Lessons from ICI’s transformation; a lecture at the Department of Trade and Industry/Forum for the Future.
It is November 1996 and I am in Harrogate, addressing the annual conference of CBI. To provoke my audience, I present two mission statements for ICI, one drawn from the 1980s, one more recent.
I describe the difference between these two statements as a difference between Mode 1 and Mode 2 business behaviour. Here is their statement from the 1980s
“ICI aims to be the world’s leading chemical company, serving customers internationally through the innovative and responsible application of chemistry and related science.
Through achievement of our aim, we will enhance the wealth and well-being of our shareholders, our employees, our customers and the communities which we serve and in which we operate”.
and this is ICI in the 1990s
“Our objective is to maximise value for our shareholders by focusing on businesses where we have market leadership, a technological edge and a world competitive cost base”.
If we read these statements carefully – perhaps more carefully than they were intended to be read – we can see three principal differences. The first gives primacy to the operational activities of the company – “serving customers internationally through the innovative and responsible application of chemistry”. The second puts the financial dimension first. “Our objective is to maximise value for our shareholders, “and operations are secondary to that end.
The first statement gives recognition to all stakeholders. “We will enhance the wealth and well-being of our shareholders, our employees, our customers and the communities which we serve and in which we operate”. The second acknowledges no claim other than that of shareholders.
The first looks forward to the creation of new businesses – “ICI aims to be the world’s leading chemical company,” “through achievement of our aim, we will enhance wealth and well-being”. The second restricts the company’s ambitions to established activities – “focusing on businesses where we have market leadership”.
But in 1996, the world had moved on to Mode 2. Mode 2 was appropriate, even inevitable, for a public company in a capitalist economy. But many of its advocates asserted that there was in practice little difference between the behaviour we would see from companies in Mode 1 and Mode 2.
Is there really a difference between Mode 1 and Mode 2? There certainly is. Recall the history of ICI. At the end of the second world war, the senior management of ICI concluded that in future the innovative and responsible application of chemistry was to be found, not just in the traditional businesses of explosives and dyestuffs, but in pharmaceuticals.
ICI put together a team of able young scientists. But returns were slow in coming. For twenty years, the ICI pharmaceutical business was a steady money loser. Eventually, however, fortunes changed with the discovery of beta-blockers, the first group of drugs to be effective against hypertension. The commercial success of these drugs was the basis for the emergence of the ICI pharmaceuticals division as a major product area and profit centre within ICI. And so the company we know today as Zeneca came into being. The science developed at ICI pharmaceuticals, and the scientists who learned their skills, did not only bring success to ICI: they were the founders of the modern British pharmaceutical industry. James Black discovered beta-blockers at ICI; won the Nobel prize for the chemistry which he did at Smith Kline; and then Glaxo used that chemistry, through Zantac, to become Britain’s leading pharma company. Black was the father of Britain’s most successful modern industry. (A point worth remembering when Mr Garnier’s remuneration package is next discussed)
That was what the company committed to “the responsible and innovative application of chemistry” achieved. What would have happened in a company whose objective was to “maximise value for our shareholders by focusing on businesses where we have market leadership, a technological edge, and a world competitive cost base”. I don’t really have to spell it out. How could you justify in these terms a business which had lost money for five years, was certain to lose money for another five years, which had no major products, and in world terms was not even in the second division far less the first? You would sell it or close it down. In Mode 2, there would have been no pharmaceutical division in ICI. And there would have been no Zeneca, and probably no British drug industry of the kind we all admire today.
I am returning to that story because it is now possible to complete it. We can follow the history of ICI from November 1996 story to the present day. As we were conducting that discussion at Harrogate, ICI was formulating a new strategy. The company would dispose of its traditional activities in bulk chemicals and fertilisers, and become a consumer focused speciality chemical company, based on fragrances. This was an example of the approach to business which I describe as meta-fund management. The corporate executive buys and sells a portfolio of businesses, rather as an investment manager buys and sells a portfolio of shares.
The objective was to put together a collection of activities with “market leadership, a technological edge and a world competitive cost base”. The strategy was well received by the stock market. But it quickly turned sour. ICI found it easier to buy the whizzy new businesses than to sell the boring old ones. And then the acquired companies failed to display the growth ICI had been hoping for. Earnings, employment, and above all the company’s share price were in steady decline. Earlier this year, ICI – for most of the last century Britain’s leading manufacturing business – was expelled from the FTSE index of Britain’s largest 100 companies, and its chief executive resigned.
The paradox is that Mode 2 management of ICI proved unsuccessful in its own terms. It destroyed shareholder value on a large scale. And ICI is, unfortunately, not a unique or rare case. If the decline of ICI is dispiriting, the decline of GEC – once Britain’s second manufacturing company after ICI – is more depressing still. Marconi was an equally dramatic example of the practice of meta fund management. This is the paradox of obliquity. Success in creating shareholder value is best achieved when it is not pursued directly. Let us try to unravel that paradox.
In that Harrogate talk, the second company I took as example was Marks & Spencer. For long, Marks & Spencer was the iconic Mode 1 company. The competitive advantage of the business was based on its reputation with customers, its relationship with supplies, and the calibre and commitment of the work force.
How did this come about? One of Marks & Spencer’s long standing policies was the provision of good meals to employees at nominal prices. The meals policy began after Simon Marks paid one of the frequent store visits which is part of the routine of all senior Marks & Spencer executives. During it, one of the assistants fainted. When she recovered, Marks learned that her husband was unemployed and the family didn’t have enough food to go round. Marks’ conclusion was not – and I want to emphasise this – that Marks & Spencer had a social obligation to relieve poverty in the community. But he did take the view that the kind of business he was building was not one in which employees fainted because they hadn’t enough to eat
That is Mode 1 behaviour. A Mode 2 company would compare the costs of providing subsidised meals with the expected net present value of the savings from reduced staff turnover. Only if the net balance was positive would the transaction enhance shareholder value and appeal to the Board.
All of us have seen calculations like that: and all of us know that they are spurious. The uncertainties about the parameters that go into such a calculation are such that you can get any answer you want. And what the sensible analyst assigned to perform such a calculation will do is to ascertain what answer his boss wants and make assumptions accordingly.
In the 1990s, of course, Marks & Spencer was, like ICI, to move towards Mode 2. The relatively mature business they had could not generate the double digit earnings growth which the stock market of the 1990s demanded to support a premium valuing. So the company put pressure on its legendary supplier relationships, spent less on its stores, pushed at the edges of its unparalleled reputation with its customers for value for money. Eighteen months after Harrogate – in the spring of 1998 – the company achieved the highest margin on sales in its history. Before – or since. Within a few months, sales fell, and profits and share price collapsed.
Marks & Spencer has recovered, of course, unlike ICI: but it will never again be the unique business it was for decades. Its competitive advantage, its distinctive capability, has not disappeared: but it has suffered permanent damage.
This is what I mean by the paradox of obliquity. Mode 2 behaviour is often unsuccessful in its own terms. Marks & Spencer in Mode 1 was enormously successful in creating shareholder value, and destroyed it in Mode 2. Just the same happened at ICI. How can companies be better at creating shareholder value when it is not their exclusive aim than when it is their primary focus?
One simple resolution is to say that if only self-interested behaviour is defined in a sufficient holistic way, there is never any conflict between public good and private interest. Good business equals profitable business. This group of arguments is appealing to some people on the right, who claim that what is profitable must, in the long run, be good: and to some on the left, who claim that what is good must, in the long run, be profitable. They favour one side, or another, of Charles Wilson’s famous, if often misreported, words, “I used to think that was what was good for the country was good for General Motors, and vice versa”.
But this position cannot be right. It is perfectly obvious that private and public interest may conflict, and often do conflict. Governments do not spend billions of dollars regulating businesses because they mistakenly think that businesses have failed to see the public interest or because the businesses in question are too dumb to see what is in their own best interests: corporations do not spend billions of dollars lobbying governments because they misapprehend their own best interests, or because government misapprehends the public interest. Bold regulation and lobbying are the products of what are perceived as divergences between private and public interest, and are correctly so perceived.
The truth is much more subtle. The truth is found in the paradox of obliquity: complex objectives in an uncertain environment – such as the development of successful business in a rapidly changing economy – are not best accomplished when they are tackled head on. This principle, or paradox, of obliquity can perhaps best be understood if we consider it in the context of the happiness of individuals. In his autobiography, John Stuart Mill, the greatest figure of utilitarianism – but not a happy man – wrote that
“I came to see that happiness was best achieved if pursued indirectly”
We distinguish happiness, which depends on the totality of our relationship with our environment, from hedonism, which is the frequent repetition of individually pleasurable actions. What ICI and Marks & Spencer did in Mode 2 was the exact corporate analogue of hedonistic behaviour by individuals: short term actions well received by city analysts and institutional shareholders.
Companies don’t succeed in Mode 2 because they can’t If we knew far more about the world than we do, or ever can, then businesses could select the lines of long term development that would maximise the NPV of the business, and calibrate exactly the quantity of resources – not too many, not too few – to spend sustaining relationships with the communities in which they work. But what we actually know, and can know, is far more limited. It is that if organisations devote too little, or too much, attention to any stakeholder group they do not prosper: they decline if they focus on shareholder value and respond to the ever transient fads of city commentators and business consultants: they fail to meet their real objectives if they are captured by employee interests, as with many public sector organisations and some mismanaged private companies: they cannot successfully pursue their core business purposes if they mistakenly think their function is to pursue their own, or other people’s conception of the public good.
The lesson I want to draw is that you cannot successfully manage a company by reference to a single objective: but equally that you cannot define or quantify tradeoffs between objectives: the job of balancing conflicting claims and requirements is the most fundamental task of management judgement. The analogy with an individual pursuing happiness, or seeing a good life, is highly relevant again: we can’t, as individuals, define our objectives in any simple way nor can we order the importance of numerous and incommensurable goals. Balancing conflicting claims and requirements is the most fundamental of life skills.
In life, and business, we should judge ourselves by a balanced scorecard. Among the management fads and fashions of the last twenty years, the balanced score card is one that survives, and deserves to survive. The principle is that the performance of a business is judged, not by any single metric – the bottom line – but by a wide range of indicators related to a company’s distinctive capabilities, the source of its competitive advantage, its relationships with its stakeholders. For ICI, whose competitive advantage rested on “the responsible application of chemistry” defined in its Mode 1 statement, these would be focussed principally thought not of course exclusively – on its scientific capabilities, and those of its employees. For Marks & Spencer, whose competitive advantage rested on what I have called its architecture – the structure of its relationships with suppliers and employees – and on its brand and reputation, the components of its balanced scorecard would have placed appropriately more emphasis on people, and on the way people outside the company perceived it. We can see how these kinds of assessment could have restrained, perhaps even prevented, the calamities that befell these businesses. They relate the metrics of performance to the competitive strengths of the corporation.
This is not about external reporting. Far from it: because much of the sort of data I am describing is the most confidential data a company Could have: data about the nature and progress of its competitive advantage. The relationship between internal and external reporting is a complex one, and we may wish to come back to this in discussion: but we have learned forcibly in the last two years, if we had not known it before, the dangers of confusing audit and public relations in financial statements. the downside of this conflation is much greater for non-financial metrics,
Let me end with a number of propositions which I believe should guide our discussions today
1. There is such a concept as national competitiveness – I know many of my economist colleagues are sceptical of this. But what we mean by national competitiveness is comprised of the competitive advantage of the nation’s companies.
2. These competitive advantages are based on the distinctive capabilities of individual operating businesses. The financial preoccupations of many UK companies in the last decade or so have undermined, not enhanced, these competitive advantages.
3. These distinctive capabilities are embedded in the relationship between companies and the social and commercial environment in which they operate. Companies can succeed only by managing the totality of these relationships
4. We make a mistake when we look for purpose in a business organisation which is distinct from the functions that business organisation discharges. Companies do not exist solely to generate shareholder value, but it cannot be their objective to promote the public good: they have neither legitimacy or competence to pursue that goal. The purpose and function of companies is to produce, in their own distinctive fields of competence, the goods and services we want, as individuals and as a society.
5. People associated with the company – shareholders, managers, customers, employees, all its stakeholders – will have their own individual and collective objectives. The success of a company depends, in the end, on the success with which it meets and balances these often incompatible and incommensurable objectives.
It is in this fundamental way that concepts of corporate social responsibility and national competitiveness are related. Properly conceived, they are the same thing.