Successful Business Leadership

By Alan K. Rudi

Why? The economy is the external environment in which you compete as a business, it is one of the most misunderstood parts of our social system, and it is where opportunities exist for businesses and people to succeed. A good business plan starts with an understanding of how the economy (global, national and local) is performing; therefore, you need to understand how the system actually works. An appreciation for the key concepts and history of our economy enables you to better examine the significant opportunities or issues for businesses in today’s economy.

The economy is a system, it has a deliberate design. Michael Novak in The Spirit of Democratic Capitalism, describes this system as divinely designed because it spreads decision-making power to individuals enabling economic opportunity and prevents the risk of a few people with concentrated power that can be abused. The economic system’s design is really a major part of our social system consisting of:

1. Government institutions - Purpose is to enforce the rules for social conduct, with significant checks and balances across multiple federal, state and local institutions to prevent one organization or individual from excessive power over people.

2. a Free Market System - Price allocates the scarce resources of society and millions of people make their own decisions in the pursuit of life, liberty, and happiness.

3. Moral and cultural institutions - Serve as a watchdog of both government and free markets to prevent abuses that can occur because of man’s fallibility. It includes freedom of the press, speech and religion, universities, churches and others provide oversight of the values, moral and cultural basis of society.

This article will focus on the Free Market System. The basic premise is that this overall social system works successfully, often times because of the accomplishments of business people, resulting in the highest standard of living in the world. The economic system is not perfect, however, as people are not perfect. We can better judge our system, overall, by looking at the rest of the world. Today, we are in an historic transition of many countries moving from socialism to capitalism. We see this occurring in Eastern Europe, China, Russia, and India with varying degrees of success and change, but they are moving forward to some form of capitalism that works for them.

There are seven critical elements to the design of the United States economic system that have resulted in our overall high standard of living and that are having major implications for how we lead a business:

1. Individual liberty and the human mind

2. Right to own property and the rule of law

3. Price as the means to allocate scarce resources and create social change

4. Competition as a price regulator and change agent

5. Profit as an incentive and not a purpose

6. Creative destruction that requires a business and people to develop their technology skills

7. Globalization and free trade that improves each society’s standard of living

What is capitalism? Ayn Rand, in her book Capitalism: the Unknown Ideal, defines it as “the economic system that has been dominant in the western world since the breakup of feudalism. Fundamental to any system called capitalist is the relations between private owners of non-personal means of production (land, mines, industrial plants, etc., collectively known as capital) and free but capital-less workers, who sell their labor services to employers.” In other words, critical to the success of capitalism are people. Someone owns a business, invests in assets and utilizes them for the purpose of meeting the needs of customer. And a business needs employees. People are needed to plan and run a business for its owners to achieve objectives.

The most critical parts of the economic system, however, are the mind and hearts of people, whether or not they are owners, management or employees. Man is the only creature on earth that can think and learn. We are designed to create, explore and develop using our knowledge and abilities. An economic system based on individual liberties is the only structure that then enables man to live according to his/her design. Socialism put the responsibility to think and create in the hands of a few, while capitalism provides the opportunity for each individual to develop and use their abilities themselves. If you look at the accomplishments of our society (great or small), they occurred when people had an idea and desire to create something that other people value. Henry Ford developed the assembly line substantially lowering the cost of the automobile making it affordable to more consumers, but he depended on other people to make it work successfully. Scientists and thinkers created the internet that then evolved into a system substantially lowering the transaction costs for all kinds of goods and services. But other people utilized the invention to create new products and services. Business and management is really about the process to create and innovate utilizing the skills and abilities of all people, and in the process fulfill a social and economic purpose.

Often times, though, business people are viewed as “greedy capitalist”, which can be true given our nature as human beings. Yet our economic system is based upon people achieving their self-interest. As a matter of fact, pursuing our self-interest is an organizing principle of capitalism. If our self-interest is pursued with ethics, values and faith, then a business and our society will be successful. If we don’t practice good ethics and values, then the moral and cultural institutions are there to identify and correct improper behaviors of people in our society. Adam Smith, a founding thinker on capitalism, in his book An Inquiry into the Nature and Cause of the Wealth of Nations (1776) said:

“As every individual endeavors as much as he can to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value, every individual labors to render the annual revenue of the society as great as he can. He generally neither intends to promote the public interest, nor knows how much he is promoting it…he intends only his own gain, and he is in this led by an invisible hand to promote an end which was no part of his intention. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.”

We need to think about two things from Adam Smith. First, the “invisible hand” is the market and competition, which force businesses to continually improve and change. Those businesses that do not innovate and change will ultimately stagnate or die. Business history is filled with examples. Second, in order to achieve our self interests, we have to achieve (or serve) the interest of customers and employees. This can also be called marketing (product, price, distribution and promotion) and human resource management. Remember, in developing the assembly line, Henry Ford improved productivity so much that he not only lowered the price of a car, but was able to increase wages substantially to keep his trained employees. It is often said that if you want to succeed in business, figure out how to lower the costs to your customers and still make a profit. Essentially, this is what is happening in today’s world of globalization and the internet. If you want to examine this idea of greed and self-interest as a means to organize socially, then listen to Milton Friedman.

Our Founding Fathers had the foresight to provide people the right to property ownership. The result is the opportunity to establish commerce and business. To establish commerce, however, requires laws that enable resolution of disputes if there is a breach of contract, standards for minimum product quality to protect people, prevent market abuses, enforce criminal laws to maintain a civil society, protect against foreign invasion, and establish a common infrastructure for commerce to operate efficiently (e.g., a highway system or the Internet). As you look around today, and explore our economic history, you see the benefits of the rule of law and how they have created a civil society.

Here’s a controversial thought. Price allocates the scarce resources of a society and causes not only economic change, but also social change. Thomas Sowell, in his book Basic Economics, points out that the price of homes on the beach are very high, but only because there is a scarce amount of land at the beach. We cannot all live on the beach, it is physically impossible. So the allocation of this scarce resource is dependent on the supply and demand conditions. Since there is limited supply and lots of demand, then the price of homes are higher on the beach. Government then establishes public beaches for all people to enjoy. When market prices are not allowed to function according to the laws of supply and demand, then there is a poor allocation of scarce resources that can result in more people suffering. Thomas Sowell cites the example of the Plava River Valley in the Soviet Union (a highly fertile agricultural area). Here prices were kept artificially low by law to protect the local citizens from higher prices. Yet many of the citizens in and around the Valley still starved. Why? They had no incentive to produce more agricultural goods than they needed for just themselves as the low prices did not justify the investment to increase food production. Those that did not farm could not access local food. The lack of a market due to a fixed low price prevented supply from developing.

Markets and competition, though, regulate prices from going too high. Simply stated, the law of supply says that producers will make more goods and services at higher prices. Yet the law of demand says that consumers will purchase more goods at lower prices. If a business tries to raise prices too high, consumers (the market) will punish the supplier by not purchasing the goods or new competitors will enter the market to replace the greedy competitor.

Let’s examine how price changes over time also cause social change by exploring the auto industry. From the end of the OPEC oil cartels in the 1970’s, the real price (i.e., excluding the effects of inflation) of a gallon of gasoline declined by two-thirds from a peak of about $3.03 in 1981 to a low of $1.17 in 1999 due to increased production of oil. During this time, a social change occurred. More people were willing to buy expensive trucks and SUVs because it was more affordable to drive them at these lower gasoline prices (the law of demand). The auto companies produced and marketed more of these vehicles. Today as we all know, the real price for a gallon of gasoline in today’s dollars now exceeds $2.80. So auto companies are beginning to produce hybrid gas/electric vehicles and consumers are increasingly purchasing them as it is more difficult to afford a Truck/SUV. A higher price of gasoline is beginning to shift the allocation of social resources to vehicles using alternative energy.

Competition is a crucial element of our economic system. As previously mentioned, it regulates prices. The more competition exists, the more difficult it is to raise prices. But competition also spurs innovation. If a business is to meet the needs and wants of customers, it simply must continue to improve existing products or create new ones. Look at the airplane manufacturing industry. Because of the intense competition between Boeing and Airbus, they are making multi-billion dollar investments in the design and manufacture of two new planes – the 787 Dreamliner and the A380 super-jumbo. Airbus decided to develop a new double-decker plane to compete with the 747, while Boeing decided to develop a mid-to-long range plane that holds fewer passengers to compete with the A380 (and they are not updating the 747). Two enormous strategic bets.

Boeing says “The 787 Dreamliner, scheduled for delivery beginning in 2008, provides passengers with a better flying experience and operators with a more efficient commercial jetliner. Using 20 percent less fuel per passenger than similarly sized airplanes, the 787 is designed for the environment with lower emissions and quieter takeoffs and landings. Inside the airplane, passengers will find cleaner air, bigger windows, more stowage space and improved lighting.” See a video of this new plane.

Airbus says “the A380 meets international carriers’ needs for capacity growth on key long-haul routes, brings new levels of comfort in all classes of service, and represents a 20-year advance in fuel savings and lower emissions. Its highly efficient operation result in much lower fuel consumption per passenger than any other aircraft. Aircraft noise levels during takeoff and landing also are an increasingly critical factor in airline operations, and the A380 provides dramatic improvements in this area as well.” See a video of this new plane.

You can just feel the competitive intensity between these two companies and imagine how exciting it must be for the people on these two projects (okay also stressful). But it is the consumer who is the ultimate beneficiary. Competition spurs innovation and change. But Robert J. Samuelson, an economic journalist, says in his article Anxiety Amid Prosperity,

“A puzzle of our time is why the economy has become increasingly stable, while individual industries have become increasingly unstable…for most businesses, sales, profit and employment levels have all become more volatile in recent decades…Competitive pressures have dramatically intensified…An intensely competitive economy enhances overall stability by holding down inflation and spreading economic disruptions throughout the business cycle rather than letting them accumulate for periodic, massive downturns” (i.e., recessions).

As leaders in large or small businesses, this long term change in how the economy functions requires us to continually innovate and effectively manage people in more challenging competitive markets.

Profit, of course, is the incentive for a business to succeed in the first place and thus take the risks to provide jobs, make investments, and produce goods or services. Often times we hear it said, though, that the purpose of a business is to earn profits. Profits are a measure of how well management has succeeded in defining and implementing a business strategy. But they are not the purpose for a business. Peter Drucker points out that the purpose of a business is to “get and keep customers”. Drucker’s point is actually very consistent with Adam Smith’s point about pursuing self-interest. If a business attracts and retains customers, and does so efficiently, the business will earn a profit and promote the general welfare of society.

If a business does not earn profits, it is a signal that resources are not being used effectively. For example, the products may not be of sufficient value, products may not be priced right to capture the value, management may not be skilled enough at competing effectively, and/or the business may not be sufficiently capitalized. If a business does not earn a profit, then effectively not enough customers have found sufficient value to justify buying the product. From the perspective of society at large, it is not an efficient use of scarce economic resources and thus the business should either fail or change. For change in a business to occur though, it is the responsibility of both management and employees. If the focus of the business is on customers and people first, then profits will follow. Sam Walton was obsessed with serving customers at low prices and a great motivator of his employees that resulted in becoming the largest, most profitable retail operation in the world. Herb Kelleher at Southwest Airlines changed to a point-to-point business model and had an obsession for both customers and employees that yielded profits every year for 25 years in a turbulent airline industry (a result no other airline can claim). Profit is an incentive to make investments and take risks, but it is not the purpose. Profit occurs because a business first serves a customer effectively and efficiently, values people highly, and then society gains.

Creative destruction is an economic concept from Joseph Schumpeter (1942) essentially saying that industries come and go over time due to the evolutionary process of new technologies displacing old technologies. For example, Smart Phones with advanced computing features are displacing key functions and uses of the Personal Computer, which displaced key functions and uses of the Mainframe computer. Clearly, development of technology is the driving force. The link below is a brief recap of the history of technology (illustrating the cycle time from discovery to market maturation) and generally what lies ahead.

The attached chart illustrates the Technology History and Future.

The implication of the above chart for business leaders is clear. We must all be aware of the technologies under development (in and outside of our organizations) and the potential consequences to business markets in the future. A good source to learn about future technologies in development today, and their business implications, is at the Economist magazine’s Technology Quarterly.

Remember, the source of creative destruction is technology development, but the application of technology that results in business/market change can occur in many different ways:

1. New products and services

2. Changes in manufacturing processes

3. Availability of new labor and raw material sources

4. Alternative methods to manage inventory (e.g., just-in-time) and information.

5. Types and processes of transportation (e.g., FedEx and UPS enabled delivery of books ordered online)

6. Different ways to communicate (e.g., e-mail, instant messenger, etc.)

7. New financial strategies and instruments

Globalization is the integration of economic and social systems between countries around the world. It really is not a new phenomenon as it was one of the top political issues in the early 1900s and also is today. Globalization does cause a convergence of products, prices, wages, interest rates, etc., towards those of the developed countries, but it takes a long time. For example, we all know of the rapid economic ascent of China due to very low wages. As a result of their economic development, one of the big issues now in China is the increasing wages of employees in the Special Economic Zones, so much so that prior cost advantages from production in China are starting to narrow. As a result, businesses are now starting to move production in China to other “2^nd Tier” cities where wages are lower.

The Economist magazine in its 2001 survey titled Globalization and its Critics says “Economic integration is a force for good, and why globalization, far from being the greatest cause of poverty, is its only feasible cure…International economic integration, in the liberal view, is what happens when technology allows people to pursue their own goals and are given the liberty to do so…the result is that society as a whole prospers and advances…the point of a liberal market economy is that it civilizes the quest for profit…if firms have to compete with rivals for customers and workers, then they will indeed worry about their reputation for quality and fair dealing.” Globalization has significantly increased the competitive intensity for businesses everywhere. And as business leaders, it requires us to build products and services with the highest possible quality at a target price in order to compete effectively. There is a positive correlation between the perceived quality of products and services and the return on investment that a business earns. With profit as an objective, it is in a business’s best interest to improve both product and people quality.

Business leaders are often criticized for globalization and its potential consequences (e.g., loss of jobs), while not defending and supporting the benefits of globalization. There are two key thoughts for business leaders to consider as decisions are made.

1. It is true that people in the United States have lost jobs as a result of globalization. It is also true that the length of time for people to find new jobs has held steady for the last 5 decades at 10-12 weeks per person. And the size of the labor force in the US has grown steadily at 1.3% per year for the last 25 years, while the population has grown at 1.1%. In other words, more net jobs overall are being created, the US economy has absorbed the addition of women and ethnically diverse people than the growth in population. The quality and pay rate of these new jobs, though, has often been less than the lost jobs. There is now a widening gap in income levels of workers in our society. If a business is to have a “reputation for quality and fair dealing”, then we need to improve the skills and abilities of people who work for us as a way to improve productivity, manage costs, improve product quality and retain a quality better paid workforce (perhaps even work with government to ease the transition for those who lose a job). As a result, we then serve society.

2. A study by the World Bank says “only countries in which we have seen large-scale poverty reduction in the 1990s are ones that have become more open to foreign trade and investment.” The more globalized poor countries have seen their Gross Domestic Product (GDP) grow an average of 5% (versus 3% in rich developed countries). Those poor countries that have affected less globalization actually saw their GDP decline, on average, by 1% per year. C K Prahalad, in his book The Fortune at the Bottom of the Pyramid, says “If we stop thinking of the poor as victims or as a burden and start recognizing them as resilient and creative entrepreneurs and value-conscious consumers, a whole new world of opportunity will open up…What is needed is a better approach to help the poor, an approach that involves partnering with them to innovate and achieve sustainable win-win scenarios where the poor are actively engaged and, at the same time, the companies providing products and services to them are profitable…by focusing on (the poor’s) capacity to consume private sector businesses can create a new market.” Prahalad has identified that the GDP of the developing world is about equal to the GDP of the developed world. There are over 6 billion people in the world with 2 billion in the developed world and 4 billion in the developing world. The poor might actually be as big a market as businesses typically serve today, but remains relatively untapped. Again though, business leaders will need to think differently if they are to find ways to serve the poor as customers and earn a profit at the same time. Believe it or not, this phenomenon is occurring today through globalization, and there are still lots of business opportunities out there.

In summary, the US and global economy are experiencing enormous change. But that is the nature of a free market economy. Alan Greenspan in his book The Age of Turbulence points out that:

“The rise in material well-being – a tenfold increase in real per capita income over two centuries – has enabled the earth to support a six-fold increase in population. Yet, for many, capitalism still seems difficult to accept, much less fully embrace. The problem is that the dynamic that defines capitalism, that of unforgiving market competition, clashes with the human desire for stability and certainty.”

The practice of business leadership, then, is to create and innovate while developing the skills and abilities of people, which enables more stability for both a business and its people. Over the long term, our economic system has in fact functioned best when all people have the opportunity to utilize their God-given abilities. In the process, a business fulfills a social and economic purpose.