The capital conundrum.

Is the gap between rich and poor an inevitable outcome of free societies?

If the current political rhetoric in South Africa shows anything it is how easy it is to become so locked in the past as to forget about the future. It is one thing to learn from the past. It is another to be stuck in it.

This is especially true when past perceptions were nurtured in highly emotive circumstances supported by fear and insecurity. None has been more powerful in shaping our destiny than the conflict over economic and political systems. With it have come biased dogma, emotive rhetoric and populist slogans that convert into automatic responses. Nothing could be less appropriate in the times we live in. Nothing threatens our search for balanced solutions more. Slogans such as “imperialism”, “working class”, “capitalist class”, “communism”, and “capitalism” do little to enhance our evolution. They merely lock us into preconceived prejudices.

One of the concepts within the debate is the efficient allocation of capital. It goes without saying that this plays a critical role in growth and prosperity.

I was reminded of this in reflecting on Moneyweb’s stated key intention of promoting “the efficient allocation of capital, which translates into the promotion of free enterprise and Nation Building”. There is nothing wrong with the concept. It is indeed a highly laudable ideal and is a natural component of the very basic definition of economics which is the allocation of all resources to where they are most needed and can best serve society as a whole. This raises the question in the times we live in, whether efficient as we have come to understand it is the same as appropriate.

So the argument is not about the concept itself, but rather how best to achieve it. This again throws us back to the baggage of the past. When you question self interest and the profit motive as being the best driver, you stand a good chance of being given some or other rhetorical label. If you question regulation and controls that aim to influence capital allocation, you are just as likely to be labelled in the opposite camp. And that’s where useful discussion gets stuck.

It really is time to ask whether indeed, in any system or past concept, capital has been allocated efficiently or appropriately in serving social needs. All of these past dogmas have been tried in some form or another or in some country or another. Yet, in most places you look, you will find huge imbalances that arguably relate back to capital allocation or dispersion. They include the availability of natural resources and economic growth; the unsustainable pressure on the planet and climate change and the massive disconnect between wealth and real value creation. Surely, it is time for a new theory based on a different mindset and promoting a different value system?

The greatest criticism of the allocation of capital in today’s economy is the massive disparity in wealth – the gap between rich and poor. It is also the most controversial because it automatically divides us into two vehement camps – those who believe that it is a tolerable outcome of a free society and those who believe that it is proof that economies have to be more regulated. It seems to present an inherent conflict between mankind’s most prized ideals – liberty and equality.

Whatever one’s view on causes, it is the biggest challenge of our time. An interesting conclusion reached in the book “Fault Lines” by Raghuram G Rajan, a former chief economist at the IMF, is that growing inequality particularly in the U.S., Europe and Asia was a direct contributor to the financial crash because governments responded to the disparities by creating easier credit. He called the response: “Let them eat Credit.”

This underscores a simple but very sad reality. The biggest cause of social ferment is comparisons. It creates envy and when this is added to democratic expressions you have a toxic mix in societies where disparities are huge. Rational arguments lose their effect in emotive conditions and then feed all kind of discontent, real or imagined.

Wealth disparity has always been with us and is as much written about as any other topic on humanity. It is a complex subject at many levels – political, economic, social, geographic, anthropological, and even psychological. But I do not believe it can be extrapolated as an automatic outcome of free enterprise. A friend of mine reminded me of this in forwarding me an Adam Smith quote: "No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable". More often than not, the disparities are caused not by markets being free but by interference and manipulation in them.

Let me isolate only a few of many important, if not overriding causes for the current crisis as it relates to the efficient allocation of capital.

An important one is clearly the different levels of remuneration, particularly in the “executive” category. After writing about this before, I am still to be convinced that the price of these skills truly reflects unencumbered supply and demand and whether this market is not, as Warren Buffet once put it, “broken”.

Another is the changing role of financial speculation from being a desirable instrument of equilibrium in the trading of financial instruments to being a dominant force in the creation of liquidity and allocation of capital. This has been severely exacerbated by the presence of very large financial conglomerates and banking institutions whose behaviour has often been manipulated to the advantage of an elite corps.

A third critical one is the role of capital in the creation of tangible wealth, in business and private ventures. The explosion of speculation in the allocation of capital has brought with it a need to review the concept of the supremacy of equity capital over all other resources. This has to be done without ideological baggage and seeing it as a threat to free enterprise. Capital is a resource and the cost of its use is either interest or profit. Labour is a resource and the cost of its use is wages. To have the cost of capital skewed by speculative returns is as inappropriate as having the cost of labour skewed by legislative inflexibility or inordinate trade union collusion.

What is really counterproductive is the ongoing assumption that the two are in competitive conflict with labour being the “underdog”.

Sitting in on a basic business awareness training session some years ago, I heard the trainer tell his group that the first thing you need to start a business was money. I was appalled as I watched the awestruck faces of his barely literate, minimum wage participants. Destroyed in their minds forever was the vague possibility of becoming a self supporting entrepreneur, even in the informal sector. It’s a view still prevalent today: that capital creates jobs, not an idea, making a difference, doing something meaningful for others and having a market. The latter will attract money, manpower and all the other “M’s” that that specific programme taught as the key ingredients for business.

The allocation of capital in creating tangible wealth and not singularly and purely to maximise its returns will ensure a narrowing of the distressful wealth gap. Yet the view that the market is a “resource to be exploited” still lingers. It is obscene, arrogant and inappropriate. It is the difference between being “profit-driven” and being “market driven.” It makes customers angry…like I was to discover an unannounced increase in my banking fees while having just read of the mind-boggling bonuses given to banking executives.

In “Value through Values”, I dedicated many pages to this crucial difference and how paradigms can be changed by simply changing perceptions. At the risk of sounding unashamedly boastful, it was a work that Raymond Ackerman described as “… the way of the future; the whisper of tomorrow.”

It’s actually nothing new. The creators and builders in business have known this all along and have intuitively behaved in this way.

Sacred cows and holy grails.

Whatever happened to that business catchphrase “the customer is king”? Or the “customer is always right”?

Has it been consigned to useless rhetoric as many of our aphorisms and universal truths tend to be? Has it become nothing more than a bit of “rah-rah” to fit into some advertising campaign or to get unwilling staff a bit fired up in improving service?

It is such a pity…because customer focus and the pursuit of service excellence are the essence of economics. It is much more than rhetoric. It is much more than sloganeering. It is indeed the holy grail of a market driven economy. Seeing customer service as the ultimate super-ordinate goal of business brings to life the axiomatic truth that supply exists to serve demand. It is not the other way around. It is an obscene thought that markets or the customer collective is an exploitable entity that exists to generate profits, create shareholder value, pay executive and other salaries, create jobs, pay taxes et al. This has arguably been the cause of many of our economic ills, particularly in the past few decades.

The whole debacle over the Walmart entry into the South African market is an important case in point. Very little of the public discussion and popular media coverage centred on what it would mean for South African consumers. One would have thought that the Competition Tribunal’s main concern would have been those benefits rather than prescribing conditions for entry. Perhaps it did take a balanced view in the end, but the fact that it had to spend so much time and debate on paying homage to other sacred cows is a worrying reflection of how far we have moved from the holy grail of customer sovereignty. Indeed, one can also ask whether it is at all appropriate to compromise customer interests in achieving a “balanced” solution.

From a purely consumer point of view, one should celebrate the entry of the world’s biggest retail group into the country. It will certainly shake-up competitiveness in retail which, not so long ago, was being questioned by the unions in the wake of bread price collusion. The deal represents some R16bn in investment, the promise of 50 new stores and some 6000 new jobs. This is only the “beast in the bush” as the Economist called it, if we fear disturbing growing protectionism, labour inflexibility and inefficiencies that have already tumbled us down to number 54 in the Global Competitiveness Index. That same article made the point that in the United States, Walmart was instrumental in reducing inflation.

In the big metros and abundant shopping mall areas one can sometimes lose sight of the benefit of competition. Swellendam has been abuzz recently with the opening of a new mall, and the coming to town of a Checkers store to compete against Spar, OK Bazaars, Shoprite, and a local discounter, Check-in. For some weeks now, there’s been much animated talk about prices, specials, parking areas and service comparisons. All agree that each store has upped its game quite a bit.

Competition in retail is only one thread of a much bigger economic tapestry. Customer sovereignty is not just a slogan. It recognises the important axiom that ultimately our true value lies in our capacity to make a contribution to others. Business is an important conduit for achieving this. In a market orientated economy all other considerations are secondary to this one overriding principle. You cannot create jobs by throwing tax payers money at it. You also should not preserve jobs by protecting gross inefficiencies. Jobs are created by serving the needs and wants of others. Jobs are preserved by competing effectively against all comers. The foundation of creating wealth is in adding value for others and indeed in accounting, wealth is measured by measuring value added. This again underscores the problem of our time of froth liquidity based on wealth creation without tangible value having been added.

In much of my consulting I would encourage companies to approach any problem, from major strategic issues to minor employee disputes from the perspective of what would be in the best interests of the customer. It is virtually infallible as a beacon and cuts through petty and narrow interest like a hot knife through butter. It invariably leads to a solution that few can challenge as being biased.

We have deviated quite severely from the purist market driven path in which the customer is king in all things. We have created many sacred cows that stand in the way of that holy grail. These include trade protectionism, executive remuneration driven by share value, profit maximisation at any cost; narrow labour interests, rigid pay demands and burgeoning taxes. To this one can add the more shady activities such as corruption, nepotism, cronyism, and collusion. The thought comes to mind whether one would not have a valid case in challenging these practices, both “legitimate” and shady under the new Consumer Protection Act. They are more invidious and damaging to longer term consumer interests than occasional malpractices.

There are some very eloquent arguments in defence of market interventions. Most of them are legitimately based on the misbehaviour of interests devoid of sound human values. The only question that we need to ask ourselves is whether the customer should be knocked so far off the pedestal as we have done. Should we not brandish the butcher’s knife at some of the sacred cows?

From an global perspective, the principle of providing humankind with the best products at the best price should be an overriding guide. But, as the Doha trade talks keep on revealing, narrow national interests continue to bedevil this process.

From a national perspective, trade liberalisation and competitiveness are by far the most essential ingredients for a successful economy in the longer term, underpinning the prescription discovered some years ago by World Bank researchers, that successful economies are those with an external focus and strong domestic people development policies. Yet, inflated popular expectations keep on driving national policies in the opposite direction.

From a company perspective, the most sustainable are those whose primary measurements of success are customer satisfaction, market share and innovation, a contented workforce and healthy profitability.

From an individual perspective, the most empowered and arguably the most content are those who seek meaning by adding value to the lives of their fellow human beings.

Many countries, businesses and individuals today are market led. The really great ones are sincerely market driven.

The customer is indeed king.

Sam the dairy man.

Sam was desperate. He had just taken over the family dairy in a town in KwaZulu-Natal. It was one of the few remaining independent dairies in the district in the aftermath of that volatile period when labour unions were vying for membership. Despite being fluent in Zulu, he simply did not have the means and experience to deal with the demands of a fledgling union that threatened to send the business down the tubes.

I, on the other hand, had just started my employee communications company when Sam called. At the time I too had little more than a passionate mission to enhance economic awareness in the workplace and promote the concept of fortune sharing based on wealth creation in companies. There was no instrumentation, no training programmes and no established process on how to do this.

By then I had learned that the fees for employee communications consulting could only be a fraction of those charged by my elite colleagues in Public Relations. But Sam baulked at paying even that, so after a bit of haggling and an assurance that he would pay my travel costs, I found myself boarding a twice weekly flight on a fully booked six-seat Cessna “something”. As I made my way to my seat, there was a distinct whispering by some of the passengers. Although never comfortable with recognition, I had become used to this puerile habit of a celebrity conscious public. But it was a bit of a let down when I turned and saw that the attention was aimed at fellow passenger and former tennis star Kevin Curren who had done so well at Wimbledon some time before.

Light aircraft are made for little people. Their seats are made for midgets. The seatbelts are made for Lilliputians. I tried in vain to disguise my inability to fasten the belt by hiding the ends in a non existent lap. The response from the pilot who did the checking was to brandish an extension in full view of all the passengers. My cover was truly blown.

Sam had arranged a two day interaction with his staff. I spent the first morning going through his figures and what I intended to share with them. The only discomfort he had was in revealing his own earnings from both the profit that he and some family members were getting from the dairy, and the salary that he paid himself and another manager. On the strength of a number of employee interactions I had had by then, I could assure him that the pay differential was rather modest.

Something else that I had long before settled in my own mind was the myth that workers by nature are full blown communists who vehemently subscribe to the concept of “from each according to means and to each according to needs.” It simply is not true.

Most workers fully subscribe to the concept of differentiated pay and have a fair understanding of the impact on wages of supply and demand for skills and qualifications. Inexplicable multiples of thousands are a different issue. But I also assured him that I would spend some time on this in my talk with them. As far as the profit was concerned, his dividend, when split with the family, was also very modest. My regular approach of comparing the dividend with what his family could be earning in interest if they sold the business and invested the money in a bank would more than satisfy the most belligerent that he was not profiting from their toil.

Sam had a healthy 2:1 dividend cover and the presentation of retained earnings as a commitment to the future of the business is one that is simply not emphasised enough in communicating profits to staff.

Satisfied that I would not unleash more labour unrest, we discussed logistics. Sam had nothing – no flipcharts, no coloured marking pens and no venue! On top of that he informed me than none of his staff had a working knowledge of English. All were Zulu speaking. I knew a few words of Xhosa and a smattering of the polecat Fanagolo. It was not a good idea to use Sam in the interaction and the only translator we could use was a combative shop-steward. It was risky, but we decided to give it a go as long as Sam sat in and monitored the translation. The venue, we decided, would be Sam’s massive cold storage warehouse. My “teaching aids” would be bottles of milk, slices of cheese and bricks of butter.

We had barely progressed beyond a few opening remarks when fidgeting and murmurs among the group of about twenty started getting to me. I feared some or other rebellion, but soon my own built-in duvet failed, and I realised that we were all starting to get frostbite. We had to switch off the freezer compressors.

Guided by the dairy’s value-added statement, I used a number of bottles of milk to reflect income from customers and removed most as “outside costs” to supplies from farmers and others. The milk left represented wealth creation. This I poured into glasses for employees, tax, retained income and then the owners’ dividend. It followed the pattern I had become used to. More than half went to employees, about a quarter to tax, 20% to savings and less than 5% to Sam and his family. The second day, I used a block of cheese and repeated the exercise.

We then went back to the slice that represented wealth creation and had one of the most productive discussions about how this slice could be increased. Most of the suggestions came from the staff themselves. Then something happened that caught both Sam and I flatfooted! The translator and previously belligerent shop steward asked Sam whether he would share any of the extra wealth if the staff helped him in creating more!

There was little hesitation on Sam’s part and I left them with a handshake on the agreement of a principle and a promise to discuss the detail of how it would be done.

Secured again by an extended seatbelt, I endured the flight back with warm thoughts of Sam the dairy man, his dedication to his customers, his community and his group of openhearted employees.

Months later I received a letter from Sam confirming the difference the interaction had made; the implementation of a modest gain sharing programme, a structured regular communications effort, and a rather hefty bill he faced for the loss of stock in a warm warehouse.

But there was a nagging disquiet that in the not too distant future, the dairy would be swallowed up by a “corporate”, the battle lines between “labour and capital” would be redrawn and a humble group of dedicated workers would join the ranks of an agitated and angry mob with inflated expectations.

The reality of perceptions.

If some Klingons were sent to earth to determine how human business works they would most likely agree on one basic observation – it’s about people serving people.

Knowledge of any business has to start by answering three questions: what; how: and why?

What I found in working with many groups from various levels of awareness over a number of years is that the “what”, (product or service) of their companies was fairly well understood and endorsed at most levels. The “how” (method of production or delivery) was not always understood by all, but it seldom led to conflicting views. Responses to “why” the company existed invariably gave three answers: the majority would say “for profit”. Some would say “to create employment” and a small residue would argue “to serve customers”.

The “service” response was often based on either the company’s high level of customer focus where the company had such a practice, or mainly on some lofty mission, vision, or purpose statement that had been repeatedly rehearsed.

From a perceptions point of view we can identify three basic models plus one which we may have forgotten as our memory of the cold war fades:

The more popularly understood profit driven model assumes that the formation of companies is sourced from capital. Its purpose or motive is to make a profit or generate a return on the investment. In the process it “uses” means such as the market, labour, state services and outside suppliers.

The wage driven model assumes that companies exist to employ people. The end purpose is wages and the means are the market, capital, state services and outside suppliers. On the surface, such a model would appear attractive, and indeed many in my workshops expressed some preference for it in an environment of high unemployment.

There is an assumption that the wage model simply won’t work because labour cannot ensure the same efficiencies as capital does. I’m not sure if this is true. The Mondragon labour co-operative in Spain is just one example of a highly successful and competitive labour driven model. Post war Japan saw its biggest growth when employment was a high priority and companies and government made that their focus. Of course, a competitive wage driven model has to adopt the same flexibility in wages as capital does in profits, which makes it a virtual non starter in the South African environment.

The state or public sourced model with wages as its purpose has arguably been consigned to the trash heap. It lacks competitiveness and is hugely inefficient. But of course, it continues to exist in various forms such as in state owned enterprises, government and municipal services and NGO’s. The danger is that they can readily accommodate inefficiencies by easy access to taxpayers’ money and too often those that should be purely service driven become wage and employment driven. NGO’s such as charities are of course purely service driven with stringent disciplines imposed by scarcity of funds.

The market driven model assumes that companies exist to serve their customers. My illustration shows perhaps an idealistic sourcing of common intent and effort from the three main actors involved: capital, labour and state. But it need not depend on this categorisation. Indeed, any of the three could stand alone as the source, and view the others as “means”.

But this is the beauty of the market or service driven model. It evolves virtually naturally into a state of partnership because the end purpose is common, not self interest driven and not in conflict with the interests of another party. It is usually one that can be shared by all -- unless you are an anti-smoker working for a tobacco company!

The most important consideration with the market driven model is that it is not a “charity”. It has a contributory approach to society but does not and need not break the fundamental principles of sound business. It must adhere to the rules of legitimate transaction; ensure sustainability through healthy profitability, prudence and maximum efficiencies throughout the value-adding chain.

One could argue that any of the models shown can achieve competitiveness and viability if it sticks to those fundamental principles. It is just harder with some than with others.

These are not my own scientifically designed models: merely a reflection of how people perceive company behaviour. The conclusion that business is about people serving people can apply to any model. But I would argue that the one that best reflects this is the market driven model.

The philosopher Bertrand Russell once concluded that “there is no reality but our perception of it.” Perceptions create behaviour. We have for too long perceived the primary purpose of business as being about maximisation of profit. This automatic assumption has encouraged many sins. It is outdated but still firmly and broadly entrenched. But if it were authentic, then most company mission or purpose statements would simply be lying. The volumes of research that has shown that not all of the great entrepreneurs past and present were driven purely by the need to make a profit would also be false.

But that tide has been turning for quite a while now with international business trust research showing that the sound modern business is more likely than before to compromise share value if it were in the interest of broader society to do so. Latest voices to emphasise this point came from Bank of England Governor, Mervyn King who lambasted British Banks for “putting profits before customers”; and from our own Mervyn King (the governance expert) who recently argued that the exclusive focus on profit was outdated.

A shift away from the profit convention is not going to be easy while the raison d’être of business rests on an understanding that the human being is purely selfish and materialist by nature. This is the underpinning premise of Milton Friedman followers which in turn has condoned, cemented and encouraged ever increasing levels of greed-driven behaviour. Friedman’s understanding of psychology can be questioned. There are many more fundamental works in psychology, including those of Frankl and Jung, which argue that man’s search for meaning is mostly found in generous and outgoing behaviour. Then there’s social scientist Robert Winston’s postulate that caring for others is as basic and as strong a human instinct as survival is.

For decades we have allowed our understanding of economics to rely on the worst in the human spirit, culminating these past ten years in a period which our Mervyn King has described as “madness”. This can only be broken by a more generally held view that the real purpose of business is to serve, and profits, wages and taxes are merely the means to sustain it. Who knows? When that era dawns, public condemnation and consumer response to inappropriate behaviour will be a far greater punishment and deterrent than laws could ever be.

The service driven model has long been a reality for a number businesses and the people who run them – enough to show that it does not detract from profit, but indeed enhances tangible wealth creation upon which profit should be based. It does much, much more: it gives authenticity to the things business likes to say about itself.

Our business life will reach its ultimate desired state and maturity when it becomes the instrument for individual meaning rather than means. It is simply a matter of changing perceptions.