Good Management Weaves Gold into the Bottom Line

A new Stanford–World Bank field experiment in Indian textile plants finds the most compelling evidence to date that management matters.

                                  

In a manufacturing center four hours from Mumbai, India, the last working elevator in a textile weaving plant grinds to a halt. The looms and workers on the second floor need more cotton yarn to weave horizontally into the vertical warp threads in order to make cloth. But the factory owner is away on a sales trip, and no one else in this 24-hour-a-day, 7-day-a-week factory of 200 employees is authorized to pay for elevator repair. A cadre of workers is left with no option but to carry 1,200-pound spools of yarn up the stairs.

"You might wonder how a factory owner who refuses to delegate authority on this level can stay in business," says John Roberts, a Stanford Graduate School of Business economist who has studied this cloth-weaving factory and many others that make shirting, suiting, or home furnishing fabrics for the Indian domestic and Middle Eastern markets.

Indeed, economists and industrial policy makers have long puzzled over astounding differences in the productivity of companies in the same industries or same countries. For example, U.S. plants making cement, block ice, white pan bread, and oak flooring display 100% productivity spreads. On a country comparison basis, India's per capita gross domestic product is one-seventeenth that of the United States.

"A natural explanation for these productivity differences lies in variations in management practices," says Stanford economist Nick Bloom, who, along with John Van Reenen, a visiting professor from the London School of Economics, has developed methods to compare management and productivity across industries and countries. They find strong correlations between management and productivity, but correlations are not proof of cause and effect.

News media, book publishers, business schools, and government officials all talk about the importance of management, Bloom says, but many workers, economists, and even some of his MBA students and managers taking GSB executive education classes are skeptical.

Some of Bloom's and Roberts' peers in economics believe that bad management practices can't exist in competitive industries, except in the short run. For example, in their view, companies in developing countries may not be adopting quality control systems that are common in countries with higher wages because wages are so low that repairing defects is cheap. Hence, their management practices are not "bad," but the optimal response to low wages.

A second reason for skepticism, Roberts says, is the complexity of management, making it hard to measure and quantify. While some business educators believe there are "best practices" that are universally good and that all firms would benefit from adopting, others hold the "contingency view" that every firm is already adopting optimal practices, which are different from firm to firm.

In a rare feat for economics, Roberts, Bloom, and three colleagues were able to provide experimental evidence that a core set of management best practices does exist. In a 2-year field experiment that ended in 2010, they compared Indian textile factories in the same labor market and showed that those that adopted so-called best practices improved their productivity about 10% within a matter of months, while a control group did not. The scholars also detailed the impediments that kept firms from adopting better practices. Besides Roberts and Bloom, the researchers are economist Aprajit Mahajan of Stanford; Benn Eifert, a recent doctoral graduate of the University of California-Berkeley; and David McKenzie of the World Bank. The $1.3 million experiment was made possible by a variety of grants, with the largest support provided by Stanford's Graduate School of Business and Freeman Spogli Institute for Inter-national Studies.

The researchers worked with Accenture consultants to expose 20 mid-size Indian textile plants owned by 17 firms to management practices commonly employed in U.S., European, and Japanese manufacturing plants. The factories, a small fraction of those in the towns of Tarapur and Umbergaon, India, were assigned randomly to a control group of 6 plants or to a "treatment" group of 14 plants. Based on their prior textile experience, the consultants chose to promote 38 practices such as routines for recording and analyzing quality defects, production, inventories, and order fulfillment. They encouraged preventive maintenance, clear job assignments, and incentive pay based on performance.

Photos taken before any changes were implemented show storerooms of yarn in disarray, factory floors littered with tools and other safety hazards, and haphazard handwritten records of product defects. While such disarray might work fine for a single artisan, Bloom says, firms with hundreds of employees performing complex operations need formalized management practices to support coordination and motivation.

The study began with consultants spending a month in each plant diagnosing problems and constructing databases for recording metrics such as output, efficiency, quality, inventory, and energy use on an ongoing basis. They then provided each treatment and control plant with a detailed analysis of its management practices and performance.

"The control plants were given diagnostics because we needed to construct historical performance data for them and help set up systems to generate ongoing data," Roberts explains.

Next the consultants spent 4 months with the 14 plants randomly chosen for "treatment." The consultants' job was to persuade plant managers to implement the practices and also to help them implement, fine-tune, and stabilize the procedures so that they could be carried out readily by employees. For example, one of the practices implemented was daily meetings for management to review production and quality data. The consultant attended these meetings for the first few weeks to help the managers run them and provide feedback.

"The treatment intervention led to significant improvements in quality, inventory, and production efficiency," the researchers wrote in a summary. "The result was an increase in productivity of about 10%, a 60% reduction in defects, and a substantial increase in profitability of about $200,000 on estimated average-plant sales of $7.5 million." In contrast, the control group factories registered less than a 1% gain in productivity.

For GSB strategy Professor William Barnett, the researchers "not only identified improvements in firms' measureable performance, they also specified the process by which it happens in terms of changes to management practices. Those changes were made with the same management, which demonstrated that achieving better practices is a learning process."

That suggests a greater role for executive education programs in developing countries, says Barnett, who codirects the business school's Center for Global Business and the Economy with Roberts and former Secretary of State Condoleezza Rice. Yet reaching firm managers in rapidly developing economies won't be easy, Roberts and Bloom say, because sales representatives for services besiege them. "We think we were able to get permissions to do our study partly because of the Stanford name," Bloom says.

In rapidly developing economies, such as India, China, and Brazil, Roberts adds, sophisticated management practices do exist in high-tech firms and in others that have had broad exposure to multinational companies, but practices are less systematic in other industries, such as textiles.

The processes that were successfully introduced included recording machine downtimes and the reasons for them, clearly marking the floor where each machine should be, daily updated visual aids on procedures and efficiencies per machine, and spare parts systematically purchased, recorded, and stored.

In quality control, the practices included monitoring, recording, and meeting to discuss defects on a daily basis, developing a clear grading system for the product and an action plan based on defect data. Previously at some plants, defects were logged in handwriting but only referred to if a customer complained. Now defects are analyzed so they can be corrected the next day and not repeated.

In the "treated" factories, Bloom says, display boards now make productivity statistics visible on the shop floor, and incentive pay is based on the data.

Factories often lost track of yarn supplies. Now they have them organized and counted so
designers can fashion uses for them.

The Accenture consultants asked standardized questions to learn why a given practice had not been adopted previously. Cultural practices and legal institutions played a role, but, Roberts says, the primary impediment to change is limited knowledge.

"We saw a significant uptake in preventive maintenance in our treatment firms but not in the control firms, who heard about it in the initial consulting. Even in the treated firms, consultants had to persuade the owners to try preventive maintenance on a sample of machines first. They needed to see proof it paid off over time."

When asked why they had not done preventive maintenance before, factory workers indicated "either it was because they never heard of it, or they didn't believe it worked, or they thought they were pretty good at what they did already."

"It's really the same story as with the U.S. auto industry in the '70s to '90s," Roberts adds. "At first they didn't adopt Toyota's lean product techniques because they didn't know about them. Then they knew about them but didn't believe they would work in their plants. Finally they needed help implementing them."

The management of the Indian textile factories was highly centralized, which also makes change difficult. While the average company had four levels of management, all the important decisions were made at the top level.

"A typical company is one guy and his two brothers who own the entire firm," Bloom says. "They are the only people who would make any substantial decisions involving money, hiring, or product change. Everyone executes what they have been told to do. In America in a similar situation, plant managers have capital budgets; they can hire and fire and have some choice of product mix."

The reason for centralization is the degree of theft risk the Indian family owners face, Roberts says. The Indian court system has huge backlogs, so it is hard to rely on laws as a disincentive to theft.

Bloom adds: "If the owner lets the plant manager buy yarn, he may buy this from a friend paying 110% of market rates and then get a juicy kickback. So to get around that problem the owners typically make all the major decisions."

Better management practices helped decentralize decision making, the researchers found. "Once I'm getting daily updates from the factory on outputs and inputs and efficiency, I don't need to be on the scene as many hours to check up on stuff," Roberts says. "For example, if I am monitoring daily yarn inventory and purchases I would notice suspicious jumps in prices or missing inventory.

"In our best managed firm, the family had only one adult male, so he had to be at the plant every day because they do not use nonfamily members as senior managers. Having better data from the plant freed him up to open two more plants because he didn't need to be there every day."

Another conclusion of the field study was that modern management leads to computerization and probably a changing workforce.

"When you need to produce daily charts, you need computer-literate managers and analysts, so you start to change the educational composition of the factory," Bloom says. "This wasn't obvious to us in advance, but it could be one reason that in the United States, for example, it's harder and harder to earn a good living if you are not very well educated. You can see in India that these management practices are bad news for the illiterate factory worker and good news for the guy with more skills."

Some theoretical work by researchers suggests that computer literacy may drive a widening income gap, and this research would support that idea, Roberts says.

The study showed "substantial productivity gains from adopting lean manufacturing practices," says GSB economics Professor Kathryn Shaw, who is well known for her careful studies of firms' human resource management strategies and the productivity impact of management practices in U.S. steel mills. The Indian textile plant study, she adds, "is uniquely able to answer the question, Why don't more firms in developing countries like India adopt modern manufacturing practices?"

"The insider econometric methods used in this study and answers obtained," she says, "have produced a research paper that will be highly valued and quoted forever."

by Kathleen O'Toole - Stanford University