policy that does not take into account individual human behaviour. Without any doubt most of the unemployed would prefer to work. But the more we rely on systems to determine our destiny, the less we are masters of our fate and the easier it becomes to blame the “system” for our own shortcomings.

The inherent danger of a welfare state; of a “mixed economy” or “developmental state” is that they can become disempowering. Admittedly, the latest evidence I have has been isolated and anecdotal but I have a sense that a growing number are becoming unwilling to work while others are expecting more for less. I do not believe (as many appear to) that this has anything to do with culture, race or nationality. My experience in South African gold mines contradicts this view.

While the chorus for restructuring the South African economy is reaching a crescendo, I keep hearing a false note, or the absence of a very important one. The same note was absent in President Zuma’s latest solo. The disillusioned masses are being promised more fishing skills, gear and bait. They are even being promised more fish. But no-where do we hear that important note of holding them accountable and unleashing a willingness to catch fish.

Of all the institutions in society, democratic governments are the most vulnerable to the virus of expectations. If these expectations are unrealistic, the government’s position becomes untenable. Perversely, the ruling parties in governments are mostly responsible for creating those expectations in the first place. What is often missed by the seduced is the potential trade-off between satisfying inflated expectations and individual freedom - a trade off between liberty and equality.

The role of the state is at the centre of economic debate. Time was that this was informed by the belief that laws reflect poorly on social behaviour and the more laws you create, the more criminals you create. While not separate from lawmaking, government’s economic role was defined as creating the conditions for maximum wealth creation and redistributing wealth to bring relief to society’s destitute who cannot be cared for by other means. Not even ardent champions of laissez-faire have much of a problem with that.

The debate about state versus private endeavour often loses touch with what happens at micro level. So it might be useful to examine the dynamic at that level – where individuals and companies create tangible wealth and have to cope with the macro economic weather.

clip_image002In the Contribution Account the role of the state is measured at 15%. This is company tax only although this allocation should include spending on social investment and other forms of government. It does not include payments to state owned enterprises, or “user-pays” government services. These are allocated to “suppliers”. The central government further gets revenue from individuals in the form mainly of personal income tax and receives 14% VAT on the R100 wealth created. This illustration shows the folly of nationalising to expand government income. In practice the state loses R15 company tax (taxing itself) to gain a R15 dividend…unless it intends stripping the asset by reducing retained income!

Of the three contributors: capital, labour and state, the government can act the most arbitrarily. But the account shows clearly how it could impact on others and discourage them to the detriment of wealth creation itself.

It needs repeating that ultimately all tangible wealth is created at this level and in this way. It is here where the rubber hits the road. It is here where behaviour gets shaped and forged, where expectations meet reality, where innovation is nurtured or destroyed, where trust or distrust is engendered, where we spend most of our lives and which, for most is the only means of expressing our contribution to others.

Tangible wealth creation is rooted in ancient logic, is axiomatic and incontrovertible. It is, has always been, and always will be based on service to the greater other - irrespective of motive. Wealth distribution or any tinkering with the status of the contributors or beneficiaries has to support that process. If they all see their purpose as maximising reward sometimes to the extent of squeezing from one another, the process becomes inward looking and parasitic.

Conversely a focus on wealth creation becomes outward looking and progressive. It actually makes no difference who the owners are: government or private enterprise. If there is an external focus the result should be the same. This seems to be absent in the current rhetoric and grand planning. There is little mention of how the size of this cake will be increased by baking it differently. It assumes that a change of asset ownership itself will achieve this.

While government should not automatically be excluded from investing in ventures where private initiative may fear to tread, the focus should still be outward looking and market driven. The cost of capital in business cannot be bypassed simply by using taxpayers’ money or public debt. Ownership comes at a cost, including skills recruitment and sound enterprise leadership. Also, what’s the point of owning high priced assets in market-reliant enterprises if the real pressure is on current expenditures such as education and social services? It’s a bit like having a “Yup-mobile” or two in the garage while your children are starving.

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If a “mixed” economy means greater dependence on the state, then most of the developed world has been on this road for many decades. The United States, that bastion of free enterprise, has seen total government involvement (Federal and State) nearly double since the 50’s. This was triggered by the great depression in the early 1930’s. Before then, Government’s involvement as measured by spending to GDP was only 3%!

South Africa’s government spending to GDP is just over 30%, one of the highest among published African figures, but below countries like Denmark (37%) and Holland (40%). These comparisons are arguably meaningless under a growing acceptance that “one size does not fit all”. Whatever “mix” is deemed appropriate one cannot controvert some basic fundamentals. The first is embracing the logic of maximum wealth creation and sensible distribution, and another is protecting Constitutional rights.

There clearly is a need for addressing imbalances in South Africa and financial controls are being tightened across the globe. The concept of a “mixed economy” should not be dismissed out of hand. But it demands far greater honesty, integrity and accountability from governments because they can act arbitrarily, are not subject to market scrutiny and are not dependent upon consumer choice in the moment. If the government is not trusted, or individuals in that government are not trustworthy, only the certifiably insane would give them more control of their lives. Any system should appeal to the best in us, not the worst. The best is that which unleashes prudence, an enthusiasm to work and celebrates service. The worst is that which appeals to self gratification, greed, idleness and celebrates material wealth.

Perhaps we should sort out these things first before implementing grand restructuring plans. We must take care that the so-called “mixed” economy does not create a suicidal concoction.

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Tuesday, September 21, 2010

LABOUR: CHANGING FOCUS.

Few things break down our immunity to the deadly economic virus of expectations more than comparisons do. The habit of comparison seems to be so deeply embedded in all of us that it often defies rational thinking. It fuels expectations and dampens aspirations. Worse still, it leads to envy, jealousy, anger and eventually violence. And by the way, it makes us terribly miserable!

It is perhaps not surprising that wealth distribution solicits far more attention and emotive debate than wealth creation does. The simple logic that you have to create wealth before you can share it is lost. But we take it a leap further into total foolishness by thinking that we can create wealth by sharing it differently, by fighting about it, by stomping on the cake. It should be of great concern to all that the economic debate in South Africa is focused virtually exclusively on wealth distribution. Sadly, it has gone beyond debate into belligerence, acrimony and combat.

In normal, even remotely market driven or “mixed” economies, there is logic to wealth distribution that resists meddling. That’s not to say it is always appropriate, just that any arbitrary meddling is dangerous. Yet we mess with it - often to the longer term detriment, if not destruction of wealth creation itself. It would also be na├»ve to assume that wealth creation and wealth distribution are not affected by external forces some out of our control and others in a deliberate attempt to manipulate outcomes for the benefit of a vested interest. What I find most amazing is the extent to which the very simple concept - understood at any level of awareness - of adding value and sharing it in a way that reinforces wealth creation, is so often and repeatedly flouted.

clip_image002This is quite a vast topic and I hope to return to the proportions in wealth distribution later. Suffice it to say these distributions are not arbitrary, depend on the nature of the business and should be informed by supply and demand. Ideally these forces in turn should be enlightened and values driven. For now let’s examine the contributors/beneficiaries separately – starting with employees.

As the Contribution account shows, employees as a group are on average the biggest single beneficiaries of measured wealth distribution. But, as I argued previously, you cannot separate measured benefit from measured contribution, because the wealth creation or valued added measurement itself reflects both. So employees are also on average the biggest measured contributors to wealth creation. But there is an important perspective. The 50% share to “employees” includes all employees on the payroll, ranging from the chief executive to the casual worker. The concept of a “working” class is a political and ideologically inflamed one which is arguably outdated and counterproductive. It is a divisive rhetoric that detracts from wealth creation.

Of course it finds fertile ground in poor leadership and inordinate pay disparities. I worked on a number of sites during my consulting years. My field of enhancing employee awareness put me in touch with the “working class” in highly interactive sessions for extended periods and often in environments of extreme union belligerence. Not once did I find any opposition to the concept of differentiated pay based on skills – not even from the most hardened labour activists. Also, the perception that top management runs away with most of the labour share is incorrect. My own research showed on average that the 5% at the top received about 15% of the share in large companies. The ratio is mostly even lower in smaller companies.

But it is common cause that pay disparities in many businesses today have long passed their tolerance levels and for questionable reasons. Executive pay has been subjected to such wide criticism that there is little need for me to add my voice to the clamour in this context and rather leave it for a separate article. The debate is rife with generalisations, inconsistencies, innuendo and inflaming assumptions ranging from Cosatu’s 1700 to 1 ratio between highest and lowest, to Pricewaterhouse Cooper’s 30 to 1. This category is muddied further by incentives and bonuses often not easy to detect. Share incentive schemes in particular distort the “labour” share of wealth creation and often hide the costs to shareholders.

What should be of concern is that the distribution of wealth is not being informed by market forces of supply and demand. In the employee share we are dealing with a severely dysfunctional market and on both ends of the spectrum. I do not find PwC’s comparisons with “global peer groups” convincing. True, some South African “executives” may be valued abroad, but this is far too narrow a market to create pay benchmarks and make “peer” comparisons valid. Just think of the havoc wreaked by a few of our top C.E.O.’s in recent years and we could argue that they would have been lucky to get a job as a packer in Sainsbury’s. But by an invalid comparison many are paid pop-star salaries even though they would not pass the elimination rounds of “Idols South Africa”. And these comparisons inform all pay structures, including parastatals, government and sometimes even local authorities.

On what are some of these “performance related” payouts based? A question raised in King III. Do they encourage longer term wealth creation or short term profiteering? The two are often diametrically opposed. The dysfunction of the labour market on the lower skills spectrum is patently obvious and I have dealt with it in a previous article. Given further interventions and interferences such as Affirmative Action, I’m not sure if we could argue that even the middle and skilled tiers of the labour share reflect real supply of experience, skills and qualifications.

Pay disparity in South Africa has encouraged comparisons and has broken down our immunity completely against the deadly expectations virus. It has created an intolerable division in a group that should be united in creating maximum wealth and prosperity in South Africa. At the very least these pay differences need to be fully divulged, explained and defended against a norm set for a particular industry or sector – a kind of company and sectoral Gini co-efficient.

There is an important feature of the employee share of wealth that shows that the powerful forces at play do not brook our silly little interventions. The Reserve Bank statistics show that this share has been relatively constant at between 50% and 60% since 1993. Yet, we have seen increases in wages and salaries over this period. Some have been supported by economic growth translating back to increased value-added at company level. But I would suspect most have not. So if the share of the pie is the same, yet most of the individuals involved have received more than the increase in the size of the pie, it can only mean a reduction in the number of individuals. Of course this is part of productivity improvement but it also shows a clear correlation between increased pay and increased unemployment – in a country rapidly heading for two classes: employed and unemployed. So much for MERG’s wage led growth theory.

My mischievous question last week needs revisiting. As biggest contributors to wealth creation, should employees not govern companies? Given the above, and the fact that executives are part of the employee share, one could argue that employees indeed do govern. But then, on whose behalf do they govern? The most common immediate response would be on behalf of owners or shareholders. If this were true, there would have been no need for Mervyn King. There may be the odd C.E.O. who would argue that they govern on behalf of staff, but most would argue that they govern on behalf of all of the stakeholders. The reality is that, as Alan Greenspan discovered, a significant number govern on behalf of themselves, unleashing another “predatory force” or internal parasite on wealth creation.

My own view is that the top brass should govern on behalf of customers with due regard to society’s needs. And the labour group at its best should focus on maximum contribution which translates into maximum added value, in turn enabling informed optimum and equitable distribution.

In this context, Cosatu’s grand restructuring may have some merits. But no-where (admittedly only in newspaper reports) have I read what labour is prepared to bring to the table. It’s all about what they expect to get. What about greater fortune sharing in exchange for greater involvement in company operations…or regular discussions on increasing wealth creation instead of strikes for different distribution? “Become the change you want to see.” – Gandhi.

Ultimate empowerment lies in what we give, not in what we get…even for a worker.

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Monday, September 13, 2010

SHARING WEALTH: STOMPING ON THE CAKE.

Ask anyone what the value of a car is to them and by far the most frequent response will be: “getting from A to B”, or simply “transport”. Occasionally you will find a creative response such as “freedom”. Watch that person closely. He or she is a budding entrepreneur because one essence of entrepreneurship is the ability to put meaning to form. It was what Henry Ford saw in the motor car and in order to “spread freedom” he developed methods of mass production to, as he put it “democratised the automobile.” The distinction between “means” and “meaning” is a very important one. The value (even to some extent, the intrinsic value) of means can always be measured; the value of meaning never. And interestingly, you rarely find a measurement response to the earlier question. You will seldom, if ever, find someone say the value of a car to him or her is “R100 000”.

Ultimately we all value things by the way they behave, not by how they are measured in monetary terms. We value them according to the contribution they make to our lives. That also applies to our judgement of people and confirms again the axiom that our true value lies in our contribution to others. We all search for meaning in everything we do or acquire. Yet many are sadly trapped in the search for means.

So while this challenges to some extent the value-added or wealth created measurement, it does not deny it. It merely confirms another, far more important dimension to value-added – that of behaviour. There is a third: that of transformation, which means simply transforming one state to another, for example, coal into fuel, or gold into jewellery etc. But behaviour is far more important, cannot be measured and its value differs from person to person. For example, I believe diamonds are totally overpriced: the market disagrees with me. John Maynard Keynes thought gold was a barbarous relic: many disagree. Many think that cocaine at double the price of gold is vastly overpriced: junkies still buy it. Walter Cronkite believed pop-stars were vastly overpaid compared with teachers: the market disagrees. The behavioural value of all things can differ from person to person, circumstance to circumstance and from time to time. We can insist that our judgement on value is correct only to the extent of refusing to buy it. But that won’t make our judgement true for everyone.

A reliable value-added measurement has to be determined in totally unfettered, pure and uncontrolled markets and circumstances. While this is seldom true we are still left with the only measurement we can use as a reflection of its relative contribution to society as a whole: whether we or agree or not. As mentioned last week, the accounting formula for value-added or wealth created is simply income less outside costs. This means all the money one gets from one’s customers, minus all the costs one has to pay to outside suppliers, including outside contractors or people not viewed as staff or one’s own dedicated workforce.

Stating this in behavioural terms the linear equation is simple: value added = wealth created = contribution = reward = prosperity. I can think of no more powerful way of saying that the universal values of generosity, care, compassion and love create both inner abundance and outer wealth and prosperity. Values do create value, even in the accounting world.

In a company or business context, there are 3 contributors to adding value: labour, capital and state. In more popular terms: employees, owners or shareholders, and government (including local government). When wealth has been created it has to be shared with these three participants. The very sad story is that in the Anglo Saxon capitalist expression, they have all mostly been understood to be in conflict with each other. When I think of wealth distribution, I have this vision of a beautiful three tier wedding cake being charged upon by drunken revellers, hell bent on getting their piece. In the process, grabbing hands stuffing mouths create an unrecognisable mush: all with “valid” reasons, ranging from being hungry to “entitlement” and being friends with the bride.

clip_image002I have been working with these categories since the mid eighties and have found that there is a near infallible logic that in normal market driven economies has kept average company wealth distribution to fairly consistent levels over an extended time and similar in most countries. While I did most of the extrapolations from many company financials, they can be checked against the national statistics of the South African Reserve Bank. (See: National Accounts: Selected Data.) They show that on average half of wealth created goes to labour, about 35% to capital and 15% to government. During the labour turmoil in Britain in the 70’s the logic of wealth creation and distribution was seen as a useful tool for information sharing with employees, and the Value added statement was developed. I found some inconsistencies in the British format and favour the European format which, with some minor adjustments, I have called the Contribution Account.

This account splits the shareholder reward in two: between “retained income” (savings), and dividend (cash to the owners) because of the fundamentally different way they are treated. The statement has many powerful attributes. With its simplicity and stakeholder approach, it is easily understood and favoured across all levels of awareness, cultures and job descriptions. But I believe it is still totally underestimated as an expression of company behaviour, accountability to stakeholders and as a strategic tool. All of which I hope to deal with at some stage.

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The example I show here is an average of companies in the country as a whole. Although wealth distribution varies quite distinctly from one company to the next depending on the nature of the business, most of the broad conclusions hold true. I am sure it will raise many questions in your mind, such as pay disparity in the labour share. Hopefully your comments will give me some guidance on which to deal with in future.

What should be quite obvious to all is that no matter how much we agitate to share wealth differently, the quantitative share (reward) depends entirely on how much wealth has been created (contribution). Indeed, the way we share wealth should support wealth creation itself, which makes a conflict of interests between the beneficiaries totally inappropriate and destructive.

There’s one attribute that is bound to solicit much comment and resistance from readers. Leaving aside your own personal value judgement and purely in a measurement sense, a conclusion that can be drawn from average wealth distribution is that by and large, employees are the biggest beneficiaries of wealth creation. They are therefore also the biggest contributors to it. But there’s a significant sting in the tail. Apart from the political, It’s a standard norm in most activities that those who make the biggest contribution should also govern those activities.

Why does labour not govern companies?

It is because they behave like takers and not contributors!

I always believed this was a good inspirational message to tell the work-force. Until a battle scarred, wise old shaft steward at a gold mine told me: “That may be true. But we behave like takers because we are treated like takers!”

Therein perhaps, lies the ultimate truth. Tit-for-tat reaches a full circle.

And the cake gets stomped on.

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Tuesday, September 7, 2010

THE BOUNTY OF BENEVOLENCE.

I’m not a great rugby fan. But I am interested enough to watch the big games and let out a yell of despair when some or other local Bok hero knocks the ball forward. Not many of today’s younger fans can remember the days when a try was worth three points and not the five it is today. It makes me wonder what the game would be like if we changed the scoring system to 5 points for penalties and drop kicks, and only three for a converted try. At best, we would have 15 Morne Steyns on the field. At worst, the game would disintegrate into nothing.

Measurements certainly have a huge impact on the way any game is played…not only in sport. Yet, we are all acutely aware of how inadequate measurements are and how many things of value in life are immeasurable. We will remember highlights of a game far longer than the final score: like Joel Stransky’s winning drop kick in the world cup, or Jonty Rhodes’s diving run out in a world Cricket series. Like The Gucci slogan says: “Quality is remembered long after the price is forgotten.”

Why change the rules and scoring of any game? Is it for the benefit of the players, the coach, or the administrators? Obviously not. The ultimate customer of any sport is none of these parties; it is the spectator. What makes for good play in any game is what the spectator finds exciting and attractive. A scoring system that doesn’t pander to this need will destroy the sport itself. And surely what we choose to measure and how, should support the real purpose of that activity? If the purpose of a business is to add value to people’s lives, then that must be the real performance indicator and driver in a business. Profit has a very important role as a “sub-score”, like winning line-outs or scrums; relying on it as the most important driving score in a business is highly questionable. Despite the growing clamour against the profit motive, few have fully challenged the profit measurement itself or offered a viable alternative.

This deficiency has meant that every good reason to question the short-term profit motive merely becomes an irritant to be accommodated. We have seen laudable efforts such as Norton and Kaplan’s Balanced Scorecard abused and manipulated simply to fit the ultimate profit measurement. People-development and corporate social responsibility (or corporate social investment) are components of the Triple Bottom Line. But that line is seen as a chore, a burdensome “have to have” rather than a real “want to have”. TBL in any case tries to achieve the impossible of merging qualitative measurements with quantitative ones. Trying to combine all these measurements or actions merely detracts from the effectiveness of the conventional single-purpose profit-measuring exercise, and none of the three sits comfortably with the others.

Getting this right is probably going to be costly and therefore reduce profit. In the meantime, compelling as the arguments may be in favour of people-development and corporate social investment as ways of ensuring sustainability or longer-term survival, the devil is at work on business reporting in general: we’re seeing increasing emphasis on short-term profitability and ever-shortening cycles of performance reporting.

There is good news, however. It is to be found in the measurement dimension of added value. It addresses all of these problems and many more.

In the very beginning there was value-added. As well as being the oldest business concept known to humankind, it was the founding principle upon which all subsequent economic development was based, and it’s by far the most important. No amount of manipulation, trading shenanigans, corruption, insider trading, speculation and other misdemeanours can destroy the validity of value-added as (a) the only true generator of prosperity and (b) an inducement for people to behave in a values-driven way.

clip_image002The accompanying illustration shows that it is both remarkably simple and comprehensive. Let’s say a caveman found an already sharpened and shaped stone, as well as a stick and a length of vine or animal sinew, and assembled them to form a crude axe. The difference between the completed axe and the three loose items would be value-added. This would have entailed the use of time, effort and all things to do with the mind such as creativity, imagination, knowledge and experience. At this stage it’s a subsistence item, intended exclusively for personal use. So it was that for centuries most economic activity was purely for subsistence and therefore immeasurable. The axe, for example, couldn’t be given a single universal value because its usefulness might differ from creature to creature. Some could have found it useful for hunting, others for cutting wood and others again for getting married (hopefully by using the blunt end!). Living in social clusters from very early times meant that humankind had a propensity for exchange. Initially it might have been a spontaneous reciprocal activity among members of a family, group or tribe; in time it would have developed into a crude barter system where values were slowly becoming measurable. It was only with the development of a widely accepted and single medium of exchange that values became more accurately measurable.

If we stretch our imagination slightly and say that our caveman had to buy the stone, stick and sinew from someone for R10, then transformed the loose items into a single axe and sold it for R20, we can accurately and neutrally put the value of the time, effort, and creativity at R10. Of course an additional resource was applied in this instance because he needed money (or a form of it) in order to buy the loose items. So there is a fourth factor: capital. The illustration is a simpler interpretation than the academic one of how the factors of production are applied in economic activity. The simple accounting formula for value added is income minus outside costs.

But it is more profound than that. As an illustration of the root of exchange it proves that, for value to be established at all, there has to be a process of trading going on. Why did the caveman produce the axe in the first place? Why not leave the stone, stick and sinew as they were? Clearly it was because of the usefulness of the axe as compared with the three loose components. And if the item is to be traded, then we have to ask: To whom is it useful? The axe is intended for use not by the maker himself but by another human being. In other words, its worth depends on the contribution it makes to the good of someone else. The ultimate and exciting point about value-added is that it’s the one measurement in accounting that measures contribution. It is also the only one that does this. In accounting terminology, the term “value-added” is synonymous with “wealth created”. What this means is that wealth or prosperity is directly and exclusively linked to the contribution you make to the good of those around you. It applies at all levels: individual, company and country. This is tangible wealth. Other forms, such as speculation, debt, investment, etc have their place but have to be ultimately rooted in or at the very least linked to tangible wealth creation otherwise they simply create froth and a cappuccino economy.

We can go yet another step further. Examining our illustration again, we see that after the sale our man has R20. He brought an initial R10, and he now has an additional R10. Where does this go? To whom does it belong? Obviously it goes to himself as the one who added the value or made the contribution. This is his reward. So there is a clear and direct link between contribution and reward. I repeat: value-added is the only measurement in accounting that shows the clear link between contribution and reward; the only one that measures both at the same time. The order is important: contribution brings reward – not the other way around. This simple arithmetic confirms the prophetic teaching that “if you give you will receive”. And it was there long, long before prophets and profits were heard of! Equally important in the current wave of labour unrest is the realisation that you cannot share wealth before it has been created. You cannot divide a cake that has not been baked; distribution depends on creation! Conflict destroys wealth, never increases it!

The linear equation for this is simple: value added = wealth created = contribution = reward = prosperity. I can think of no more powerful way of saying that the universal values of generosity, care, compassion and love create both inner abundance and outer wealth and prosperity. Values do create value, even in the accounting world.

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