Monthly Archives: January 2004

Beware of squandering equity

AFTER announcing its latest results, Dimension Data now seeks approval for a new share scheme. The company says it “is proud of its history of employee involvement in share ownership”. Whether shareholders are as proud is a moot point.

Didata-&-Share-SchemeReturn on assets managed collapsed from a once heady 25% a few years ago to below zero and now to what management calls a “solid turnaround” of 2%. Will a new share scheme make any difference to the performance graph?

It shows how long it can take the capital markets and seemingly sophisticated investors to wake up as well as giving us some other useful lessons.

With performance improvement, a thriving industry of educators, consultants and evangelists offer “motivational” solutions for incompetence. They range from management education, training and team building to experiences in the wild, pep talks and the use of incentives. None of them works for long.

However, because performance is never good enough there is a constant search for new remedies to lift it. Dr Tom Gilbert wrote a masterful book on the subject of performance management in 1978. Pulling no punches, he argues that the subject of motivation arouses more nonsense, superstition and plain self deception than any other topic.

He argues that there are two aspects to it. First, there is a support system — the quality of expectations, information, facilities, measurement and feedback that management provides — the elements we should focus on but neglect. Second, there are personal motives. The belief is that if you don’t give people what they expect for good performance they will slack off. Results will also decline if they don’t want what you offer them.

With incentives there are two kinds: money and recognition for good work. The most powerful lever of all is money. However, the truth is it has less effect on productivity than the other support factors, especially expectations and information, because it’s the hardest one to grasp. Moreover, the higher you go in the organisation, the more slippery it gets. Why is that?

Because you confront a host of vested interests in incompetence, the issue becomes highly emotional and political. It is about distribution of wealth: who gets rewarded with how much for what?

That’s why top executive pay, coupled with corporate governance, is such a hot topic. Two remedies for improving results are performance bonuses and the use of share options. The problem is that there is no positive correlation between money paid and competence.

The fact is that top executive pay derives from one thing: the value of any firm is linked to its monopolistic position in the market segment it serves. This enables it to create high profits. It also means that many powerful people who control company performance systems are not paid for managerial competence. If they were, many would be out of a job.

That fear is a major barrier to the efficient use of money to influence behaviour. Look how many top teams quickly drop an economic value-added incentive scheme even if they get as far as introducing one. It is too tough for them.

The belief that the “profit motive” is a prime cause of competent performance is widespread. However, the most incompetent performance often results in big profits. The power to set and control prices is the only power corporations need to ensure the profit motive is selffulfilling. Collusion with competitors to develop “orderly market arrangements” is a most effective stratagem. Companies in SA’s telecoms industry are excellent examples of that. There are many others.

When people perform incompetently, and most do for most of the time, they inflate the costs of doing business. Top management in both private and public sectors then raises prices to cover them. Most of its talent is applied to developing strategies that make the price rises as invisible as possible.

When business slows, customers, especially the big ones, won’t accept the increases. That’s when the word goes out from the top: “Cut costs!” The message sent is that a higher level of incompetence is fine during boom times when customers can carry the cost burden.

Share option schemes probably have no effect on managerial performance, yet are the most costly from a shareholder perspective. Management justifies their use with the specious argument that they will make employees think like owners. They are no more than a perk.

If management has only one legitimate purpose — to maximise shareholder value — then a key measure will be the share price.However, using it as the basis for an incentive scheme stimulates behaviour that destroys shareholder value.

Didata is an example of a once brilliant company that did just that. Jeremy Ord and his team chased the share price at a huge cost to everyone but themselves and those shareholders and employees who had the knowledge and sense to pull out in time.

On a positive note, they showed yet again that productivity of the asset base fundamentally drives any firm’s share price and value. Therefore, any incentive scheme should be designed to influence behaviour that results in an improving, sustainable return on assets managed.

Shareholder equity is far too valuable to be squandered on managers who neither think like owners nor understand that business design and asset productivity ultimately drive strategic positioning and the value of the firm.

Get the return on assets managed up systematically and sustainably, and then watch the share price follow.

Black, a consultant, writer and coach, is co-author of Who Moved My Share Price? published by Jonathan Ball.