THE INSISTENCE ON VASTLY HIGHER EMPLOYMENT RATES...:

The Romney Economy: At Bain Capital, Romney remade one American business after another, overhauling management and directing vast sums of money to the top of the labor pyramid. The results made him a fortune. They also changed the world we live in. (Benjamin Wallace-Wells, Oct 23, 2011, New York)

The Bain & Company consultants who traveled the circuit of American business in the late seventies and early eighties experienced a mass of frustrations. The efficient, data-driven theory of business the consultancies had developed did not in any real way cohere with the practice of business that they saw in executive suites in St. Louis, Rochester, Houston. The theory said that companies should focus on their core business, but everywhere corporations were developing misguided plans to become conglomerates. The ­theory said management should measure everyone's productivity in a firm, down to the lowliest employee, and every last worker should be rewarded or punished depending upon his performance, but the social relationships of business seemed to have decayed into a long, amicable golf-course lunch. There was a loyal, almost paternalistic attitude toward workers, protecting them even when they seemed to be drags on growth. When I interviewed Romney's early colleagues about the business world that they surveyed during this period, they tended to adopt an attitude of high disdain. "Sloppy," one told me. "Complacent," said another. "Lazy," said a third, "and out of tune with the change that was going on in the world." [...]

Of all the business theories developing at the time, Romney and his cohort were particularly influenced by one that played to their sense of detachment from the business Establishment. In 1976, two business scholars, Harvard's Michael Jensen and the University of Rochester's William Meckling, published an important paper elaborating a new idea of the firm, one that would come to be called "agency theory." Previous corporate theory had emphasized a separation of powers between shareholders (who own a company) and management (the executives who run it). This situation, Jensen and Meckling pointed out, introduces a "principal-agent" problem, in which each agent has incentives that run contrary to the shareholders' interests and could hamper the firm's ability to function.

If you were looking across the landscape of American business 30 years ago, you could see agency problems everywhere. In the sixties, companies had become conglomerates so frequently that 20 percent of the Fortune 500 underwent a merger or an acquisition in a three-year period. CEOs had enjoyed building empires, and their shareholders, satisfied by decent returns, had often deferred to management control. But during the stagnant seventies, CEOs seemed loath to close factories and lay off workers. By the early eighties, as growth once again seemed possible, shareholders had become more restive, and innovative thinkers on Wall Street had begun to press the case that these companies had grown inefficient and timid, that management was underperforming.

Bain consultants did what they could, during their assignments, to improve their clients' operations, but they were often frustrated by an agent problem of their own: Bain was just a consulting firm, and "a consulting firm," says David Dominik, an early Romney colleague, "can't make anything happen." But Jensen and Meckling had sketched out one potential solution: If managers could secure financing to run their own companies, they might be able to build a better corporation, one that delivered stronger returns to its owners.

You could view this idea at least two different ways. One was as a chance to change the way American business is run. Another was as a business opportunity to exploit. Romney saw both.

Every business story begins with a proposition, and the one that launched Bain Capital was the notion that the partners might do better if they stopped simply advising companies and starting buying and running the firms themselves. [...]

In the mid-eighties, a European retail outfit called Makro, a kind of continental Costco, was looking for an executive to help run its U.S. business, and it called a Boston supermarket executive named Tom Stemberg, inviting him to tour a pilot store outside of Philadelphia. The store didn't impress him much, but he noticed that the office-supply aisle was absolutely packed with shoppers. He told the Makro executives to abandon their model and concentrate solely on office supplies; when they declined, he decided to give it a try himself. Boston business is a small world, and when he went looking for a venture-­capital partner, he eventually found his way to Mitt Romney and his new $37 million fund. "Most V.C.'s thought it was ridiculous," Stemberg says. "Mitt was highly unusual in that he went to the research level to study it."

The trouble with the idea, to Romney's subordinates at Bain Capital, was that the small businesses Stemberg needed to draw weren't accustomed to visiting a store for office supplies; they got them from separate vendors, some who ­delivered--one supplier for pens and paper, one for printer cartridges, and so on. "Some of us were worried that we needed to change consumer behavior," recalls Robert F. White, one of the firm's managing directors. Romney persisted. As members of the group surveyed more and more small businesses in suburban Massachusetts, they discovered that if you asked a small-business manager how much he spent on office supplies, he would give you a low estimate and tell you it wasn't worth it to send someone in a car to buy them. But if you asked the bookkeepers, you got a far higher number, about five times as much--high enough, Romney and Stemberg thought, to get them to come to the store. The idea became Staples. Romney's Bain Capital colleagues were soon helping to select a cheaper, more efficient computer system for the first store; they were helping stock the shelves themselves. As Staples succeeded, and began to expand, they looked at analytics for everything--the small-business population around a proposed store site, traffic flow--and gamed out exactly how big a customer would need to be before it demanded delivery. Romney sat on the Staples board for years, and his company made nearly seven times what it invested in the start-up.

Romney and his team did this sort of thing again and again, sometimes in venture­-capital deals but more often through buyouts--Brookstone, Domino's, Sealy, Duane Reade. In their more complex deals, they couldn't rely on their own team to seek out every inefficiency. They needed a more powerful lever, and they turned to the solution Jensen and Meckling had begun to explore a decade earlier: offering CEOs large equity stakes in the company in the form of stock or stock options. This was a relatively new idea, mostly untried in American business. At the same time, a board formed in part of Bain Capital appointees who had put up their own money in the deal would be more engaged in management details. "You have the total alignment of incentives of ownership, board, and management--everyone's incentives are aligned around building shareholder value," Dominik says. "It really is that simple."

In 1986, Bain Capital bought a struggling division of Firestone that made truck wheels and rims and renamed it ­Accuride. Bain took a group of managers whose previous average income had been below $100,000 and gave them performance incentives. This type and degree of management compensation was also unusual, but here it led to startling results: ­According to an account written by a Bain & Company fellow, the managers quickly helped to reorganize two plants, consolidating operations--which meant, inevitably, the shedding of unproductive labor--and when the company grew in efficiency, these managers made $18 million in shared earnings. The equation was simple: The men who increased the worth of the corporation deserved a bigger and bigger percentage of its spoils. In less than two years, when Bain Capital sold the company, it had turned an initial $5 million investment into a $121 million return.

...is essentially a preference for such gross inefficiencies as a way of redistributing income.

Posted by oj at October 26, 2011 7:08 AM
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