18326481-empty-computer-room-abandoned-building-basement-sf-old-mintThis is my promised third column in a series about the effect of H-1B visa abuse on U.S. technology workers and ultimately on the U.S. economy. This time I want to take a very high-level view of the problem that may not even mention words like “H-1B” or even “immigration,” replacing them with stronger Anglo-Saxon terms like “greed” and “indifference.” The truth is that much (but not all) of the American technology industry is being led by what my late mother would have called “assholes.” And those assholes are needlessly destroying the very industry that made them rich. It started in the 1970s when a couple of obscure academics created a creaky logical structure for turning corporate executives from managers to rock stars, all in the name of “maximizing shareholder value.”

Lawyers arguing in court present legal theories – their ideas of how the world and the law intersect and why this should mean their client is right and the other side is wrong. Proof of one legal theory over another comes in the form of a verdict or court decision. We as a culture have many theories about institutions and behaviors that aren’t so clear-cut in their validity tests (no courtroom, no jury) yet we cling to these theories to feel better about the ways we have chosen to live our lives. In American business, especially, one key theory says that the purpose of corporate enterprise is to “maximize shareholder value.” Some take this even further and claim that such value maximization is the only reason a corporation exists. Watch CNBC or Fox Business News long enough and you’ll begin to believe this is the God’s truth, but it’s not. It’s just a theory.

It’s not even a very old theory, in fact, only dating back to 1976. That’s when Michael Jensen and William Meckling of the University of Rochester published in the Journal of Financial Economics their paper Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure.

Their theory, in a nutshell, said there was an inherent conflict in business between owners (shareholders) and managers, that this conflict had to be resolved in favor of the owners, who after all owned the business, and the best way to do that was to find a way to align those interests by linking managerial compensation to owner success. Link executive compensation primarily to the stock price, the economists argued, and this terrible conflict would be resolved, making business somehow, well, better.

There are many problems with this idea, which appears to be more of a solution in search of a problem. If the CEO is driving the company into bankruptcy or spends too much money on his own perks, for example, the previous theory of business (and the company bylaws) say shareholders can vote the bum out. But that’s so mundane, so imprecise for economists who see a chance to elegantly align interests and make the system work smoothly. The only problem is the alignment of interests suggested by Jensen and Meckling works just as well – maybe even better – if management just cooks the books and lies. And so shareholder value maximization gave us companies like Enron (Jeffrey Skilling in prison), Tyco International (Dennis Kozlowski in prison), and WorldCom (Bernie Ebbers in prison).

It’s just a theory, remember.

The Jensen and Meckling paper shook the corporate world because it presented a reason to pay executives more – a lot more – if they made their stock rise. Not if they made a better product, cured a disease, or helped defeat a national enemy – just made the stock go up. Through the 1960s and 1970s, average CEO compensation in America per dollar of corporate earnings had gone down 33 percent as companies became more efficient at making money. But now there was a (dubious) reason for compensation to go up, up, up, which it has done consistently for almost 40 years until now we think this is the way the corporate world is supposed to work – even its raison d’etre. But in that same time real corporate performance has gone down. The average rate of return on invested capital for public companies in the USA is a quarter of what it was in 1965. Sure productivity has gone up, but that can be done through automation or by beating more work out of employees.

Jensen and Meckling created the very problem they purported to solve – a problem that really hadn’t existed in the first place.

Maximizing shareholder return has given us our corporate malaise of today when profits are high (but are they real?) stocks are high, but few investors, managers, or workers are really happy or secure. Maximizing shareholder return is bad policy both for public companies and for our society in general. That’s what Jack Welch told the Financial Times in 2009, once Welch was safely out of the day-to-day earnings grind at General Electric: “On the face of it,” said Welch, “shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy… your main constituencies are your employees, your customers, and your products. Managers and investors should not set share-price increases as their overarching goal. … Short-term profits should be allied with an increase in the long-term value of a company.” 

Now let’s look at what this has meant for the U.S. computer industry. 

First is the lemming effect where several businesses in an industry all follow the same bad management plan and collectively kill themselves.  We saw it in the airline industry in the 1980s and 90s.  They all wanted to blame regulation, then deregulation, then something else. The result was decimation and consolidation of America’s storied airlines and the services of those consolidated companies generally sucks today as a result. Their failings made necessary Southwest, Jet Blue, Virgin America and other lower-cost yet better-service airlines.

The IT services lemming effect has companies promising things that can not be done and still make a profit.  It is more important to book business at any price than it is to deliver what they promise.  In their rush to sign more business the industry is collectively jumping off a cliff. 

This mad rush to send more work offshore (to get costs better aligned) is an act of desperation.  Everyone knows it isn’t working well.  Everyone knows doing it is just going to make the service quality a lot worse.  If you annoy your customer enough they will decide to leave. 

The second issue is you can’t fix a problem by throwing more bodies at it.  USA IT workers make about 10 times the pay and benefits that their counterparts make in India.  I won’t suggest USA workers are 10 times better than anyone, they aren’t.  However they are generally much more experienced and can often do important work much better and faster (and in the same time zone).  The most effective organizations have a diverse workforce with a mix of people, skills, experience, etc. By working side by side these people learn from each other.  They develop team building skills.  In time the less experienced workers become highly effective experienced workers.  The more layoff’s, the more jobs sent off shore, the more these companies erode the effectiveness of their service.  An IT services business is worthless if it does not have the skills and experience to do the job. 

The third problem is how you treat people does matter.  In high performing firms the work force is vested in the success of the business.  They are prepared to put in the extra effort and extra hours needed to help the business — and they are compensated for the results.  They produce value for the business.  When you treat and pay people poorly you lose their ambition and desire to excel, you lose the performance of your work force.  It can now be argued many workers in IT services are no longer providing any value to the business.  This is not because they are bad workers.  It is because they are being treated poorly.  Firms like IBM and HP are treating both their customers and employees poorly.  Their management decisions have consequences and are destroying their businesses.

At this point some academic or consultant will start talking about corporate life cycles and how Japan had to go from textiles to chemicals to automobiles to electronics to electronic components simply because of limited real estate that had to produce more and more revenue per square foot so it was perfectly logical that Korea would inherit the previous generation of Japanese industry. But that’s not the way it works with services, which have no major real estate requirements. There is no — or should be no — life cycle for services.

So evolution is not an option because there’s no place to evolve to.  The IT industry has turned into a commodity business of high volume, lower margin products and services.  The days of selling a $250,000 system for $1,000,000 and passing around big commission checks are gone. 

Good management and business optimization are both essential and rare.  You can’t succeed by merely saying you will solve your problems by selling more.  You have to run your business a lot smarter.  The way for an IT company to succeed is by being being smarter than the competition, not sneakier, dirtier, or less empathetic.

Empathy, what’s that?

IBM and HP (my go-to examples lately) are failing to recognize that a big part of their business has become a commodity.  Calling it a low margin business and selling it off ignores the basic need for these companies to evolve and make serious changes to their business models.  If the world is moving to low cost servers and you sell off your server business, what will you sell in the future? 

Cloud computing is a prime example of a high volume, low margin, commodity service.  If you don’t make the adjustments to operate as a commodity business, you won’t be able to succeed with selling cloud services.  IBM and HP continue to cling to their 1990’s business model.  Soon they will have no high margin products and services to sell, and they will no longer have any high volume products or services.  Every time they sell a high volume, low margin business they paint themselves tighter in a corner. 

A few weeks ago I was on a Southwest flight.  I heard one Southwest employee say to some others “planes can’t make money if they are sitting on the ground.”  They all knew exactly what needed to be done and why.  You rarely see that business awareness and focus in every employee of a company, yet it is common at Southwest.  You don’t see it with most other airlines.  Southwest knows the value in their service lies in transporting people.  If their planes are not in the air, they’re not transporting people.  Do HP’s or IBM’s whole organization understand the “value” of their service? 

It is only a matter of time until a company emerges that truly understands the value of IT service, because that need isn’t going away.  Companies are only as smart as the collective intelligence of all their workers.  If all their workers understand the value and business model, they can be a formidable competitor.  When that happens IBM and HP will be in serious trouble.  IBM ignores 99 percent of its workforce and keeps them in the dark.

There was period when the whole airline industry acted stupid.  A lot of them failed and it was pretty ugly.  There was a period when the Detroit automakers suffered a major brain freeze.  Japanese companies introduced cars that were much, much better and slowly eroded Detroit’s dominance in the industry.  Today Toyota and GM trade places for the world’s largest car company. Who would have thought that would happen?. 

We’re right on the edge of losing our computer industry.  As the market moves to Intel servers, anyone can become a big player.  Where does that leave HP and IBM?  The quality of “services” is so terrible right now the market is hungry for a better provider.  If one emerges in Asia where does that leave HP and IBM?  When that new spunky company makes it to the CIO’s office HP and IBM will be in serious trouble.

Honest to God, these American companies think that can’t happen.

We are at a very dangerous period of time in computer history and the storied companies that made most of that history don’t even see it.  That’s because they are fixated on the vision of their leaders and their leaders are fixated on visions of their own retirements coming an average of four years from today.

So look, for example, at Meg Whitman and Ginni Rometty.  All the things they’re doing to “transform” their businesses are causing more harm than good.  They really are not aligning their business models to evolving market conditions. 

We’ve lost the consumer electronics industry, we’ve lost over half of the automotive industry, we’ve lost millions of manufacturing jobs, and we’re about to lose our computer industry, too.

But it doesn’t have to happen.

In 1989 when Sony bought Columbia Pictures for $4.3 billion, many in Hollywood thought the end of American entertainment hegemony had begun. But it didn’t happen. It didn’t happen because the value in Hollywood lies almost entirely in the people who work in the entertainment industry — people who mainly lived at that time in Southern California. Sony, in turn, thought it was going to suck lots of profit out of Columbia but they couldn’t because a big star still cost $10 million per picture, a top director $5 million, etc. And don’t get me started on those Hollywood accountants! All Sony got was the skeleton of Columbia, not the heart or the blood.

Now look at the American IT industry in a similar light. American companies have been pretending to offer a superior product for a superior price while simultaneously cutting costs and cheating customers. Do you think IBM respects its customers? They don’t. But what if they did? What if IBM — or any other U.S. IT services company for that matter — actually offered the kind of customer service they pretend they do? What if they solved customer problems instantly? What if they anticipated customer problems and solved them before those problems even appeared? You think that can’t be done? It can be done. And the company that can do it will be able to charge whatever they like and customers will gladly pay it.

True mastery, that’s what we’ve lost. No, we haven’t lost it: we threw it away.