In an environment of company collapses and the onset of a recession, the job of managers is more of a tightrope walk than ever before.
The party is over. The abrupt downturn in business conditions in Australia last year sent household names like HIH and Harris Scarfe to the wall, and there could be many more before the end of 2002.
In the United States, names like Polaroid and Pacific Gas & Electric are among the casualties, and the number of junk bonds in default are rising in a record year for big bankruptcies.
Managers are fumbling their way through a new and threatening world that many have never experienced before. A world fraught with dilemmas and legal issues flowing from what is expected to be a tsunami of litigation for alleged mismanagement of companies and funds.
Management is now a balancing act: taking unconventional and contrarian measures that result in outperformance and not in losing business or getting sued. Few managers under the age of 40 have had first-hand experience of this. Managing a company during a business slump is a different ball game.
Furthermore, many of those who were around in the recession of the early 1990s fear that the downside could run deeper and longer this time. The leading authority on US recessions, the National Bureau of Economic Research, says that the US has been in recession since early 2001. US recessions have averaged 11 months in duration since the World War II and 18 months since 1854.
A new global environment
But, the threat of terrorist attacks, increased security and defence costs, continued excesses in stockpiles, and persistent slack in industrial capacity raise questions about the likelihood, timing and quality of a recovery. Furthermore, many stocks here and in the US look overvalued. In their book, Valuing Wall Street, authors Andrew Smithers and Stephen Wright argue that the US stockmarket is still 50% overvalued, despite falls over the past 18 months. Using their methods of analysis, the Australian market is even more overvalued.
This downturn may be different from others. It has not been caused by a collapse in demand after banks raised interest rates to fight inflation. This one seems, instead, to have been underpinned by investment patterns. The boom of the 1990s inflated expectations of profit growth, which in turn encouraged companies to borrow heavily and over-invest.
It explains why the spate of interest-rate cuts in Australia and overseas seems to have been relatively less effective in reigniting demand. By definition, recessions underpinned by investment last longer and deeper. Controlling inflation is easier than overhauling financial excesses and over-capacity. Cutting interest rates seems a blunt instrument when there is an overhang of debt, particularly with banks tightening lending standards.
The problems are not limited to investors and companies that took on too much debt. Entire industries, from steel to aviation, are on the skids. The terrorist attacks on September 11, 2001, only exacerbated the structural weaknesses in the world’s biggest economy, which already had zero savings amid the financial and economic imbalances that had built up over the past decade.
At the time of writing, US industrial capacity utilisation fell to 75.5%, the lowest level in nearly 20 years. With profit sliding, lenders become more reluctant to provide credit, thus making companies finance growth from internal funds. And there lies one challenge for today’s managers: taming excesses and over-capacity requires hard decisions.
After a period of unprecedented growth that masked mistakes like cost over-runs, bad acquisitions and non-performing business units, companies are combing through operations for ways of conserving cash to see them through the downswing.
The once-adored technology sector has imploded – nearly 300,000 jobs lost worldwide at the time of writing, according to the Financial Times – and companies around the world are broke or getting there.
Sacked or sued: What are the penalties?
In Australia, the collapse of Ansett, One.Tel, Harris Scarfe and HIH shook the economy and business confidence. Questions have been raised about whether the corporate governance of the failed businesses was adequate, but nothing has changed in terms of accountability.
For managers and directors, the rules are exactly the same. Indeed, there are no big changes in the Corporations Act 2001, which was introduced as the new constitutional foundation after the High Court denied the Federal Court jurisdiction over company law matters. Directors and company officers are still expected to act in the best interests of shareholders. The new laws, which took effect in July 2001, did not introduce new penalties if they fail to do so.
But it is likely that the courts will be challenging the rules more often. These are worrying times for directors, managers, auditors, and even fund managers, now that even trustees are getting restive. In the past, when fund managers did not perform, they were sacked. Now, they are being sued. The pension fund trustees for the Anglo-Dutch conglomerate Unilever are taking action against Merrill Lynch for negligence and alleged mismanagement of their £1 billion pension fund. The trustees are seeking £139 million in damages.
Professor Ian Ramsay, who runs the Centre for Corporate Law and Securities Regulation at the University of Melbourne, says we can expect more lawsuits in Australia. “We will see a raft of litigation testing the laws. When people have lost their investment in a downturn, they have the incentive to get that back.”
Insolvency lawyers are already rubbing their hands in anticipation of the actions that will flow from the collapse of HIH, One.Tel and Harris Scarfe. Accountants, lawyers and management consultants in other areas are being sued as never before; and insurance brokers report higher levels of claims.
Also fuelling the growth is the availability of third-party funding – through such outfits as the Australian Litigation Fund and the Insolvency Management Fund – that allows insolvency practitioners to use outside money to pursue legal claims.
Why so much attention from Canberra? Because Australia has, per capita, one of the highest shareholder populations in the world. When businesses collapse, investors, like creditors, want answers, and they get angry if there is no one to blame.
But, although the professional advisers, in particular HIH auditor Arthur Andersen, might be hit the hardest, increasingly aggressive practices by liquidators and regulators ensure that managers are also under the gun. For example, the Australian Securities and Investments Commission (Asic) is suing three former GIO officers over profit forecasts made during AMP’s hostile takeover bid. It has also commenced proceedings against Nicholas Whitlam, alleging that he breached his duties as an officer of NRMA and NRMA Insurance Group
Ramsay says regulators are opening the door to even more litigation. “We will see stakeholders riding on the coat tails of Asic to see how deep the pockets are.”
To innovate or not to innovate
The danger for managers and their companies is that the new bleakness will usher in a fear of risk-taking. In tough times, conservatism is rewarded and innovation stifled.
A survey by the human resources specialists Leadership Management Australia found that senior managers are focusing more on putting out fires and less on the future. The survey, of 23,000 Australian business leaders, managers and employees across Australia, found that only 18% of senior managers cited strategic thinking as the most critical competence in 2001, down from 25% the year before. Fourteen per cent saw planning and organising as essential, compared with only 8% the previous year.
Some managers are adopting lateral techniques to trim costs. For example, the consultancy Accenture has introduced FlexLeave, a worldwide scheme that allows staff to receive 20% of their salary and employer-provided benefits while taking up to a year’s sabbatical. The German electronics company Siemens has a similar scheme.
The new insecurity is reflected in a survey by the recruitment specialist TMP Worldwide of 6000 people in Australia, which found that 46% of respondents would accept a pay cut if their company was struggling financially and that 64% earning less than $20,000 a year would accept a cut.
Meanwhile, no one is talking any more about the war for talent. Keeping good people is easier when there are fewer jobs around. At the same time, there will be more bargains around and many opportunities to buy up potentially lucrative businesses that are struggling to stay afloat.
This is the upside for businesses that manage well in the downturn and that are run with a combination of caution and boldness. The question is, how many managers will recognise this and have the courage to take advantage of the upside?
Australia’s management community: The hidden rot
How Australian managers really rank on the global stage
by David James
The performance of Australia’s managers typically ranks highly in international management comparisons. Often, Australia’s managers are said to be in the top 20, sometimes in the top 10; mainly depending on the economic performance of the United States, Japanese and European economies.
But such assessments tend to the genteel; something like a gentlemen’s club (they are mostly male) ranking of its members. More realistic is the hard financial data, and the picture that emerges is mainly of mediocrity.
There is no single figure that reflects Australia’s management culture, but it is possible to establish a composite picture.
First, the currency. The Australian dollar has suffered a long-term decline over the 1990s. This seems to be due to many factors: the continuing decline in commodity prices; the relatively small number of government bonds due to a long-term reduction in sovereign debt (which, as the International Monetary Fund has observed, may perversely be reducing demand for Australian-dollar securities); and a stockmarket that is unattractive to foreign investors. Yet, it is far from being a vote of confidence in Australian managers.
Then, there is the stockmarket itself. Since 1987, Australia’s market has increased its capital value by barely half. The US market has trebled; the British market more than doubled. Although there are some mitigating circumstances – such as the high level of dividend payments in Australia and what look to be excessive share-price valuations in the US market – it is, again, anything but a positive indicator for local managers. To give some idea of the international implications, the Morgan Stanley Capital Index (known on Wall Street as the “Finger of God”) indicates that, over a 10-year period, the average return in US dollars of the Australian market is just over 1%. The equivalent figure for the US is more than 10%.
Then, there is foreign direct investment (FDI). According to the World Investment Report 2001 by the United Nations Conference on Trade and Development, Australia’s performance in FDI is roughly in line with its average share of world gross domestic product (GDP), employment and exports. But this represents a long-term decline. In the period 1988-1990, Australia was one of the most attractive countries for FDI, with a ranking of nine on the inward FDI index. Now, it is not even in the top 30. The index gave Australia a ranking of five in 1988-90 (the higher the figure, the better the country is for FDI). The ranking today is one.
The local performance in terms of establishing global corporations is also less than impressive. According to the World Investment Report, only News Corporation ranks in the top 100 transnational corporations (Rio Tinto is also included, but this is dual-listed as British/Australian). BHP Billiton would also rank in the top 100, but its “nationality” is uncertain. What is conspicuously lacking on the Australian scene, apart from News Corporation, is the generation of big global participants.
Therefore, on currency, stockmarket, FDI and the creation of global corporations, Australia’s managers must be said to be under-performing. At the very least, they have been unable to maintain Australia’s ability to “punch above its weight” in the international context.
Why this desultory performance? One reason is the dominance of domestic oligopolies, whose strategies have largely been defensive: to maintain a dominant market share while cutting costs by reducing employee or supplier expenses, or improving distribution efficiency. When there have been forays overseas, they have tended to be half-hearted or disastrous. The recent travails of National Australia Bank, which had to make a $3.3 billion writedown of its US subsidiary HomeSide, is just one example among many of the difficulties that Australian companies have in overcoming the tyranny of distance.
There are few signs of improvement. The Business Council of Australia and other business lobbies are urging an easing of the restrictions on mergers in the domestic environment. The argument for intensifying local oligopolies is that they are needed to create the scale for international competitiveness. The chief executive of the Business Council, Katie Lahey, says Australian companies need to be developed to a size at which they can compete internationally. Scale, she says, is a highly important issue.
This is dubious logic and probably is not the true agenda in any case. Size is not the determining factor when competing globally; skill is. When local corporations argue that they should be allowed to merge in order to compete, it amounts virtually to an admission of managerial inferiority. What tends to be the point of difference in the global environment is an understanding of customers in different markets, not the ability to mobilise capital or tangible assets. (Some industries are capital intensive, but it is far more likely that a strategy based on unique knowledge will work for companies from Australia.)
In any case, that is not the real intention. Australia’s large corporations (not including those in the mining sector) are about to head down a cul-de-sac. They are becoming too big for their domestic markets. When companies reach a dominant position in their markets, it becomes harder to meet the cost of capital from “natural” growth in demand (this is a problem globally for some of the world’s biggest corporations).
The risk, then, is of cannibalisation: competing against yourself in the market. The difficulties of Australia’s largest domestic corporation, Coles Myer – and the recent restructuring – is a response to precisely this problem. The company has become too big for its market, it has no substantial plans for overseas expansion, and its internal divisions started to cannibalise each other. Target, Kmart and Myer-Grace Bros are being returned to their positions of five years ago to stop them from competing with each other, and the company is hoping to expand by moving into the financial services sector.
This pattern is likely to be played out across the economy; hence the need to remove competition and merger restrictions, and the resorting to “international competitiveness” arguments to justify what is a continuation of the defensive strategy of domestic market dominance and cost reduction.
In short, time is running out for Australia’s management community. It has largely failed to capitalise on the longest post-war economic boom, however the effect of recession is likely to be less damaging (simply because Australia did not rise as high). But, it is clear that the international economic environment is becoming more hostile, and the mediocre are less likely to survive.