May 2008

Top-heavy management drains companies

By Hans D. Baumann

Why is it such big and formerly very prosperous companies as General Motors (GM) and Delta Airlines, to name a few, flounder and teeter on the brink of bankruptcy?

They might follow their esteemed predecessors such as the Studebaker Co., Pan American Airline, and RCA.

The cause is not obsolete technology or adverse business conditions.

One may blame GM's woes on high pension cost. That is partially true, but not the full story. After all, the German Mercedes plants, having one of the highest labor costs in the world, just reported their biggest profit ever. So did Toyota, outstripping Ford in car sales.

So, what is happening?

The answer may be, when companies grow at the top of the organization, they become heavy on the management side. They become unmanageable. There are too many reporting layers and with it an un-yielding bureaucracy.

Contrary to public opinion, the problem lies not in production but with the administration and management. After all, the time it takes to assemble a given size car is practically identical for all major car companies.

We can see the same problem in the airline industry. Take Delta Airlines for example. In 2006, Delta had a loss of 36%. Were their planes less efficient? I don't think so.

The answer lies in the administrative area. Delta has 119 employees per airplane. Southwest Airlines manages with only 69 employees per plane. Yet they made a nice 5.49% net profit.

Where are the extra 50 Delta employees? I certainly did not see them behind the ticket counter or at the gate. My guess is they all sit behind their computers in administrative offices.

I hope U.S. Congress will prevent further mega-mergers between large airlines and their unavoidable decrease in efficiency and loss in customer service. Mergers, largely, serve only for the benefit (bonus) of the top management of companies merging.

Almost all fail later on. Tyco Laboratory and AOL might serve as an example.

Unfortunately, this cancerous growth in administration is also prevailing in the U.S. Military.

Take the Army for example. In World War II, there were 14 soldiers for every officer. Now we have one officer for every five soldiers. Between the squad and the army group level, there are no less than 11 reporting layers. The result is there are fewer and fewer actual fighting units left. That is, with a standing army of about 500,000 soldiers, we can only muster about 60,000 to fight in Iraq. The rest deploy elsewhere or support the fighters in Iraq.

What is the answer? Tell your company to grow horizontally, which is to say maintain as many financially independent divisions as possible.

That, after all, was the way GM originally started, when it still was a highly respected and profitable organization, prior to the 1960s and before the "combine everything" for the sake of "economy of scale" became so fashionable.

A good example of how to do it right is Illinois Tool Works (ITW).

This company operates with an astonishing 600 financially independent divisions. Some of them even compete against each other. The company, as a result, shows excellent financial numbers. Not only do their sales and profits increase greatly, their margins (percent of profit on sales) increase too.

That is an astonishing feat for a company this size. In 2006, ITW reported margins of 16.5%. This is in sharp contrast to their peers averaging only 9.5%.

James Farrell, ITW's former chairman and chief executive, stated, "I split up units once their sales exceed $50 million."

All I can say is, "right on!"

ABOUT THE AUTHOR

Hans D. Baumann, P.E. (hdbaumann@comcast.net) is an ISA Life Fellow. He has designed over 30 valve lines, holds 154 patents, and has written hundreds of papers and seven books on the subject. He has industrial an engineering education and a Ph.D. in mechanical engineering. His most recent book is Ideal Enterprise: Managing by the Law of the Sphere, ISA Press, 2002.