Committee for Economic Development of Australia (CEDA) senior economist Melissa Wilson says boards can improve management capability to boost business dynamism.
Two leading global surveys paint a picture of Australia’s declining innovation credentials. The Global Innovation Index highlights innovation strengths and weaknesses, in particular gaps in innovation metrics. The IMD World Digital Competitiveness Ranking evaluates countries’ ability to embrace digital technologies and transformation. This special feature examines innovation’s issue with management performance, featuring expert commentary and showcasing industry leaders trying a different tack to attain the desired results.
Improving management capabilities may be Australia’s best chance to lock in another generation of economic prosperity. Evidence shows our managers perform below the world’s best. This explains a large part of the productivity gap between Australia and high performers such as the US. Businesses are generally unaware of their own capabilities or how to improve them. This presents a prime opportunity to create a more dynamic and productive economy.
Business dynamism is a key feature of a healthy economy. As businesses start and fail, and expand and contract, productivity is boosted as firms seize new opportunities, innovate and put resources to their most productive use. A dynamic and productive economy is essential for job creation, income growth and, ultimately, the long-run prosperity and high living standards we expect. But Australia was suffering from a lack of dynamism and productivity growth long before anyone had heard of COVID-19. Treasury research shows Australian firms fell further behind the global productivity frontier over the past two decades.
Debate about how to boost dynamism and productivity often focuses on the policy levers governments can pull, but business plays a critical role. A dynamic business sector requires dynamic leaders. This is where management capabilities come in. International research shows they are a key driver of performance at the firm level and, ultimately, of productivity and prosperity at the national level.
Surveys indicate that the US has the best managers, followed by Sweden, Japan, Germany and Canada. Australian businesses sit in the second tier of countries alongside France, the UK and Italy. While most countries have some firms operating at best practices, lower-ranked countries have larger “tails” of weaker performers.
Bloom, Sadun and Van Reenen (2017), using data from the World Management Survey, estimated that management capabilities may explain up to half of the productivity gap between Australia and the US, which leads on productivity.
An Australian study commissioned by the Department of Innovation, Industry, Science and Research in 2009 found that a single-point increase in an Australian firm’s management score (on a scale of one to five) is equivalent to a 44 per cent increase in the firm’s invested capital, or a 56 per cent increase in the firm’s labour force. These results highlight how, by adopting best practice, firms can also have a meaningful impact at the macroeconomic level.
The World Management Survey shows that businesses with better capabilities tend to be larger and older, with more educated managers and workers. External influences are also a positive. In Australia, as elsewhere, multinationals not only consistently demonstrate strong management capabilities, but also tend to transfer best practices to the domestic market through their commercial interactions with local firms. Firms held to account by public shareholders or private equity owners are typically much better managed than those that are family or government-owned.
In a cross-industry study using Australian Bureau of Statistics data, Department of Industry Innovation and Science research (2019) found Australian firms scored highly on strategic management capabilities, but were particularly weak on adopting and integrating digital technologies into their strategy and operations, and in shifting towards environmental sustainability. These digital and environmental capabilities have been shown to add value, improve efficiency and boost resilience. They will become more important in an era increasingly driven by rapid technological change and sustainability concerns. In addition, relative to their international peers, Australian managers lag the most on “instilling a talent mindset”.
One important finding from these studies is that most firms are unaware of their own management standards and how to improve them. But adopting best practices doesn’t require innovation or new ideas — firms simply need to acquire and absorb information that already exists. We need more firms to measure and critically assess their management practices, identify performance gaps and initiate improvements.
Risk appetite and dynamic capabilities
To date, most Australian research into management capabilities has focused on ordinary capabilities. These are operational and focused on efficiency or “doing things right”. Strong ordinary capabilities can raise productivity at the organisation level, pushing laggard companies closer to the productivity frontier. But they also assume a stable operating environment and therefore can’t guarantee long-run success in an uncertain and rapidly changing world.
Companies must be willing to tolerate some level of risk to operate effectively in an uncertain environment. Yet corporate incentives and control processes, particularly in large organisations, can discourage this.
Firms can use risk assessment to make decisions amid uncertainty, but this relies not only on an appropriate risk appetite, but also on being able to assign probabilities to potential outcomes. This is not always possible, especially in the current environment of rapid technological change, geopolitical shifts, pandemics and natural disasters.
To ensure survival and build competitive advantage, firms must therefore accept imperfection and take bolder decisions. In other words, they need dynamic capabilities. These are forward- looking, strategic in nature and focused on effectiveness and “doing the right things”.
Dynamic capabilities allow firms to sense new opportunities and threats, mobilise resources to seize these opportunities, and undertake renewal and transformation. Companies with these capabilities are more resilient and can manage their current business effectively, while also preparing for the future. Dynamic capabilities support innovation, expand the productivity frontier and generate future economic growth.
There has been little research into the dynamic capabilities of Australian companies, although this year’s IMD World Competitiveness Yearbook provided some insights. CEDA is the Australian partner for the yearbook, which ranks countries using a combination of statistical indicators and a survey of executives. Australian executives scored themselves particularly poorly in this area, ranking Australia 60th (out of 64 countries) for entrepreneurship of managers; 56th for company agility and responding quickly to opportunities and threats; 43rd for awareness of changing market conditions; and 39th for flexibility and adaptability in the face of new challenges.
In contrast, Hong Kong and the UAE ranked among the top few countries on all of these measures. Similarly, Australia scored poorly in terms of attitudes towards globalisation (50th) and foreign ideas (53rd), yet international experience and exposure are associated with better management capabilities and outcomes.
Melissa Wilson is senior economist at CEDA.
Questions for boards to consider
The COVID-19 pandemic has brought to the fore the importance of management capabilities in driving business performance and survival. As we increasingly turn our attention to reopening our economy and businesses, understanding where Australian management capabilities sit — and how these can be improved — will be important for lifting Australia’s competitiveness, productivity and long-term economic prosperity.
Critical areas for boards to consider in assessing and understanding the state of play and role of management capabilities include:
Are we putting enough emphasis on dynamic capabilities relative to efficiency and so-called “ordinary” capabilities?
Too much focus on ordinary capabilities can hinder the innovation required to develop dynamic capabilities and pursue long-term competitive advantage.
Do we have the diversity of experience and capabilities at the board and management levels?
David Teece and Kieran Brown of the BRG Institute (2020) point out that directors with experience in strategy, technology, brand and operations are important to complement those with more traditional legal, accounting and financial backgrounds.
Are we building the right capabilities, culture and processes to enable timely and effective decision-making in the face of ambiguity and uncertainty?
As Teece has emphasised, at times of high uncertainty, leaders need a sense of urgency, and can’t afford to wait to have all of the information before making decisions.
Are management teams capable of effectively managing multiple phases of business activity simultaneously, from core to growth to exploratory?
Firms with strong dynamic capabilities can manage the current business effectively while also positioning the business for the future.
Do we have the management capabilities to avoid the inertia that can come with success?
Stanford Graduate School of Business professor Charles O’Reilly points out that structural and cultural inertia can hamper the ability to adapt and respond to new opportunities and threats. He argues that while companies are open to innovation and experimentation, many fail at scaling new businesses, especially if this requires cannibalising existing revenue sources.
These issues are ones board directors and management may be reflecting on now. To add to understanding and consideration of these issues, and against the backdrop of a lack of data and evidence about the dynamic capabilities of Australian businesses, the Committee for Economic Development of Australia is undertaking a broad- based assessment of these capabilities in Australia.
For companies, the benefits of better management practices are clear. As the world emerges from the COVID-19 economic crisis, Australia’s future success must be underpinned by a dynamic and innovative business sector. Management capabilities will be critical, not just for business performance and survival, but also for lifting Australian competitiveness, productivity and long-term economic prosperity.
This work is the first of its kind and aims to inform efforts to improve performance within and across businesses in Australia.
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