When More Is Not Better: Overcoming America’s Obsession with Economic Efficiency

by Roger L. Martin

Roger Martin, dean of the Rotman School of Management at the University of Toronto from 1998 to 2013, writes about a fragile imbalance in the U.S. economy and the erosion of the middle class. Major themes include efficiency vs. resilience, reductionist thinking vs. complex adaptive systems, and gaming the system. He cites examples of companies where an obsession with efficiency was catastrophic, and conversely, where slack is the secret sauce. He offers policy solutions in such areas as antitrust, taxation, stockholder voting rights, and education.

From 1947 through 1976 “the real median family income in America grew at a healthy annual compound rate of over 2.4%… that is, doubling in one 30-year generation.” From 1976 through 2018… “the growth in median income fell to an anemic 0.6% per year… The prosperity of a vast majority of families is no longer moving smartly upward.”

The distribution of income and wealth is looking less Gaussian (normal curve with a large middle and small tails) and more like a Pareto curve (colloquially known as 80/20 rule) where most of the benefits accrue to a small portion of the population.

Corporate profits are following a similar trend. “In more and more industries, profits are concentrated in a handful of companies… In 1978 the 100 most profitable US firms earned 48% of the profits of all publicly traded companies combined, but by 2015 the figure had nearly doubled, to 84%.”

BUT WHY? Martin points to an obsession with economic efficiency “which has produced a dangerously unbalanced economy lacking resilience.”

The book tells the sad story of private-equity firm 3G Capital’s acquisition of Kraft Heinz. Slashing 20% from overhead expenses resulted in “a 3.5-percentage-point reduction in profit margin… [and] forced Kraft-Heinz to announce a massive $15.4 billion write-down in its assets in February 2019… 3G Capital is learning an important lesson: serving the customer distinctively at a profit is a goal that requires thoughtful and intelligent slack—friction against efficiency.”

The book also explains why operationally healthy companies Toys R Us and iHeartMedia went bankrupt. “The bottom line is that a relentless and unconstrained drive for capital efficiency saps LBO acquisitions of all their resilience.”

SURROGATION. The author introduces the term surrogation, which is the conflating of proxy measures (surrogates) with the desired outcomes. Examples would be tying executive compensation to stock price performance or tying teacher compensation to test scores.

Business executives can guard against this by using multiple measures. For example, Southwest Airlines uses four: cost, customer satisfaction, employee satisfaction, and profitability. “It reinforces that these four proxies add up to an approximate measurement of the model’s outcomes, not a representation of the model itself. More generally, it recognizes that a system is a complex combination of parts—that move both separately and together—and that success requires maintaining a balance between that connectedness and interdependence of the parts and separation between them.”

COMPLEX ADAPTIVE SYSTEMS. “Executives are taught to manage machines… This training teaches them to break down their companies into the constituent parts—individual disciplinary pieces—and optimize each piece; all with the assumption that the pieces can be added back up to produce a productive and useful whole.”

“Managers should instead embrace the reality that a business is a complex adaptive system, in which the components and subsystems are highly interdependent, human processes in which over-optimizing one part compromises optimization of another part and can lead to alienation and disengagement from the people you need to be most engaged.”

The book includes examples of successful companies that take a holistic system view.

SLACK. MIT/Sloan professor Zeynep Ton, author of The Good Jobs Strategy, “sees slack as a variable in a complex adaptive system to be balanced rather than as an error to be eliminated… Deming himself recognized the systemic complexity of businesses and taught that there is always an optimal level of slack for any business system—and that level is not zero. Slack…contributes to greater reliance.”

UNCERTAINTY. “It is never possible to be certain in such a complex adaptive system…In a complex adaptive system, there are no perfect answers, or even perfect directions. There are just better and worse ones in the moment… There will always be unexpected effects.”

Martin offers several recommendations for political and education leaders.

LEGISLATIVE REVIEW. “Every new piece of legislation dealing with the economy should be made subject to periodic review and sunsetting if it doesn’t pass muster in such a review. This will raise the cost and lower the value of gaming [the system] by shortening the period during which the profits from gaming can be accumulated.”

TRADE POLICY. “Contributing to this imbalance is the fact that American trade policy is in fact freer than that of its trading partners. Virtually every major developed country restricts competition in sensitive sectors of its economy in numerous ways.”

ANTITRUST. “The argument that the technology companies that preside over two-sided monopolies aren’t hurting consumers because their service is free is misguided. In a two-sided market, there are—as the name indicates—two sets of customers. For Google, for example, on one side is the search-engine user and on the other side is the advertiser seeking to communicate with that searcher. To say that Google couldn’t be causing harm as a monopolist because it doesn’t charge anything to the first customer is embarrassingly naïve. The other set of customers—who increasingly get gouged as Google becomes more of a monopolist (or in fact a duopolist with Facebook) in the online-advertising market—matter as much as the first set in the two-sided.”

Martin explains that antitrust laws were weakened in the 1980s and 1990s. “The efficiency defense should be relegated to the dustbin of history, and policy makers should ensure that antitrust laws return to their original purpose of serving as a deterrent to monopoly outcomes, regardless of short-term efficiency gains.”

STOCKHOLDER VOTING RIGHTS “As presently constructed and regulated, the capital markets are feeding, encouraging, forcing, and rewarding short-term, anti-resilient behavior… The result shows up in the pursuit of short-term efficiency proxies like workforce reduction, outsourcing, and off-shoring—proxies that are destroying companies’ longer-term competitiveness and resilience to external shocks.”

One promising development is that the SEC approved a new Long Term Stock Exchange (LTSE) founded by Eric Ries, author of The Lean Startup. “LTSE will explicitly require companies that list on the exchange and investors that trade on it to follow practices that are oriented toward the longer term [although] the exact listing rules had not been made public as of this writing.”

Another approach to counter short-termism is tenure-based voting. In France, shareholders get two votes for every share of stock they’ve held for more than two years. Martin says, “I would go further than France, because two years is not long-term enough to enable management teams to take consequential action, and doubling of voting rights is not enough to make a meaningful difference. Instead, I would give the owner of each common share one vote per day of ownership up to four thousand days, or just under eleven years.” This would curtail the influence of an activist hedge fund whose holding period is measure in months.

TAX RATES. “Policy makers simply must increase the tax rates at the high end of incomes. Since 1987, at the federal level, the top marginal personal-income-tax rate has been below 40% and has averaged 36%—in contrast to the half-century preceding 1987, during which the rate averaged 80%… My recommendation is a top federal rate of 45% for incomes between $500,000 and $5 million, 55% between $5 million and [$10 million], and 65% above $10 million.”

EDUCATION. “The job of educators should be… to help students become capable of thinking in a complex and uncertain world… not to make them capable of operating only a narrow part of a complicated machine… Currently, the formal education system produces overconfident reductionists who don’t see that they are operating in a complex adaptive system and are altogether too sure of the quality and usability of their piece-part solutions.”

“At present, the formal education system predominantly teaches certainty… There is zero reward for nuance, for ‘maybes,’ for ‘it depends’… We need to teach students to balance the manipulation of quantities with the appreciation of qualities.”

Martin notes that his recommendations are not theoretical: “They may come from a different context or jurisdiction [but] they are demonstrably doable—because they have been done.”

Martin, Roger L. When More Is Not Better: Overcoming America’s Obsession with Economic Efficiency. Harvard Business Review Press, 2020. Buy from Amazon.com

Disclosure: As an Amazon Associate I earn from qualifying purchases. I received a review copy of this book.

Related reading:

The Good Jobs Strategy: How the Smartest Companies Invest in Employees to Lower Costs and Boost Profits by Zeynep Ton

It’s Not Complicated: The Art and Science of Complexity in Business by Rick Nason

The Shareholder Value Myth by Lynn Stout

Slack: Getting Past Burnout, Busywork, and the Myth of Total Efficiency by Tom DeMarco

The Tyranny of Metrics by Jerry Z. Muller

Published by andreweverett360