My academic credentials are nearly nonexistent on this subject. I took a single one semester class on Business Law in High School. I took some American Institute of Banking classes decades ago when I worked for a Bank. What you are getting is a worm's eye view of the situation, what things looked like from the other end of the organization chart. Like many, I have repeatedly asked myself "why did they do that?" when some particularly spectacular piece of management stupidity surfaced either at work or in the news. The same kinds of things kept happening over and over so there had to be some underlying method to the apparent madness. It took me a long time to extract the method as the "usual suspects" were of no use. None of what I am about to reveal is to be found in any MBA curriculum, academic publication, or in the prodigious output of the "business press" (Forbes, CNBC, etc.). But these are iron clad principles that have the force of law in actual business practice.
But first, how could this be one of my posts without a digression? So let me digress, but only for a very short time, and ask "how do CEOs justify their large compensation packages"? Their answer is that "they work hard and they are smart". And by "smart" they really mean something more along the lines of skillful. They have to be very smart to understand the complex problems they wrestle with on a day to day basis. But they also have to apply the very best judgment to solving these problems. So more than just raw "smarts" are required. So, in their eyes, they really are very special. Let me first address the "hard work" issue as it can be easily dispensed with.
I have frequented several sandwich shops over the years. The ones I frequent (and here I am specifically talking about the non-chain shops, e.g. Subway) have been run in many cases by Korean women of a certain age. I have no idea how many hours they put in but its a lot. They are there from dawn till dusk. In one shop I now frequent all the pastries are baked on site every day. So the proprietor is there from before sunup until the shop closes late in the day. These ladies put in an unbelievable number of hours. And this applies to many small businesses. I have frequented establishments run by both sexes and all ethnicities. Many small businesses depend heavily on the proprietor. And they depend on that person putting in long hours every day and having the flexibility and skill to perform multiple duties. I would stack up the range of skills and the work ethic of these proprietors against any "ten million dollar man" (and they are nearly all men) helming one of these corporate behemoths.
The rest of this post will address the intelligence and judgment components.
General Ledger
Ok. I was not altogether honest. Because I need another digression. The term or art for the corporate books is General Ledger. Some of you may be familiar with Quick Books, an inexpensive software package designed for use by small businesses. And a thorough discussion of General Ledger systems would span several weighty volumes. But there are only a few things you need to understand. And those things can be covered quickly.
General Ledger systems have what's called a "chart of accounts". This is a list of buckets (e.g. accounts) into which items of income or expense are placed. There is a separate chart of accounts for each department. Each account for a department is "rolled up" to create a division total. These totals are rolled up through larger and larger portions of the corporation until you finally get to the top. Then all the top accounts are rolled together to figure out how the corporation as a whole is doing.
General Ledger systems fulfill several roles. So it is useful to have lots of separate accounts. In a store there can be an account in the "shoe" department for "men's shoes" and another for "women's shoes" and one for "socks" and so on. So each time a pair of men's shoes is sold the amount is added into the correct account. In a similar manner the sale of a pair of women's shoes goes into its account. And so on. And we can have an account for "sales tax" and other accounts for other things. So in order to find out how the department is doing you can add all these accounts together. But you can also add the accounts for "men's shoes" together from all the shoe departments in all the stores to see how "men's shoes" are doing over all. This should give you the flavor of how General Ledger works and why most General Ledger systems have lots of separate accounts.
And so far, I have talked about income accounts. There are also expense accounts. The shoe department might have a "salary" account. But, in the same way it was useful to have lots of income accounts, it might be useful to have an "overtime" account and a "bonus" account (shoe sales people might get an extra "bonus" for selling a particularly large amount of shoes). And there might be a "lighting" account and an "advertising" account and so on.
So that gives you a flavor of how General Ledger works at its most basic level. And I demonstrated how it might be useful to add the accounts up in different ways. Corporations of any size add the accounts up in at least three different ways. (1) They add them up one way to calculate their Income Tax bill. (2) They add them up a second way to produce the "Annual Statement" for stock holders. And (3) they add them up a third way to assist management in running the company. Why do they do this? Because each "way" serves a different purpose. In the first case the idea is so show the least profit so the Income Tax bill will be as low as possible. In the second case the idea is to show the most profit so the stock holders will be happy. In the third the idea is to shed light on what parts of the business are doing well or badly and which managers are doing a good or a bad job.
As an example of this, Boeing is one of several companies that is not profitable, at least when the accounts are added up in the proper way. How do we know? Because they have not paid any Income Tax in years. However, if we add things up in the "Annual Statement" way, Boeing is very profitable. So it is only fair that their senior executives should be paid millions. And, as far as I can tell, Boeing does a terrible job properly adding things up in the third way, the way that allows them to make good management decisions. Because they have made a lot of really boneheaded decisions over the past couple of decades. With that digression complete let me get back to the main line of analysis. My first issue of management stupidity is:
General Ledger Visibility
What do I mean? Well, a few years ago Boeing was going through hard times. This resulted in a laser focus on expenses. This in turn resulted in an edict from the top echelons of the company to trim the use of office supplies and to cut travel expenses. What? Boeing is a multibillion dollar company. In this environment accountants have a term for things like office supplies and travel expenses. It is "not material", as in "this will not have a material effect on the financial situation". So why did Boeing management highlight these two tiny expense categories even though completely zeroing out all expenses in these specific categories would not have affected Boeing's profitability in a noticeable way? It is because small though they are they are "visible" in General Ledger. Each department has a General Ledger account for each. If the amount of expense in either or both of these accounts goes down the reduction will directly increase profit. But, you say, what about doing something that would make a big difference like say making Boeing engineers more efficient?
There are lots of engineers. They have relatively high salaries (not senior management salaries but definitely not janitor salaries either). If you were to say increase the efficiency of engineers by 1% wouldn't that save lots more money than you would by dinging the office supply and travel accounts? It turns out surprisingly the answer is no? The thinking goes that Engineers are on salary. If you increase their efficiency by 1% their payroll cost does not change at all. They just end up sitting on their hands for a few minutes over the course of a week. So no number in General Ledger changes so there is no savings. Is this right? It doesn't matter. Management thinks it is right. So since, to management's way of thinking, reducing office supply costs and travel costs changes the numbers in General Ledger, albeit by a small amount, it is better to do that than to try to increase the efficiency of Engineers because the latter change will not show up in the General Ledger numbers.
This General Ledger Visibility problem raises its ugly head in even more perverse ways. One way to restate the problem is "General Ledger is more real than reality". In the early days of the space program there was a process called "ground truthing". NASA people would look at satellite pictures or other measurements. Then they would go out and actually look at what was on the ground, the ground truth. They wanted to understand how much of what the satellite said was really real. Then they could figure out how far to trust the satellite data. In many cases the satellite data gave a better picture of what was going on than you could get from the ground. In other cases there were various fixes and adjustments that were necessary to get the satellite data to align with reality. And in still other cases the satellite data was misleading and could not be trusted.
General Ledger systems are like satellite data. Sometimes they tell you what is going on better than any other method. Other times they can be trusted after the appropriate adjustments and fixes have been applied. And other times they just plain mislead you. Many executives, however, are true believers when it comes to the numbers General Ledger systems spit out.
Manageable versus Unmanageable Costs
Let me be clear what I am talking about here. If an executive believes that actions he takes can affect a cost then that cost is manageable. Otherwise, it is unmanageable. Let me give you an example, in this case an example that has nothing to do with Boeing. A company I worked for used a lot of natural gas. Now this cost was visible in General Ledger. It had its own little line in the chart of accounts in a particular department. And the amount was large, millions of dollars per year. So that was not the problem. The problem was that the company had almost no control over the cost of natural gas. So to a great extent the cost was unmanageable. Now they did what they could. They put a great deal of effort into using the gas efficiently so they used as little as possible. They also tried to be smart about how they bought gas. If the thought the price trend was up they would sign up for a long term contract at a fixed price. If they thought the price trend was down they would avoid long term contracts and buy on the "spot" market.
Now the above example is a set of specific circumstances. So I'm going to move on to a more general situation. (I don't know if it applies to Boeing but likely it does.) Companies occupy buildings. In some cases they own the buildings but the trend is toward leasing. These buildings involve operating costs, specifically power for heating, lighting, air conditioning and other machinery, etc. The prime consideration that goes into how most buildings are built is construction cost. They are typically built as cheaply as possible and no thought is given to whether this will result in high operating costs. So typically these buildings are very inefficient to operate. In the last decade or so a lot of effort has gone into studying this. And it turns out that a lot of ways have been identified to reduce operating costs, particularly costs associated with energy use. And some of these ways turn out to have very good cost/benefit ratios. I have a brother who has studied this area thoroughly. He says that a lot of these "retrofits" pay for themselves by reducing operating costs dramatically. A typical payoff period is 18 months. That is a fantastically quick return on investment.
But in spite of this it is very rare to see buildings retrofitted. Why? Well, let me trot out a very lame excuse first. Many building leases are "all in". The price of the lease requires the landlord to pay operating costs like energy bills. So if the building is retrofitted it will be disruptive to the company using the building and, since the rent is fixed, there will be no cost savings. This is lame. If the retrofit is done and the rent is reduced but by less than the savings both sides benefit. The land lord has more money left over after his operating costs have been deducted from the rent check and the tenant sees cost savings because the rent is now lower. So why doesn't this happen? Because management sees rent as an unmanageable cost. It doesn't matter how high it is. It's unmanageable so efforts are turned to reducing costs in other areas. Is management correct? No!
Red money, Green money, and Blue money
If you think at all about the color of money you probably think it's all green. A nickname for U.S. currency is "greenback" because that's the predominant color of our currency. I used to also believe that all money was the same color too. This led to a lot of frustration.
In a previous job (not at Boeing) I was responsible for selecting and procuring computer equipment. This was back in the old days when a nice computer ran several million dollars. So we are talking decisions that involved very high levels of management because the equipment was very costly. (The company was far smaller than Boeing so a million dollars was a very big deal.) I am going to skip over all the "do we really need to do this" part of the discussion. Let's assume that everyone has agreed that the investment needed to be made and we were just trying to figure out how the acquisition should be structured.
What I mean by "structured" is "buy, rent, or lease" and "new or used". The idea was to pick among the various possibilities. Now naïve old me, I cranked up the spread sheet and starting calculating the cost of the various options. My assumption was "all things being equal" (and I wrangled all the technical issues to make sure that all things in fact were equal) we just wanted to structure the deal to result in the lowest overall cost. This is where I learned the hard way about red money, green money, and blue money. What do I mean?
Well part of that whole General Ledger thing is what is called a budget. Before the year starts all the income and expenses for the next year are estimated. Then the idea is not necessarily to make income go up and expense go down. It is to hit your budget numbers. (I must say that if you missed your income numbers on the high side and your expense numbers on the low side people would be pretty happy even though technically you missed your numbers.) But part of the process of creating the budget was to guess what would happen, money-wise. So the budget might include money for our piece of computer equipment. And an assumption would be made as to whether it would be bought, rented, or leased. Needless to say, there were separate "buy" "lease", and "rent" General Ledger accounts. So typically one of these budget accounts would have money in it and the others would be empty.
Silly me. I knew that there were separate accounts. But I had heard of money being "reprogrammed" in the federal budget to cover some unexpected event. And I'm a computer guy. I know that all this budget stuff is just numbers in a computer file. It's not that hard to move the numbers around. So I do my analysis. And I figure all I have to say is "if we do it this way we can save a lot of money so we just reprogram the money and everyone's happy". That's when I learned about red money (capital), green money (lease/rent), and blue money (maintenance and other operating costs). Apparently there is no philosopher's stone to turn one color of money into another color.
Now there some good reasons for not changing the color of money. There's fraud. You don't want people just changing things around willy nilly. But it is not hard to put procedures in place so you make sure the changes serve a legitimate purpose (saving money) and not just providing a cover for hanky panky. And there is the issue of "ratios". Most companies operate on borrowed money. And the banks are supposed to make sure that the company can pay the borrowed money back. So they might require a company to maintain a certain "capital ratio". The details don't matter but the result is that a company might not want to make a capital expenditure (buy some expensive piece of equipment) because it will cause the capital ratio to go out of whack. Contrarily, it might be necessary to buy something rather than rent it to keep some other ratio in line. But in my case none of these considerations came into play. Changing the color of money was perfectly feasible. It was just not done.
The Myth of Rationality
The model business people hold up of themselves to the world is that of rationality. They are not swayed by sentiment. "It's just business, mam." They want you to believe that the decisions they make are based on careful analysis and are driven solely by the profit motive. But its not so.
After many years, Boeing seems to have finally gotten the 787 program on track. They are able to build and deliver the planes on schedule and the airlines are able to put the planes in service and keep them there. But a lot of pain, suffering, and money, have been poured down numerous rat holes to get to where we are now. If you listen to management propaganda, then each of the major decisions made at the start of the program was the result of cold rationality applied to careful analysis. Here is a list of the most important and consequential decisions management made:
- They would move from a plane made primarily out of aluminum to one made in large part out of carbon fiber.
- They would transition from a "send a lot of small parts from subcontractors to a Boeing plant for final assembly" to a "send large pre-assembled pieces of the plane to a Boeing plant where they will be snapped together" construction method.
- Instead of Boeing doing all the design and "integration" (making sure all the parts fit together) work a lot of the design and integration work will be done by contractors with Boeing supervising.
- Instead of almost all of the plane being built in the U.S. large parts of the plane would be farmed out to foreign countries.
Taken separately any of these decisions might make sense. But taken together they represented a recipe for disaster. In my opinion, when these decisions were made Boeing management was in poor shape. What is common to all these decisions is that each decision separately would require more and better effort from Boeing management than the alternative "do it the old way" option. This is particularly true of decision #4.
The 787 program has been a fiasco for most of the lifetime of the plane. I thought at the time that Boeing really needed to do #1. But this would be hard to do. So I thought they should focus on it and avoid change elsewhere in the program. Obviously they didn't. The result was chaos everywhere. And chaos is very expensive in the plane building business
There were a number of engineering problems. This delayed things. Then parts came in incompletely or incorrectly assembled. Then the pieces did not fit together very well. And various subcontractors had trouble coming up to speed. In particular, problems in South Carolina were so great that Boeing decided they had to buy the subsidiary responsible for work there so that they could fix management there. Given that early on South Carolina had been a major problem area would you recommend minimizing their responsibilities or doubling down? Boeing decided to double down. In fact, they decided to quadruple down. Not only did they increase the volume of work of the kind originally planned but they also ended up adding in more work. They went so far as to build a full assembly line so they could play South Carolina off against the northwest. And there have been major quality problems with work out of South Carolina as late as as earlier this year. (The current official story is that "everything is good there now".)
There has been similar problems with components made in Italy and other places in the world. And, as a side effect of moving so much expertise and responsibility off shore, we have in effect taught a lot of people around the world a lot about how to build technologically advanced airplanes. This has major impacts from both a civilian perspective (China is in the process of getting a commercial airplane manufacturing capability off the ground, as are a number of other countries) and governmental perspective (the dual use nature of this technology makes it militarily important both for offensive (building better military planes) and a defensive (getting better at shooting down our military planes) perspective). People get wound up about Edward Snowden and not at Boeing. That's because Boeing has a lot of political clout and a good PR operation and Snowden doesn't. But Boeing has done a better job of providing aid and comfort to potential adversaries than Snowden has.
Anyhow, this overload caused by management overreach has resulted in a lot of problems for the 787 program. It seems back on track after many years of delays. A number of analysts think the program will never make back its costs. I think it eventually will, perhaps a decade from now.
The Boeing 787 program is a classic example of the maxim "if they want to do it they will find a way and if they don't want to do it they will find an excuse". I have seen innumerable projects that penciled out just fine. But management didn't want to do them (e.g. retrofit buildings) so they didn't. I have seen innumerable projects that did not pencil out (e.g Boeing moving their headquarters to Chicago) but management found a way. If you ask management they will say that in each case "it was simply a cold hard business decision" but you will be hard pressed to find a business case laid out in detail and that that actually pencils out.
Across the board cuts
Boeing, and lots of other companies have announced (and implemented) "across the board" budget cuts on a number of occasions. This is where you cut the budget of each part of the business by the same percentage. Turn the issue inside out and see what it looks like. If the answer is "across the board cuts" what does the result of the "hard nosed business analysis" have to be to justify this action? It has to be that all parts of the business are exactly as efficient/inefficient or important/unimportant? What are the chances that is actually true? "A snowball's chance in hell" overestimates the likelihood.
What across the board cuts tells you is that management does not understand the business they are supposed to be experts in managing. There should be strong parts of the business and weak ones. There should be parts that are more important and other parts that have less importance. And it is the primary job of management to know exactly which parts those are. Then you cut more heavily in the weak areas and more heavily in the less important areas. It even makes sense to not cut a weak area if it is critical. But you should have been shoring that important but weak area area up long before the need to cut arose. Why weren't you?
Championing across the board cuts is prima fascia evidence of incompetence. Whoever champions this should be fired immediately for cause. The only defense is if the executive in question can prove that he was literally forced to adopt equal cuts by outside forces. And if he received only moderate pressure he should be fired for not finding a way to effectively counter the pressure.
But across the board cuts are common. As are other less obvious signs of incompetence. Every time I see a management decision I ask myself the simple question "does this decision and its rationale demonstrate a deep and honest understanding of the organization"? Frequently it doesn't. As another example, various large financial institutions almost completely crashed the economy of the entire world a few years ago. Executive after executive said "I didn't know my subordinates were engaged in dangerous/unethical/risky practices" or "I had no idea that these procedures could crash the economy (or. perhaps more importantly, destroy my company)". At a minimum these statements demonstrate an ignorance of critical aspects of the business these people are charged with managing (and paid outrageous sums to manage effectively). They should have all been fired for cause for incompetence, I don't care which. I believe that many of them knew that bad behavior was rampant on their watch. But that same bad behavior resulted in them being paid massive amounts of money.
Management Responsibility
In this last example (Wall Street a few years ago) we see a question of where management's responsibility lies. I would like to turn the problem around. I often found myself with a situation where I thought that management should take some action. Frequently they didn't. It took me a long time to figure out what the real problem was. Management certainly does not want subordinates making decisions that management feels are properly in their domain. And they are diligent about asserting themselves in these situations. But what about the situation where assuming responsibility is, shall we say, inconvenient? I have found that management is equally diligent at dodging these "opportunities", usually by inaction. I came up with the following formulation years ago: "it's not a problem if it is not causing management problems".
We see this everywhere. There is a certain amount of work to do. Management doesn't want to pay for all of it to be done. The obvious solution is "off the clock" work by subordinates. If everything gets done and we stay within budget then, viewed from the management perspective, there is no problem. If there is no problem then there is no need for management to do anything. So we see a lot of creativity deployed to create situations where subordinates, for one reason or another, end up doing a lot of work that is uncompensated or undercompensated. You can root around in pretty much any newspaper during pretty much any week and you will find one or more examples of employees doing work that benefits the company but is not fully reflected in those employee's paycheck's. The company and the techniques and the justifications vary from case to case but the result is always the same. That's bad. There is worse.
Boeing was in a dog fight a few years ago over the "military tanker" contract. About fifty years ago Boeing built a bunch of airplanes that were used for in-air refueling. Needless to say, it was long past time to replace these planes with newer ones. But tankers are unsexy. So there was always some other sexier place to spend DOD money. So Boeing was having a hard time getting the government to sign on the dotted line for new planes. To be fair, Boeing tried all the legitimate techniques for getting the business first. But year after year passed by and no signed contract materialized. What's a Boeing manager to do? Well, there's always the illegitimate techniques? But they are at best a public relations problem and at worst are flat out illegal. This is a case where no manager wants their fingerprints visible on anything. What does the actual management playbook (as opposed to the one they teach from in school) say to do in these circumstances? You glower at your subordinate(s) and say "I don't care how this gets done, just do it.". If anyone asks later, you say "well, of course everyone knew that I expected them to behave in a legal and ethical manner at all times. That goes without saying.".
I don't want to re-litigate the whole tanker incident. Frankly, it was a few years ago and I remember only some of the details. And it represents an extreme example. The details ended up in the public domain. And important people were fired. Other important people went to jail. But "I don't care how, just do it" is a common strategy for providing management with plausible deniability.
Usually, what's involved is pretty mundane. My ex-boss used to work a horrific number of hours because management provided inadequate resources and he felt a responsibility to get the job done and done well. My cousin was talking about her company being too cheap to buy her a color printer. She had to jump through a bunch of unnecessary hoops to get what should have been a simple job done. Besides the "just do it" component the other point of commonality in all these cases is this. The job got done. It got done in a way that was invisible to General Ledger. The fact that it got done and that there were no visible negative consequences meant that from management's perspective there was no problem,
I spent years trying to bring my now ex-boss around to my point of view on this. He finally saw the light a couple of years after I retired. He no longer works horrible hours. And the company seems to get along ok now that his efforts are no longer heroic. Once management sees something that affects them negatively then they have a reason to take action. But the other thing I told my manager is that this sort of thing is dangerous. If you can turn your problem into management's problem without leaving any of your fingerprints visible then you're fine. But it is often impossible to do that. So the manager knows (or should know) what's going on. At that point he may decide you are not a "team player" or you are a "troublemaker". In other words, he can work things so in effect his problem becomes your problem. But the thing to remember is he could have done that anyhow.
Conclusion
You have no doubt correctly concluded that I think senior management of large companies is wildly overpaid. So let me conclude with a quick note about how this came to be. How would like it if your friends and family and softball buddies set your pay? And, oh by the way. you are the one who gets to pick the specific set of friends, family and buddies that serve on your "compensation committee". That's how it works in these large companies. Senior executives and members of the board of your company decide how much you as CEO get paid. You have come up through the ranks with the senior executives so you probably like and respect each other. As CEO you have more say than anyone else as to who serves on the Board of Directors of your company. So who do you pick as board members? Friends, possibly some members of your executive team, and CEOs (or senior executives) of other companies that you are friendly with. Everyone knows it's a "you scratch my back - I scratch yours" situation. If everybody decide that these positions should pay extremely well then everybody (or at least everybody we care about) does extremely well. But wait, there's more.
The possibility exists that this might look bad. Luckily someone came up with a great way to deal with this a few decades ago. Companies that specialized in determining "appropriate" compensation for senior executives were invented. Officially they are expert in impartially determining what a "fair" compensation package looks like. So they provide complete cover. "We hired this highly respected company to figure all this out then we did exactly what they recommended." Problem solved. It's just another one of those "hard nosed business" situations. But guess who picks out which "compensation specialist" company gets the job? The CEO. And no one has to tell anyone anything for these companies to figure out that their job is twofold. First, they come up with an astronomical number, the more astronomical the better. Second, they come up with a bunch of really high quality BS to justify the number. This second part is where they really earn their money.
And any "compensation specialist" company that does a really superior job deserves to be paid accordingly, right. It's only fair, after all. So, once a company is able to develop a bit of a reputation, it does really well. In the real world, the group made up of your friends, family, etc. would do a poor job compared to the job these companies do. Your friends would not come up with a figure that was nearly high enough. And the fact that these "compensation specialist" companies are so expert at coming up with an astronomical number and then papering the whole thing over with truly awesome BS is why they get paid the big bucks, baby.
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