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FUSCHL 2008 INPUT PAPER

 

by Enrique G. Herrscher

 

THE SYSTEMS APPROACH TO GOOD AND BAD BUSINESS

 

Introduction

 

For someone who all his life has advised and taught business, whether companies contribute to the common good, or produce more damage than social benefit, is possibly the Nr. 1 question. Obviously it is not a “yes or no” issue, nor can it be handled merely by talking (or even acting) about Social Responsibility. A systemic approach starts by looking at the underlying business logic and the context where such logic may be applied (specially: Latin America); then, uncovering the underlying design, including size, ownership, growth processes, power and the competitive arena; concluding with the, interactions and consequences of growth.

 

The underlying business logic

 

The business system we are referring to in this paper works within the market system: an arrangement by which a society produces its private goods according to individual preferences and decisions. Its legitimacy therefore depends on the degree to which, as Adam Smith would have it, intelligent selfishness leads “automatically” the individual, “as if guided by an invisible hand”, to do what is good for society. So our first question would be: is that so?

 

In  the ideological arena, we find two extremes: that this is always so, and  that this is never so. From our systemic view, both positions are untenable.

 

·        To assert that the “invisible hand” always works would mean to be blind to the abundant tendency towards monopoly, the prevailing concentration trend, the inordinate growth, the excessive want-creating advertising and all sorts of economic manipulation processes existing  in the actions of a good portion of corporations. These deviations [1] leave the mechanistic rules of Newton’s physics-oriented “perfect market” theory more than damaged.

 

Another way of looking at this is to observe the failure of the trickle down effect, the assumption that economic improvements will “automatically” spread to all sectors of society. The obscene gap between rich and poor in most Latin American countries disproves this theory: in many cases,  economic growth leaves whole sectors of society not only untouched but even worse than before. In fact, people excluded from increasing wealth around them [2] are generally much worse off – and more prone to violence – than when everyone is poor.

 

 

·        To assert that the “invisible hand” never works would mean to be blind and not seeing the enormous service the market system provides, even with its significant limitations: an incredible number of transactions are performed each second in every country, even in the smallest town, all over the world, allowing us to manufacture, move, sell, buy and cash an infinity of goods and services and providing jobs for us and our families, without the intervention of mega bureaucracies.

 

Even if, thanks to technology, a super state (or “the party”) were able to organize “automatically” all that system, we have seen (the  late Soviet Union was a dramatic example) that such a   bureaucratic centralization is neither desirable nor viable. We note three major reasons: (a) economic processes are too complex for such a centralized management; (b) such a concentration of power seems to lead inexorably to widespread corruption; and (c) worse of all: whoever tells us how many shoes to manufacture, at what size and what color, will end up telling us on  what side of the street to walk, what we should think, and how we should denounce  those who think otherwise.

 

 

We postulate that the systems approach, with its preference for “and” over “or”,  helps us to steer away from these two extremes, providing a bridge that, first of all, eliminates the notion of a social system working “automatically”, as in  both instances above. Social systems are complex, and cannot be managed by “automatic pilot”. No absolute power is good, neither in the hands of the State nor in those of the market.

 

What is then an advisable and viable model? Firstly, one that distinguishes (a) “private goods” that satisfy individuals or very small groups (like for instance families) that  should available according to the market system and would be acquired with what we could call dollar ballots: each one uses his or her  money according to his or her preferences; and (b) “public goods” that satisfy large groups (such as inhabitants of a country, a province, a town), that should be decided by actual (political) ballots: they are non divisible goods, such as justice, security or anti pollution action, which will affect the whole group [3].

 

Secondly, one  where public goods are not decided upon by “dollar ballots”. Irrespective of who is the provider (see Note 3), the criteria should not depend on wealth but on public interest.

 

Thirdly, the market system needs rules, and those rules (a) should disturb the market mechanism as least as possible, but (b) cannot be established by the market itself: when needed,  they require “political ballots”. In other words: we envisage a mixed model.

 

 

 

Down to earth

 

Looking around us (particularly  from a Latin American viewpoint) we venture to state the following premises:

 

a)      Even allowing for the ambiguity of the terms, there are “winners and loosers” or, as per Daniel Quinn (1993)) “takers and leavers” or (simplifying) “tops and bottoms” per Barry Oshry (1995) or – as commonly described – “rich and poor”.

 

b)      Our capitalist system, based on above mixed  model, is not meant to be equalitarian but, given  that now – thanks to technology – there are enough basic resources for all, it is indeed supposed to provide at least a minimum wellbeing to the whole spectrum.

 

c)      However, we are at a great distance from achieving this. Latin America has by far the biggest gap between rich and poor, between “takers and leavers”, according to any methodology that may be used.

 

d)      Systemic thinking should, as one of its major goals, try to be instrumental in reducing this gap.

 

e)      One way of achieving such a goal is to increase positive-sum transactions, without candidly forgetting that many other transactions will continue to be zero-sum.

 

So our second major question would be: are there characteristics of organizations that would favor such goal? That would promote more positive sum than zero sum transactions? That would bring business closer to the people?[4]. That would reduce the gap between rich and poor? That would contribute  to bring the “trickle down effect” closer to reality? That would assure that companies became truly subsystems of society?

 

According to above “mixed model”, what we are looking for are companies that, while pursuing their profit motif, behave as subsystems of society. Obviously, what we are really looking for is design rather than behavior. Many corporations “behave well” and others “behave bad” irrespective of the characteristics that follow. Nevertheless, until we find patterns of behavior – trying to avoid gross generalizations – we will not come close to answering above question.

 

We will  call this type of design “corporate quality”. It goes beyond of what is known  as “institutional quality” in TQM (total quality management), and also of the “social and ecological responsibility” so much talked about these days. Unlike the –very much welcome – actions regarding social issues, defense of nature and direct philanthropy, our idea of “corporate quality” has to do with one thing and one thing only: the way of doing business

 

 

Design 1: size

 

Latin American visitors to Europe are often astonished to see small and even tiny companies (perhaps about 200 employees, in some cases not even 5), manufacturing some specialized gadget and exporting it all over the world. Frequently family-owned, they acquired world-class category thanks to creativity, innovation, quality, punctuality, industrial and commercial reliability, sometimes over many generations.

 

Our first idea, looking for a “design favorable to corporate quality”, was size. Those European-type [5] SMEs would seem to fit – much  better than big corporations – the  qualification of “corporate quality”. Several reasons may explain this, the most important, in our view, has to do with SMEs being “companies with human face” as the French used to say, whereas BC (big companies) almost always seem to be run “anonymously”.

 

Is this a loosing proposition? Have SMEs a chance of “representing” the major corporate component of modern capitalism?[6] Not easy: seems too much of a David – Goliath struggle (but remember how that ended). Without denying the difficulties – mainly financial and cultural – we point out the profound revolution due to two factors: communication technology (read: Internet)[7] and networking: the devise to overcome smallness in a competitive world[8].

 

However, assigning (particularly in developing countries) SMEs the sole role of bearer of “corporate quality” would give raise to two questions: (a) are SMEs “enough” to carry the burden of the private portion of development (or should we again resort to “and rather that o”)? and (b) can we rule out BCs entirely? Surely there are in our countries BCs that not only qualify as to “corporate quality”, but are very much essential for the development of such countries. Suffice to think, for instance, of the three major “Argentine multinationals”[9]. Companies like that must be big in order to master the required technology and command the resources to be a major world class player.

 

So, even if we look at SMEs as our best model of corporate quality, it cannot be size alone….

 

Design 2: ownership

 

In Latin America, three aspects are noteworthy that may not be so widespread in other regions: (a) SMEs (i.e. their owners and great part of their qualified employees) are the basic components of the middle class; (b) the middle class, often squeezed between a conservative elite and a populist-prone lower class, is to a great extent the key and guarantor of democracy; and (c) democracy, in most of these countries, is not a “given” as elsewhere: history shows often military dictatorships surpassing years of democracy.

 

Our point here is that an abundant number of “small owners”, as well as a good portion of their staff (due to the shorter “distance” between boss and  employee) are essential for our countries, over and above the economics involved as direct effect of size.

 

Likewise, abundance of SMEs assure a social fabric that – together with other factors – promotes family values, culture, education and the art of living together. In Argentina, during the 90’s, the demise of the majority of SMEs due to an ill managed and ill advised economic policy (the famous “1 peso = 1 dollar” exchange rate) showed that no increase in productivity (if any) could compensate the nefarious social effects of economic concentration.

 

Design 3: growth

 

In nature there is no unlimited growth: cells, animals and plants (humans as well) grow until they find their genetic threshold (unless there is illness, notably cancer). Can human constructs, such as corporations, be the only exception?

 

Accountants will tell us that, until full capacity [10] is reached, all growth lowers costs. This is assumed to lower prices and benefit society, but often the advantage does not reach the consumer but “stays in the business” (or in the pockets of its shareholders and CEOs): witness the huge wealth of some of these institutions.

 

However, we consider that this is not the main issue. The  real question is: why, how, for what purpose does a corporation grow? Basically, there are for a corporation two ways to grow: (a) either by  expanding its own capacity, in order to increase its present operation or to add new lines, or (b) by  acquiring another company and incorporating its operations, facilities, personnel (save for the inevitable lay off of redundant positions), technology and – sometimes - management : the well known (incredibly growing) process of “M&A” (mergers and acquisitions)[11]. Obviously, this almost always means to eliminate a competitor, such effect often being the major purpose of the action[12].

 

It may sound simplistic, but we are tempted to label as “good growth” the internal expansion of activities (a managerial, commercial or technological achievement) and as “bad growth” the acquisition of another entity  or, even worse, of a series of entities as part of an established strategy  (in most cases, a financial achievement).

 

No doubt there are many cases of “inevitable” mergers due to valid strategic considerations. But more than often the underlying motif has a name: increase of power. And here we arrive at the fourth key aspect.

 

Design 4: power

 

Take the typical supermarket (generally a branch or subsidiary of a BC) trying – quite naturally – to absorb the greatest quantity of customers of its area of influence. It – also naturally – will compete with the neighboring small independent shops. The BC offers significant advantages: variety of goods all in one place, good prices (made possible by its great purchasing power), long hours open (because many personnel allows many shifts), convenient payment options (due to HQ’s financial strength) and, often, price and quality transparency. The small shop cannot do many of these things, but has other advantages: personal attendance (often through several generations), perhaps closer (no second car needed), frequent customers may “pay later” (end of the month). Moreover, one of more families may live from that shop, adding to above mentioned middle class.

 

So, big and small may offer distinctive benefits, are different businesses, even selling the same goods. Live and let live: welcome big and small. Another story would be the supermarket trying to be the only supplier in the district: that would be the kind of growth we are alerting against. This is frequently  where the “power element” steps in.

 

Sometimes the desire to increase power is just greediness for money. More often, we believe, it is rather an obsession for “more and more”, i.e. power for the sake of power. But the mechanics, the instrument, is almost always the same, and again has a name: the abolition of competition. This lead us to the last and final key aspect.

 

 

 

Design 5: competition

 

Two alternative forces make the market system work: competition and cooperation. Leaving the latter aside – it deserves a paper of its own – let us say that competition is the cornerstone of capitalism: lacking this, the supply – demand mechanism would cease to operate, and capitalism would look very much like the Soviet system[13]. This means that capitalistic entities trying to eliminate competition are undermining the very basis on which the capitalistic system is built.

 

Admittedly, also SMEs may want to be monopolies for their specialized product or service, and often (so far, mainly in the developed countries) those are the success stories we mentioned before. But such success is not based on power but on  quality, reliability punctuality and constant innovation. And the moment someone else reaches that level of excellence, the monopoly is gone.

 

A systemic conclusion

 

Combining above five dimensions of company design, we postulate – as a general but not absolute notion – that SMEs are  worthy of our preference when teaching, consulting and acting in political matters, because (a) they contribute better to the social fabric; (b) they fit more naturally into the competitive system; and (c) they tend less to expand by “bad growth” and to exert power to eliminate competition.

 

What should we do to promote “good business”? Favor SME with convenient credit by a Development Bank?  Watch carefully big business  to enforce antitrust laws?  Improve legislation to assure competition? All seem promising approaches.

 

However: many laws exist in most countries assuring competition. Do we need more? Or is the problem the compliance? Or does the problem go much deeper?

 

SMEs are, in our view, essential for society, and better suited than BCs to avoid deviations that destroy competition, basis of the whole system. Certainly, one key element is the legal system guaranteeing competition, and its true enforcement.

 

But, behold: a  causal loop props up, hot from the System Dynamics oven: enforcement requires political support. Political support will only be forthcoming if the political forces are more powerful than big business. That means: strong political parties that watch over the “mixed system” mentioned at the start: neither State nor market supremacy. But political parties only flourish when there is an active middle class, and middle class thrives when there is abundance of SMEs.

 

 

Surprise: sound business practice, what we called “corporate quality”, has to do with small and medium size companies, development of which depends (among others) on strong political parties! The very subject we discussed at the 2003 ISSS meeting at Crete, when the “Latin American Agora conversation” tried to ascertain whether the Party system should be improved or changed for something else.

 

None of above are “absolute truths” or definitive conclusions. Dialogue may uncover many other relations, and further research may determine many additional causal loops. But more analysis should not obscure the fact that, in view of the chronic Latin American  poverty gap we stressed (and of similar problems elsewhere), we should assure, urgently, that action follows thought, because knowledge without commitment is not enough.

 

Let us hope that these lines can contribute to the dialogue.

 

 

 

Bibliography

 

 

 

·         Castells M. (1998): La Era de la Información – Economía, Sociedad y Cultura. Alianza, Barcelona

·         Cleri, C. (2007): El Libro de las PYMEs. Granica, Buenos Aires

·         Herrscher, E. G. (2000): Introducción a la Administración de Empresas.  Granica, Buenos Aires

·         Herrscher, R. M. (2007): Los viajes del Penélope. Tusquets, Buenos Aires

·         Kliksberg, B. (2002): Más Ética más Desarrollo. Fondo de Cultura Económica, Buenos Aires

·         Kuhn, A (1963): The Study of Society – a unified approach. Irwin / Dorsey, Homewood, IL

·        Oshry, B. (1995): Seeing Systems – Unlocking the Mysteries of Organizational Life. Berrett-Koehler, San Francisco

·         Quinn D. (1993): Ishmael.  Bantam/Turner, New York

·        Schumacher, E. F. (1973): Small is Beautiful. Hartley & Marks

·        Schumacher, E. F. (1999): Small is Beautiful: Economics as if people mattered: 25 years  later…with commentaries. Hartley & Marks

 

 

 

Enrique G. Herrscher

Buenos Aires, 21st. January 2008

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



[1] In E.G.Herrscher (2000), we stress the point that, in addition to the market imperfections due to these deviations, there are aspects that even a perfect market would not solve nor is it meant to. See next section.

[2] Bernardo Klicksberg (2002), sponsored by the Interamerican Bank, is our major activist regarding poverty and exclusión in Latin America.

[3] The distinction is not a clear cut line, and in many cases is politically loaded. For instance, health care or education may for some have a basic level considered public goods and a higher level taken to be private goods. Note the dissociation between characteristic of the goods, from who provides them. So in principle there can be private providers of public goods (the armaments industry!) as well as public providers of private goods (typical of socialist economies). Re the “two types of ballots” idea: see Alfred Kuhn (1963).

[4] We admit that “people as opposed to business” is a very simplistic way of putting it (business is also composed of people) but for our purpose the distinction seems to be quite clear.

[5] We are aware of the many SMEs. in USA, in Japan, now in China and India, but given the European origin of most Latin Americans we believe that model more adequate. On the other hand, in Latin America SMEs. are by far the most numerous entity (see Carlos Cleri, 2007) but not nearly as successful as the Europeans.

[6] We refer to the “opposition” between big and small, mostly because of the M&A trend to be mentioned  later, but acknowledge also the increasingly frequent cases of big companies surrounded by a cluster of small enterprises doing business with them.

[7] Let me contribute a cuasi-personal anecdote. In his recent book about the Malvinas/Falklands war, the 80 years history of the small ship where he served and the life of the inhabitants of the archipelago  before, during and after the war, my son (Roberto Herrscher, 2007) observed, in a visit 24 years after the war, the unloading of mail from a small plane at one on the loneliest tiny islands. He was told that in the old days, communication (for instance, to call the doctor) was done by smoke signals from the top of the mountain. Now he saw a case of books sent by Amazon: someone from the end of the world could make an international transaction. Likewise, any SME – provided a pc and electricity are available – can transact business all over the  world.

[8] See Manuel Castells (1998)

[9] Techint, leading global producer of steel  tubes and other activities; Arcor, world’s leading candy manufacturer; and INVAP, technology-based developments in nuclear and space projects.

[10] Today we know that the limit is not only physical or employed capacity, but also “complexity capacity”: how much complexity can an entity absorb? Incredibly, many important expansion projects failed for not considering this factor.

[11] For this discussion, there is little difference between Merger and Acquisition. As per our experience, in both cases the process almost always ends up by “big fish eats small”.

[12] It is even frequent that the acquired company is immediately or very soon liquidated, the elimination of the competitor being not the main but the only purpose.

[13] Some years ago Argentina was in such a bad shape that someone jokingly labeled it “a mixture of capitalism without competition and socialism without plan”


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