Over the past several decades the number of metrics used to measure a company’s worth has narrowed to one: profit. The formula is simple
Profit = Excellence
You can find this simple construct in everything from the bombastic pronouncements of Donald Trump to the harangues of Jim Cramer. While these public figures may not represent the more thoughtful among us, make no mistake; their views on what constitutes excellence are widely accepted. The problem is that the formula makes no sense from a factual perspective and creates tremendous problems in assessing risk.
Excellence results in many things such as creativity, cooperation, inspiration, collaboration and so forth. Profit is a secondary or tertiary result of excellence, not the other way around. Profit is an outcome, not a strategy. Attempts to make it a strategy usually result in some pretty bizarre behavior on the part of corporate managers and employees; we all remember Enron and WorldCom.
Risk management, in the context of this erroneous formula has become an exercise in attempting to determine how much profit might be affected by a negative event. Corporations seem insistent on this approach regardless of the consistent and increasingly dramatic evidence that it doesn’t work and, at best
that it provides a false sense of security. But there is a drumbeat for change. What follows is an analysis that began over a decade ago. While the information isn’t new, there is some evidence that the
perception that profit as a strategy no longer has utility.
A 2004 study reported in Business Week magazine provides us with a comparison between a company that attempts to achieve profit at any cost (WallMart) versus a company that fosters excellence in its workforce (Costco). The results, as summarized in the following tables, are dramatic although the first table seems to suggest that Wal-Mart is running a tighter, more cost effective organization.
*Excludes part-time workers **Workers less than a year not covered
The second table demonstrates the result of the Wal-Mart profit strategy versus the Costco investment in excellence strategy. By paying its workers a living wage, providing them with healthcare and a retirement plan that will actually allow them to retire, Costco is reaping significant benefits.
*For all of Wal-Mart **Over the past five years in the US
The distance between Costco and Wal-Mart’s approach has remained consistent, as have the results. In an October, 2011 analysis written by Jeff Reeves, Editor of Investorplace.com provides clear evidence that Costco continues to thrive with revenues up nearly 30% in the past year while Wal-Mart experienced it’s 9th consecutive quarter of declining sales as of August of 2011.
What does this have to do with risk management? Everything. When an organization focuses on excellence it galvanizes its workforce, not only by providing them with financial incentives but, more importantly, by creating an environment where they take initiative to achieve the company’s goals. The alternative approach (where employees are seen as drones representing an expense to be minimized) results in less, not more profit.
But the disparity between the two approaches is actually more insidious. Statistics compiled from a variety of sources show that 75% of all employees have stolen from their companies amounting to a loss of $50 billion and 7% of annual revenues. Those are huge numbers. Not surprisingly, a study done by Chen and Sandino at the University of Illinois clearly shows that there is a direct correlation between lower wages and greater theft by employees.
Costco’s employee theft is 1/10 of the industry average. The statistics don’t end here but they consistently demonstrate that people’s feelings about where they work are fundamental to how they perform. Organizations that invest in excellence not only suffer less theft, they also benefit in ways that are more difficult to measure. When employees feel good about their work environment they are much more likely to defend it against individuals who behave in a way that could harm it. Back in the days before risk management was a profession,companies relied on the loyalty of their workers as the primary guard against damage to their reputations and their bottom lines. The comparison between Wal-Mart and Costco clearly demonstrates the folly of moving away from this idea and embracing a set of abstract numbers to guide an organization’s decision-making process.
The perception of risk is based on emotion. Apple’s recent decision to bring some of it’s manufacturing back to the US is clearly a reaction to the deplorable conditions at the Foxccon factory in China that resulted in a number of suicides. Apple understands that its brand cannot survive that kind of damage. Wal-Mart, on the other hand seems to embrace its reputation as an organization that only pays lip service to providing employees with reasonable compensation and benefits.Ask yourself who has the greater risk.
Tags: Accounting , calculation , company , metric , profit , risk