Counting what counts.

Lessons from rugby on appropriate company scoring methods.

If you can’t measure it, you can’t manage it, they say. And so we have created a world driven by measurements. We have become so fascinated with scoreboards that we have may have forgotten that they too are merely an outcome of our behaviour; that it is not the scoreboard that gives us contentment and satisfaction, but the actions and motives that drive it.

I may have used the rugby analogy before, but it deserves repeating in this context and as a continuation of last week’s article on shareholder paramountcy. It’s been said that rugby became a Neanderthal perversion of football, when in 1823 at a place called Rugby; William Webb Ellis gathered the ball in his arms and ran for the goals. Others believe in a more ancient origin dating back to the Middle Ages when teams from neighbouring villages would have great merriment in trying to carry a wine bag over a line protected by the opposing team.

Today, rugby is viewed by its fans as being as tactical and strategic a game as chess is. It has features such as scrums, rucks, mauls, line-outs, first phase through to multi-phases and many others. All, of course, are applied in the overall purpose of carrying the ball over the opponents “try” line and enabling a “conversion”. Today a try is worth 5 points and a conversion 2.

Rugby statisticians, coaches and players spend a great deal of time measuring all the tactical components such as line-outs, rucks, mauls and scrums won, as well as percentage possession and territorial advantage. In addition the scoring method has actually changed over the years. Time was when a try was worth 3 points and not the 5 it is today. The rules of play have also changed over time. The impact of the scoring on the game itself is clear even to the less knowledgeable. Increasing the value of a try has encouraged more “open” and “running” play. If, for example, they were to change the value of a try to 2, and the value of a penalty kick to 5, clearly the entire play of the game will change.

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?

We should always be mindful of the caution, popularly thought to be Albert Einstein’s, that “not everything that counts can be counted, and not everything that can be counted counts.” The point is simply that given our fixation with measurements, the sense of control they give us and their ability to rule and guide our lives we have to be very certain that these measurements support and encourage appropriate behaviour, policies and actions that ultimately serve society’s best interest.

Many do not. Many, from the personal to the national and international such as Gross National product, debt calculations, inflation, exchange rates, Gini-coefficients, indices, and trade statistics seldom tell the full story and should arguably not always be given the sacred status that they are.

If there is one sacred cow that I would like to take to the slaughter house, (perhaps confirming to many that I have finally flipped) it is the company income statement. Company measurements may not be considered important to policy makers at a national or global level. But they are. Even Nobel laureate, Milton Friedman recognised this in his missionary defence of the profit motive in 70‘s and 80’s. It is at a company level where individual behaviour finds expression and gets forged. It is the smallest gear attached to the economic drive shaft that then drives the bigger gears. It is at the heart of our transactional relationships. While we need not succumb to these values at a personal level, it is extremely difficulty to avoid following the herd and kowtowing to profit driven behaviour when most of us are part of that herd.

The last two to three decades have cast serious doubts on the continued appropriateness of the income statement and its supporting pillars of profit maximisation and shareholder value. We cannot discount that it has played some role in creating the challenges of our times: the growth of speculation, financial froth, short-termism, impatience, growing unemployment worldwide and widening inequalities. While it certainly has to be retained as a capital magnet and an important indicator of profitability, it has arguably become counterproductive in dealing with today’s needs of sustainability, long term job creation, competitiveness, customer care, social responsibility, research and innovation, job creation, and industrial and social accord.

If the challenge is to return to substance and tangible value, then tinkering with the income statement through King Reports, Integrated Reporting, Triple Bottom lines and Balanced Scorecards simply will no longer suffice.

If the ultimate purpose of business is to add value to people’s lives, and to create maximum value for all the stakeholders, then that is what should be measured – value added or wealth creation. The fuller value added statement or Contribution Account supports as many, if not more, sound business principles and strategic value as the income statement does. The point is no sound and prudent business principle needs to be lost with a difference scoring method. In a future article, I hope to show how a value added driven strategy will address many of today’s socio-economic problems.

I do not underestimate the quixotic element of my hypothesis. Few things in society today have constructed as many vested interests as profit maximisation and its associate scoring system have. No doubt many will view as outrageous sacrilege this tilting of a wooden lance at such an intimidatingly august windmill as the accounting world.

The income statement served us well since profit was first calculated many centuries ago and in a different era when it was underpinned by some would argue different values. But its day as the most important driver in business may have been done in these times of searching for fresh answers to critical problems.

Shareholder delusions of grandeur.

Challenging assumptions about the power and role of shareholders.

Of all the metaphors in the English language, the one that is the most intriguing is the “tail that wags the dog.” It creates all kinds of flights of fantasy involving different breeds and different tails. Because I have two pet boerboels, the most fanciful to me is imagining their docked tails wagging 40 odd kilograms each of solid muscle and bone.

The metaphor fits well with the concept that shareholders are an omnipotent collective that have ultimate control over the destiny of companies and that this power is entrenched in the overwhelmingly vital contribution they make to the company and society as a whole.

I must emphasise that this is not an attempt to demean or understate the important role that the shareholder and therefore capital plays. There is no point in trying to establish a hierarchy of importance to company wealth creation. It is as senseless as arguing that breathing is more important to life than blood flow.

But for whatever reason, perhaps even as a throwback to cold war rhetoric, and certainly rooted firmly in concept of the inalienable right of ownership, the paramountcy of shareholders and the overriding importance of increasing shareholder value dominate business thinking and coverage of business affairs. This has done little more than demean the real overall value of companies to society and the important contribution of other role players. It has also skewed the debate around Black economic empowerment, cultivating a delusion that empowerment lies in ownership and that Malema style “economic freedom” can only be achieved through possession or control of productive resources, including companies.

The paramount importance of shareholders is not even statistically true. As a recent example I have converted the Barloworld 2011 value-added statement to a Contribution Account^© which I have explained in an earlier article.

The graphic shows that Barloworld employees (including management) were responsible for nearly 80% of the value created last year. Shareholders created 12% and government 9%. Because of its structure, the company’s wealth distribution differs significantly from the national average of 50% to employees, 35% to capital and 15% to the state. Barloworld today is a very different company from the industrial conglomerate it used to be years ago, and is more of a brand trading company than a manufacturing one which accounts for the relatively large employee share.

It really does not matter whether we want to challenge the concept that wealth distribution represents each share of wealth creation. Statistically, value added is a measurement of contribution, and therefore each share of distribution must measure the relative share of contribution. We all have our subjective views on relative values, but price is the only objective common ruler of value that we have.

Taking the Barloworld example further, wealth created of about R8½-bn in 2011 (adjusted to Contribution Accounting) was its contribution to South Africa’s Gross Domestic product, and nearly 19 000 employees contributed (and received) some R6.7bn. But to really assess the company’s impact on the economy, you have to note the total revenue of just under R50bn, and the fact that because of the company’s activities it created a revenue stream of more than R40bn for others.

I’ve always been bemused by the focus of company reporting and the emphasis on the net profit figure. In the Barloworld case, after tax profit was just over R1bn or 2% of revenue. Heavens! What happened between R50bn and R1bn! To argue further that the R50bn is all made possible exclusively through squeezing out R1bn seems ludicrous at best. In a future article, I will argue that with the growing stakeholder approach to companies, the predominance of the income statement over the value-added statement, or preferably the Contribution Account can be questioned.

One argument for shareholder dominance is that they earn the right of control because they take all the risks. This may be true in cases of one or two individuals who have a major shareholding and are actively involved in the company. But for the large body of shareholders represented by institutional investors, one has to factor in relative risk. They would hardly feel the loss of a small part of a portfolio spread over many investments. In today’s world, jobs are not guaranteed and the loss of a job to an employee is far more devastating and the risk far greater.

The biggest misconception about company ownership is that shareholders are a small generic collective with identical aspirations, expectations and behaviour traits. In addition they are often portrayed especially in populist rhetoric as an elitist bunch of capitalist fat cats that “profiteer” from the masses.

Nothing is further from the truth. Shareholders can range from the one man owner of a small company to millions in large corporations represented by pension funds, insurance companies and investment management companies. In Barloworld, for example, directors and employees hold only 0.13% of the issued share capital. The rest is held by the general public, largely (66%) through pensions and life insurance. In turn, nearly half of this is held by the government employee pension fund.

The classic understanding of shareholding is that it provides capital in return for a share in the profit of a company or venture. For a very large number of small and medium entrepreneurs, who are the backbone and significant contributors to GDP and employment, “ownership” spells a lot of red tape, stress, and an income below that of an average government employee, according to economist Mike Schussler.

As companies grow and need more capital, they issue shares which raise capital on a stock exchange. In most of these cases, the founders are still heavily involved in the operations of the company and their relationship with it is very different from a share investor. At this point, the company is still primarily focussed on its operational activities in the marketplace and does not readily kowtow to the whims of shareholder interests apart from offering competitive returns.

Something fundamental seems to happen though, when these economic entities get swallowed up into large holding companies, in turn owned by institutional investors whose interests then become overriding, often narrowly focused on short-term returns and leading to the appointment of “professional executives” to ensure their outcomes. This leads to a centralisation of economic power, paradoxically funded by public money, and wielded by “proxy”. Many forget very soon that they ultimately get their power from being custodians of the public’s savings.

In the process, we create very powerful portfolio managers and institutional Geppeto’s who appoint their own Pinocchio’s in companies to chase maximum shareholder value in the shortest time possible. Rewards at this level are set up to encourage this behaviour but when these Pinocchio’s act exclusively to enrich themselves, the Geppeto’s shout: “Foul! We asked them to steal for us, now they are stealing from us!”

It is small wonder that the world has rebelled, with some shareholders (Theo Botha) challenging both Geppeto and Pinocchio and some Geppeto’s (Allan Gray) challenging Pinocchio. It has all culminated in an erosion of consumer and investor trust in business and their executives.

Yet, at the heart of a good business lies a very socialist principle: that of people serving people. When it stops doing that, shareholders should run…much sooner and faster than when profits are down!

For their power is a delusion. Real power resides with customers.

Business as usual.

Are companies becoming increasingly insensitive to public censure?

Swellendam: - They break the rules, pay a fine and then move on…until the next time. The latest was another case involving South African Airways, which, the Competitions Commission has ruled must pay a penalty of nearly R20-million, and Singapore Airlines a further R25-million for fixing prices on the Hong Kong route.

Not so long ago, some food giants were found guilty of price fixing and faced penalties running into hundreds of millions. Then there were some players in the construction sector found guilty of bid rigging during the soccer world cup – and many more millions in penalties had to be paid. Last year, the Competitions Commission was investigating 361 complaints – up 25% on the previous year. Twenty one complaints were recommended for prosecution covering amongst others the storage and trade of grain, fruit and pelagic fish processing, tyres, chemicals, reinforcing steel bars, steel, copper tubes and pilings.

We seem to have short memories when it comes to this kind of behaviour. Fellow journalist Barry Sergeant, reminded me after my recent Goldman Sachs article that those very same revered bankers were fined $550-million in settling a fraud case in 2010. Actually I had not forgotten. It was included in one of my hyperlinks. But then it makes me as at fault as the rest in not making more of it and viewing the event as “history” and that we have “moved on”.

Then there’s the historic low level of trust in business, executive pay levels that are difficult to comprehend and defend, a decline globally in customer satisfaction and the number of complaints to the National Consumer Commission four times higher than they had expected. It all gives one a sense that business seems simply to shrug off protests from the public -- from shareholders to occupiers of Wall Street. Billions are being spent on brand building, reputation consultants and PR spin, which in theory can all be jettisoned in an instant by damaging coverage in the media and social media. I say in theory because it seems as if many, including customers, seem to view the transgressions as not much more than traffic fines and will continue doing business with the transgressors – Goldman Sachs included.

But this is really a rather narrow perspective of the business environment today. Yes, in many respects, a large number of businesses are failing to meet the moral and ethical standards the public is expecting of them. It is also true that greed, instant gratification, impatience and short-termism has flung Capitalism into a crisis and has left many sceptical of the current business model. But largely because of this the goal posts themselves have shifted remarkably. Public expectations of companies have exploded on many levels – customers, labour, government and lobbies such as the environment.

In the last 30 or so years we have had a mushrooming of rules, regulations and watchdogs. Laws, both domestic and international governing trade, competitiveness, labour relations, the environment and consumerism have been written or re-written. Historic practices that in the past may have been dubious at worst have today become criminal, and the old adage that “the more laws you make, the more criminals you create” becomes apt.

That business sadly and in most cases, is lagging behind this changing environment, is patently obvious. What it cannot excuse for any reason, particularly not profit maximisation, is that it starts applying “cost-benefit” calculations to misbehaviour. It will simply unleash more distrust and public wrath in the form of more laws and heftier penalties.

In response to this new environment, companies have undertaken a number of measures to ensure greater social commitment. King III is one on governance and transparency, and internal accounting processes have been bolstered with instruments such as the Integrated Report, Sustainability reports, the Balanced Scorecard and the Triple bottom line. Ironically, a number of the transgressing companies had these in place before their transgressions. Companies have also adopted broader accountabilities and statements of intention such as the Ethics statement and Ethics committees; a core values statement; statement of purpose and a statement of principles -- all of these, of course, to the delight of organisational theorists and management consultants.

Even as a consultant, I never fully subscribed to the need for all these lofty statements. Indeed, management guru Jim Collins has argued that great companies seldom found a need to formalise these qualities. Admittedly, today he and his former colleague Jerry Porras are making fortunes out of teaching companies how to put these statements together.

The simpler the better. There are many words that describe and define company behaviour: ethics, morals, a moral compass, values, principles and culture. Some consultants will most likely not agree with me, but I think the most powerful and valuable, and arguably the only two really necessary, are ethics and values. The clear distinction between them is that ethics are what you wear, values are what you are. Like a dress code, ethics can be articulated, communicated and enforced in a company. But they should be driven by universal values, which are notions to which the vast majority of humans would be able to subscribe. They include honesty, fairness, compassion, prudence, generosity and integrity. There are really only a few, and should not be confused with the concept of “that which we value”, or cultural values such as polygamy, wedding rituals; or even existential states such as liberty and equality.

For companies to address the current trust crisis, they have to really do only one thing very well: become exclusively, unconditionally, uncompromisingly and unwaveringly customer focussed.

That is not only captured in the most powerful human value of all, care for others, but it is a return to the essence of what has always been good business. Sincerity creates consistency.