U.S. Firms Restructure and Revitalize
By Andrew Wilson
This is a chapter in The Dynamic American Firm, (Kluwer Acedimic Publishers, copyright 1996, ISBN 0-7923-9662-6). The book is a collection of essays by Dr. Murray Weidenbaum, Andrew Wilson and other authors.
Competition is a hard task master. In the '60s and '70s U.S. firms were able to set their own standards for performance in the absence of strong competition from the outside world. Wage hikes totally out of line with productivity increases were passed on to customers through high prices. Faulty products were passed along as well. Corporate bureaucracies flourished in a smug, insular environment.
"The inflation party", as Heinz's Tony O'Reilly calls it, "was the great underwriter industry in the 1970s." "When inflation was roaring," O'Reilly notes, "there was ready acceptance of the mind of the consumer for almost unlimited price increases. We passed on our increases and then some." If a manager built up too much inventory or gave away too much in labor contracts, inflation would bail him out, allowing him to bill those cost (along with a generous mark-up) to the consumer.
The emergence of the global economy, coupled with worldwide disinflation, spoil the fun. Suddenly, companies (and unions) were no longer operating within an hermetic system that tolerated, or even encouraged, high prices and shoddy performance. Far from being able to pass on price increases and faulty products, Companies suddenly found was necessary to lower prices and raise qualtity in order to remain competitive.
By and large, U.S. Companies have responded well to challenge -- despite the caterwauling of pessimists from the America-can't-compete school thought, there has been a strong resurgence in productivity and success in the U.S. manufacturing sector, in particular. Output per man-hour in manufacturing in the U.S. grew at an annual average of only 1.7% in the ten years to 1981; since then, a search to almost 3% a year -- almost as fast as Japan and faster than Germany.
Productivity in the economy's service sector has also begun to surge as a result of massive restructuring, application new technologies, and increased direct investment. Using Department of Labor information in keeping closely with the Fortune Service 500 definition of the service sector, productivity growth over the period 1990 through 1992 increased to an average annual rate of 1.7%. For the decade of the 1980s, service sector productivity grew about half that rate, .9% a year.
Behind the solid performance reflected in the macro-economic numbers are hundreds, or thousands, of stories of companies staging strong comeback -- companies like Ford, Chrysler, Whirlpool, Harley-Davidson and Hewlett-Packard. Meanwhile, other U.S. companies have come out of nowhere over last decade or so to become true world-beaters -- companies like Intel and Microsoft.
The chorus of despair raised by the America-can't-compete school in the early eighties now seems largely misplaced, if not a little ridiculous. Nevertheless, American firms were taught important lessons in the process of learning to compete.
Six Important Lessons For Business
The first business lesson talk by the emergence of the global economy is that the domestic market is no longer the exclusive preserve of any company or labor union, the matter how large and powerful.
The second lesson taught is that American companies can compete, without help (or hinderance) of government intervention. Not all firms have been able to meet competition, as shown by the closure of many steel, textile, and shoe factories. However, even in the industries that have been hit the hardest by international competition, some firms of met world standards of performance, price, and quality. Consider, for example, the great success of Nucor Steel, Milliken Textiles, and Timerlake Shoes.
But the third lesson is that local or domestic standards of performance are no longer relevant; world standards are now the test. The world become one expansive shopping mall through which consumers stroll at their leisure, free to pick and choose products for many countries.
The fourth lesson taught is that firms must be global customers as well as producers. They must seek out the lowest cost suppliers around world, or else they will have to concede a part of their domestic and international markets to competitors who do make the search.
The fifth lesson is that vertical integration -- controlling all stages of production process -- can be extremely hazardous. A weak link anywhere in an inflexible chain of production can spell disaster. Integrate companies run the risk of becoming beach whales -- left behind in low water because of a failure to adapt quickly enough to change in particular area of technology.
The sixth and last lesson is that it pays to be aggressive investing abroad and seeking increased international sales. That is true for big and small firms alike.
Biting The Bullet
In the initial shock of adjusting to sharply increased competition, the fat and happy must learn to become lean and mean in. Across the length and breadth of the U.S. industrial sector, increased import penetration in the late seventies and early eighties sparked an all-out war on costs. After three decades of almost uninterrupted growth in revenues, profits and employment, U.S. industrial firms -- en masse -- were forced to bite the bullet of downsizing and restructuring beginning late seventies and early eighties.
In nearly every sector of manufacturing -- aerospace and apparel through textiles and transportation equipment -- companies have made deep cuts in payrolls, which constitute about two-thirds of the total cost of production. They have reduced the number of employees (both workers and managers) required to produce a given level of output. Further, they have put the clamps on wage and salary increases, limiting them to an average of just one percent per annum in real terms in the 1980s. In some industries,workers have "given back" prior wage and benefit increases, while those who have survived in managerial positions have come to except longer hours and heavier were closed for little or no extra pay.
In addition, many other change of changes have further enhanced productivity in competitiveness. Many companies have obtained union agreements for more flexible work roles -- broadening traditional narrow job classifications and permitting important savings in the production process. Some companies have gone to a tiered wage system the pays new workers far less than veterans. Finally, strike activity has dropped to the lowest point since the Labor Department starting keeping records in 1947. For all of 1993, the number of work stoppage is involving 1,000 employees are more totaled 35 -- compared to 317 two decades earlier.
Manufacturing employment in United States fell from a peak of 21.2 million in mid-1979 to 17.7 million at the end of 1993. But while employment has sunk, actual production has climbed. The U.S. industrial production index stood at 114 at the end of 1993, up 33 percent for the end of 1979. Even though U.S. firms have moved a large amount production work offshore, the cardinal fact remains that industrial production inside the United States has been going up -- not down -- over the past decade and half.
Clearly, inside United States, industrial firms have learned to produce more with less -- with fewer workers and less investment in new plant and equipment than ever before. In a word, they have become more competitive.
That puts the monkey on the back of the Europeans -- and even the Japanese. As a result of the increased competitiveness of firms in United States and other parts of the world, European companies, in particular, are confronting the need for radical restructuring programs of their own.
Consider Italy's GFT, which produces top-of-the-line men's suits under the labels such as Giorgio Armani and Valentino. In 1992, GFT succeeded in obtaining union acceptance of a plan to shift half of the companies production capacity offshore to Mexico, China and other places. Said Giuseppe Cadili, a 30-year veteran of GFT: "We thought of opposing a strategy of internationalization, the company with gone completely bust."
According to a survey conducted by consulting firm in 1993, over half of the 400 largest companies in Europe are planning significant cuts in their workforce in the next few years. That is in addition to the sizable cuts that already been made in recent years.
With the creation of a single European market, and continued globalization, it is clear that Europe has to many companies producing too much of just about everything. That includes 22 airlines, 12 automakers, 36 brands of baby food, and 225 makes of home appliances. What's worst, a problem of excess capacity is combined with a problem of high labor costs.
To shake the burden of domestic labor costs that exceed $25 an hour, German manufacturers shed over 500,000 jobs in 1992 and 1993 while opening new plants in Eastern Europe, China and United States. "You use to join Siemens for life," notes Claude Courteaux, Paris-based senior vice president with General Electric Company's Medical Division. "Now, there can be no more promises."
Scores of U.S. companies that been through the wringer in restructuring have discovered it is perfectly possible to drive down costs while increasing quality and customer satisfaction. In addressing a group of European CEOs in 1994, John F. McDonnell, the former CEO of McDonnell Douglas, the 23rd largest U.S. industrial company, offered some pointed advice.
Robert B. Shapiro, CEO at Monsanto Company, makes a similar point:
The "Hollow Corporation" Revisited
In what could be described as the high water mark for a veritable flood of pessimism on the state of U.S. industry, Business Week magazine ran a cover story in 1986 entitled, "The Hollow Corporation." The article attempted to show that U.S. firms were turning into empty, "de-industrialized" shells of their former selves -- unable to develop or build, serving only as passive vessels for distributing or selling products made by other companies, often of foreign extraction. Said Business Week: "from autos to semiconductors, many U.S. manufacturers are turning into markets for foreign producers. A new type of company is emerging -- one that may design or distribute, but doesn't actually make anything. A hollow corporation. It is a phenomenon of our economy cannot afford."
The article was not totally off mark. As Business Weekobserved, "U.S. manufacturers are pursuing a strategy of out-sourcing, buying parts or whole products from other producers, both at home and abroad -- with a vengeance." Moreover, "outsourcing breaks down manufacturers traditional vertical structure, in which they make virtually all critical parts, and replaces it which networks of ... suppliers."
Both observations were perfectly true. However, in sifting through the facts, Business Week reached wrong conclusion, confusing healthy adaptation to change for evidence of decline and surrender.
Paralleling the course of former communist states, big firms have abandoned the quest for autarky as a bankrupt strategy. The outright collapse of integrated production empires in some industries and the extensive dismantling of other industries have cleared the way for accelerated gains in productivity and performance within a new environment based on voluntary exchange.
Nowhere or is that state of affairs more apparent than in the computer industry. Up
starts like Intel and Microsoft have created legions of new millionaires within their own
ranks -- while using technology to provide a leapfroging improvements in product
performance that have quickly become new industry standards. Notes Intel's Andrew Grove:
Grove went on to note that the new computing industry resists central guidance.
At the same time they're buying from more outside vendors, many U.S. firms are putting once-captive supply organizations to the test of selling in the open market. IBM, for example, aimed for $1 billion in outside chip sales by 1995 -- up from zero in 1992. In alliance with Motorola and Apple, IBM is also taking aim at Intel (which supplies about three out of every four microprocessors used in today's personal computers) with a new ultra fast and inexpensive microprocessor called the PowerPC. Almost all Apple Macintosh Computers are now based on the PowerPC. But IBM still doesn't build PCs based on the PowerPC chip, and no Mac clones -- as many expected it would buy now.
In similar fashion, General Motors, the most integrated of the big three U.S. auto producers, is out-sourcing more and pushing its huge Automotive Components Group (ACG) to sell more on the outside -- even to direct competitors in the automotive field. ACG is closing money losing businesses and pushing for growth outside the United States. In 1994, it's sold $75 million of anti-lock break systems to Toyota and other Japanese car-makers, some of them for cars made in sold in Japan.
The factor the matter is that in today's environment, no firm can make make-versus-buy decisions on sentiment or tradition. They are compelled to seek the least cost solution for their product requirements. The message to former "captives" is clear: Compete, or perish.
What Business Week called "hollowing out" could better be described as a "winnowing out" process. Far from sounding the death knell, increased outsourcing has strengthened U.S. industry. It has pushed specialization to higher level, encouraging big firms to focus more narrowly on areas of true competitive advantage, while creating a wealth of opportunities for smaller, leaner firms. All in all, it is hard to think of a better example of what Schumpeter called "creative destruction."
Shifting Sands: Foundations of the Firm
The global economy is a reminder to businesses everywhere at the "firm," per se, is not an end in itself, but merely the means to other ends -- the ends of satisfying customers and, in doing so, providing a reward to the firm's owners, or shareholders.
Over 50 years ago, University of Chicago economist and law professor Ronald Coase examined the roots of firms, asking what economic and legal purposes were served by the existence of large, disciplined business organizations. Why was so much economic activity carried on by firms as opposed to being done in a totally decentralized way through individual entrepreneurs contracting with one another for the needed goods and services? Clearly the latter method has the advantages of subjecting all parties to the disciplines of the marketplace -- the disciplines of competition, publicly quoted prices, and specific performance requirements.
Consider the problem of hiring hundreds of workers under separate contracts, as opposed to paying the same number of workers a wage -- which is a price not for specific performance but for the right to direct their performance. Relying on managerial judgment and expertise, communicated through a chain of command, the firm eliminates the need for costly, protracted bargaining in the marketplace.
In short, a firm promotes economic efficiency by substituting a visible hand of management for the invisible hand of the marketplace. That insight earned Coase a Nobel Prize in economics in 1991. It also goes a long way in explaining the nature and direction of important changes -- suggesting why, in today's environment, the once-powerful invisible hand has atrophied, becoming less strong and controlling.
If firms are regarded as a mechanism for reducing transaction costs, then it is clear that they have lost a large part of their raison d'etre. As a result of improved communications and the emergence of a global economy, transactions costs are not nearly as high as they once were. It is simply a lot easier and cheaper to buy many goods and services in the open market that once wives. What's more, heightened competitive pressures have laid bare the chief weakness of organizing economic activity through a firm. Since employees are not paid directly for their output, a firm's workers and managers have less incentive to cut costs and add value than do outside contractors bidding for work.
It is, therefore, to be expected that more and more transactions are taking place outside of firms, in marketplace. One tell-tale sign: while Fortune 500 companies have shed close to 3 million jobs over the past decade, the business service market has added over 3 million jobs over the same period. Companies are buying a wide range of services from the outside which were once performed by full-time employees. In many cases they are engaging the services of former employees as consultants. Thus the same competitive forces that went into creating a huge pool of corporate refugees are also responsible for growing demands for their services.
Like "de-industrialization," the rapid rise of business services and self-employment over the past several years has set alarm bells ringing in the enlightened centers of thought. "In the future," one displaced executive told Time magazine, "we're going to be moving from job to job in the same way that migrant workers used to move from crop to crop."
Perhaps. But unlike the migrant worker moving from crop to crop, today's corporate refugee, equipped with a personal computer, printer, copy years and fax machine -- all purchased for about $7000 -- can earn a good living toiling in the comfort of his, or her, own home. That is so because the information revolution has greatly reduced the transactions costs -- for big firms and small contractors alike.
The same logic regarding contracting for services applies to contracting for the key components in product -- everything from the springs in ball-point pens to automobile shock absorbers. Given cheap communications and worldwide sourcing, why make anything that is more easily and economically purchased? Intel's Andy ?Grove states bluntly: "Anything that can be done in the vertical way can be done more cheaply by collections of specialist companies organized horizontally.". He cites a telling (non-computer) example: "Takes skis. Any ski boot works with any binding. Any binding fit any ski. That permits innovation to take place independently in boots, bindings and skis."
The recent problems of Japan's NEC illustrates the futility the go-it-alone approach within the context of an increasingly integrated and technologically sophisticated world economy. While NEC holds about half of the total Japanese market for personal computers, it is now losing both market share and money as a result of a marketing blitz by U.S. companies with ultra-low-priced PCs that have the processing power to handle the 10,000 complex characters in the Japanese language. The arrival on the scene of Intel's 386 microprocessor in 1985 gave Compaq, Dell and other U.S. computers the ability to leapfrog NEC (which makes its own microprocessors) with superior products. Rubbing salt in NEC's wounds, Compaq has run the ads in Japanese newspapers likening the personal computers sold by NEC to the prehistoric wolly mammoth. Badly stung, NEC has begun to import U.S.-made computer chips.
And if outsourcing is on the rise, so, too -- for basically the same reasons -- is decentralization. Ideally, decentralization serves as an internalized form of outsourcing -- resulting in greater cost consciousness among employees, a stronger commitment to the success of the enterprise, and wider scope for risk and innovation.
Academician/consultant Rosabeth Moss Kanter tells a story that shows how quickly the recent past has become ancient history in corporate America in a visit to IBM in 1981, Ms. Kanter offended her host by using the word "entrepreneurial." And IBMer at the same time told her: "To us that means people who have beards, hang out in basements, and are un-disciplined." But times of changed inside Big Blue -- as everywhere else in corporate America. Breaking the company's decades-old, white-shirt-only tradition, Lou Gerstner -- brought from the outside to take over as CEO in 1993 -- created an immediate sensation by arriving for his first day of work wearing a blue shirt.
By stressing itself-directing teams, big firms, within their own button-down, command/control, committee-ridden organizations, are trying to recreate the same kind of creative tension that exist in small, independent firms. In doing so, they are trying to reduce what could be described as internal transaction costs -- all the additions to costs caused by excessive bureaucracy, oversight and central direction, and by poor communications across functions, between business groups or among people with different levels of the organization. Shurly Ronald Coase, writing in the first half of the 20 a century, could hardly have imagined the eventual extent of such costs within large-scale private enterprise.
The redoubtable Jack Welsh of GE has become the most noted and quoted, the most passionate and eloquent advocate of change within the ramparts of giant-size corporations, advocating the creation of about "boundaryless corporation ... where we knocked down the walls that separate us from each other on the inside and our constituencies on the outside." "What we're trying relentlessly to do," he quoted in GE's 1992 annual report, "is to get that small-company soul -- and that small companies speed -- inside our big company body." Waxing warmer still, Welsh wants "to ignite this big company with passion, hunger, appetite for change."
Perhaps no U.S. firm has enjoyed greater success with thoroughly decentralized, highly motivated style of management than Rubbermaid. The company makes only the most mundane products -- mop's, dust pans, laundry hampers, garbage pales, dish drainers, ice cube trays, mailboxes, birdhouses, and many many more. It is now the "champion innovator," churning out new products at the rate of one a day for stores around world. Each new product reflects the efforts of a cross-functional team, usually consisting of five to seven people. However, the various teams must compete fiercely with one another for R&D dollars; each potential new product is weighed in the balance against a number of others.
Information technology plays a dual role as Rubbermaid -- a sort of good cop/bad cop
routine, which gives small teams the freedom to operate the world stage, while allowing
top management to keep an eagle eye trained on the results of each of the teams, down to
the smallest details such as the amount of material that has ended up as scrap. As
Wolfgang Schmitt, Rubbermaid's CEO, told the Center for the Study of American Business:
Though the products it makes are as dull as dish drainers, Rubbermaid has made it all the way to the top of Fortune magazine's list out to be "Most Admired Corporation in America" as a result of a sustained record of fast growth and dazzling financial results. The firm appears to have succeeded in squaring the proverbial managerial circle -- by achieving higher levels of cooperation and competition within its own organization.
Fortune Favors The Bold:
As mentioned previously, it seems that the only defense in today's global economy is a good offense. That conclusion is powerfully underscored by 1991 Conference Board study of 1,250 U.S. manufacturers regarding their participation in the world marketplace.
The report states unambiguous that sales growth for firms with no foreign activities is half of that of the survey average. In every industry and in most size categories, firms with international activities grow faster than those without. Profitability also increases for firms with a broad global scope. Companies with foreign plants in all three global regions (North America, Europe in the Pacific Rim) post figures for return on assets and return on equity that are significantly better than companies whose international activities do not cover all three key regions.
Commitment to competing globally goes hand in hand with sales growth and superior profits. According to the Conference Board, firms with no operations abroad average (five-year) sales growth of just 8 percent vs.16 percent for international firms.
Perhaps the most surprising finding of The Conference Board report concerned the performance of smaller firms. The report blows a gaping hole in the idea that global business is a game for giants -- requiring the extensive professional and financial resources found only in big firms. Clearly, lowering of "transactions costs" are result of advancements in information technology and the increased openness of the global economy has been a critical factor in enabling small firms to become active on worldwide basis.
As with bigger firms, internationally-active smaller firms (below $500 million in annual sales) outperform domestic stick-in-the-muds of all the same size by a wide margin. What is more remarkable, within the total group of firms that are internationally active, the smallest of the small exhibit the most dramatic improvements. To wit, small multinational companies, those with annual sales under $100 million, perform as well as, and sometimes better than, large multinational companies.
The smallest of these multinationals average of five-year sales growth of 67 percent. They also averaged 35 percent return on equity over three years. Although the Conference Board's sample of small multinationals was made up of only a few firms, it suggests that success overseas is not strictly a function of size.
The new ease with which firms are able to move information, capital, and work across national borders ranks as an epochal development. In one stroke, it has dealt a triple blow to big government, big business, and big labor. All three are struggling to adjust to new conditions which are fundamentally inimical to all attempts to directi and control economic activity through large bureaucratic organizations.
The down-and-dirty restructuring of many U.S. firms is being succeeded by a search for new organizational arrangements that involve reduced reliance of command-and-control managerial systems -- and increased reliance on the kind of voluntary exchange that happens in an open marketplace. Firms are giving more work to outside contractors has a result of lower "transactions costs" for marketplace transactions; and they are seeking to minimalize the internal transaction costs by pushing more of management and direction of the remaining work down to the level of self-directing teams.
An aggressive global approach confers obvious advantages in lowering costs, gaining access to new markets, and leveraging the benefits of capital investment and new technology. Small firms, as well as large, are reaping the benefits.
What's more, there is no safety or repose in the stay-at-home approach. Like military commanders contemplating a vast improvements in tanks and war planes following World War I, the leaders of business organizations have been forced out of the trenches and into more mobile, expansive mode of operation. Active global involvement is no longer an option for most firms of any size. It is a necessity.