Despite the popularity of masters of business administration programmes, management is the great unknown in economic models. One problem has been quantifying management practices.
Recently, academics Nicholas Bloom and John Van Reenen seem to have surmounted this difficulty. They began with a tool for evaluating management practices developed by McKinsey and Co. This uses 18 dimensions of management practice grouped into four areas: operations (introduction of modern manufacturing techniques, their rationale, and process documentation); monitoring (performance tracking, review and dialogue, consequence management, and performance clarity and comparability); targets (breadth, interconnection, time horizon, stretching, and human capital management) and incentives (rewarding high performance, removing poor performers, rewarding high performers, and attracting and retaining human capital).
The authors initially collected detailed survey data for several hundred medium-size firms across several European countries. The data was validated through multiple interviews, and later, in collaboration with McKinsey, the sample was expanded. The first important result is that the index of managerial practice, constructed in this relatively objective and quantifiable manner, turns out to be strongly correlated with the economic performance of firms. In short, firms with better management practices do better in terms of their productivity and profits. This is not a guarantee that good management leads to good performance, but it is the best evidence we have ever had for such a hypothesis. All the money spent on management education and management consultants may make sense, after all.
The second learning is that there is a huge variation in the quality of management practices, within and across countries. In a four-country comparison, the US tops in quality of management practices, followed by France and Germany (together), with the UK trailing. A subsequent larger study still has the US first, followed by Sweden, Japan and Germany, then the UK, France and Italy, with Poland, Portugal and Greece next. China and India bring up the rear. But the variation within countries is much greater than across them, so individual firms are not trapped by the national environments in which they operate.
Third, certain observable factors help explain the variability of management practice. International and domestic competition both improve management practices. Multinational firms tend to have better management practices — so do firms with better-educated managers. Ownership also matters, in a specific way: Family-owned and managed firms where succession is by primogeniture seem to do worse.
Fourth, the variation within India was greater than in other countries, with relatively large proportions of very good and very bad firms. In addition to the family-owned firms run by eldest sons, government firms also have very poor management practices (yes, this is borne out by the data — politicians do take note). At the other end of the distribution, the top 10% of Indian firms in the sample were better managed than 75% of US firms surveyed. The spread of productivity across Indian plants is also much greater than that in China. This suggests that something in the business environment in India permits more heterogeneity in practices and outcomes. My guess is that India still has too many constraints on competition, permitting poor management practices and outcomes to persist.
I don’t have access to the raw data, but I also conjecture that India’s top performers are in the information technology industry, or its offshoots such as business process outsourcing firms. India also has a long history of private enterprise, which tended to be stifled in the decades of socialism. But these are issues for further research.
A final observation compares the impact of improved management practice with increases in labour or capital. The results of the larger study indicate that a one point increase in the management quality index (say from 2.5 to 3.5 on a five-point scale) would have the same effect on output as a 25% increase in the labour force, or a 65% increase in invested capital.
So, management does matter. In fact, it matters a lot — more than many people realize, even with all those business school graduates in the workforce. But the studies also indicate that managers tend to overestimate how good their practices are (Indian and Chinese managers are the most overoptimistic). So, even when people realize that management matters, they don’t have a good feel for whether they are doing it well or not. That lack of self-awareness may be due to a gap in management education, or the absence of benchmarks, or just the lack of the right measurement tool up to now. In any case, the data show that, as in many other areas, India has tremendous opportunities not only to catch up in management practices, but to leapfrog advanced countries, and improve its economic performance as it does so.
Nirvikar Singh is professor of economics at the University of California, Santa Cruz. Your comments are welcome at email@example.com