Capital managers have always viewed companies as collections of assets rather than employees, but over the last 30 years, this mentality has become an unfortunate, unquestioned part of our mainstream culture. The viewpoint didn’t really become real for me until I took my MBA finance class, a class that teaches decision-making based on a company’s financial status. I was amazed how different the world looks when you only care about the books.
For those people who are unfamiliar, there are a few basic financial statements that all public companies release quarterly. One is the balance sheet, which shows a snapshot of everything the company owns and how much of those assets can be claimed by creditors versus stockholders. The other major one is the income statement, which matches a company’s revenues to the expenses that generated those revenues.
Here’s what I finally understood from taking this class: if you evaluate a company only by these statements, you have different inclinations than if you work for that company and know the employees personally.
A company’s workforce is not, contrary to what a layman might think, considered an asset. Not even if you have the smartest scientists in the world doing your research. Their work product is sometimes considered an asset, but not the workers themselves. The only place the workers show up on financial statements is on the income statement as an expense. We can sometimes forget that only a couple generations ago, human capital was purely labor. Those companies who chose to treat their workforce like family were being uncommonly magnanimous. From an accounting standpoint, those employees were literally interchangeable. To achieve X dollars in sales, they unfortunately had to expend Y dollars in labor wage.
As developed economies made the modern transition to a force of knowledge workers, you would think that the mentality surrounding their contribution would also change. However, several forces have counteracted that. Specifically, two phenomena born from the eighties.
The first was the proliferation of MBA’s. The second was the advent of professional consulting. MBA’s, which are well-rounded business degrees today, were almost purely financial degrees a generation ago. This influx of newly-minted MBA’s, bent on earning lush 80’s and 90’s-era bonuses, focused exclusively on the appearance of those financial statements. This focus sharpened as Wall Street became less concerned with annual figures and more concerned with quarterly ones. The healthiest financial statements, they found, were the ones that paid the least possible amount for compensation (an expense, not an investment) in proportion to its sales revenue.
Those MBA’s who didn’t work for these companies directly became financial consultants or capital investors. Consultants and investors, being third parties, care so little about the well-being of a workforce that it actually registers in the negative numbers. They have no sense of loyalty to or investment in these employees – something that makes them both very effective and ofttimes short-sighted.
Now, I realize that this is starting to sound a little communist. I don’t fault companies for making hard decisions about workforce levels in order to survive. A recent TechCrunch article by a former Microsoft executive demonstrates how companies can easily gorge themselves on employees and become inert as a result. Consultants and investment partners help keep companies from getting “locked-in” to their own culture and bad habits. Furthermore, employees in my state are at-will, meaning that companies could invest heavily in employee training only to have that employee walk out the door the next day. This is a very serious investment consideration. Finally, and perhaps most importantly, profit maximization is one of the fundamental goals of a business.
What I do mind is when hard decisions are made easily and callously because financial statement orientation is simply accepted in mainstream culture. Accountants, consultants and private equity are just as capable of becoming locked into shortsighted framing. Actually, they might be more susceptible, because their positions reinforce the notion that they know best how to run companies.
A friend of mine who’s a hedge-fund manager liked to tell me about the people he met when he worked in private equity; the new generation of under-30 investment professionals who quote gleefully and unironically from Wall Street and Glengarry Glen Ross. They loved the movie Up In The Air, except that they wanted more scenes about newly-fired employees being thrown out of buildings. Never having belonged to a real workforce themselves, they move straight into playing God with other company’s employees – and they get off on it.
This is a result of allowing the callous mentality to nestle unchallenged into popular culture. It’s a very seductive thought process. I remember doing class exercises with financial statements and remarking how certain everything looked with ratio math and financial models. I remember how easy it was to think, “This company is run by idiots! Why did they ever do this?” When you are fundamentally detached from the sacrifice, it’s so easy to say, “The world is full of tough choices, and these cuts are necessary.”
Just think: with a volunteer military, it’s very easy to go to war, isn’t it? How easy would it be if there were still a draft?
Fundamentally, what is a company (or an institution)? Financial thinking says that a company is its assets, or more severely, its stockholders. That is a very concrete, easily understandable concept to deal with. It’s much messier to think of a company as its employed talent. At the same time, it’s hard to look at a company like Motorola with tens of thousands of employees worldwide and say that the company is anything BUT its workforce. What makes up the bulk of a company? Its employees. What is its greatest day-to-day concern? Employee interactions. It’s rather cold to look at a hundred thousand-employee company and say that the substance of that company is its stockholders, property and equipment.
Here are a couple more thoughts on how we view our employees as a result of culturally ingrained financial thinking:
– There is an extent to which we actually invest in our employees, but that investment is not reflected in financial reporting. First, we pay to onboard new hires. We then pay to train and mentor employees as they progress. Both those expenditures enhance the company’s intellectual capital, making it more valuable. Ideally, those dollars would show up as an intangible asset, like Goodwill, and then be adjusted down if trained employees leave. This figure would form the basis of employee retention goals. The problem with this idea is that, in the event of bankruptcy, it would be impossible for an investor or creditor to “claim” that asset.
– Intellectual capital is only shown as increased salary expense, a negative incentive. A company of 1,000 labor workers at $30k a year costs the same in SG&A expense as a company of 300 engineers at $100k a year. Theoretically, the engineering company should be more concerned about employee retention, because if an employee leaves, a lot of knowledge will leave with him/her. In reality, the engineering company would be the first to try to replace their engineers with younger, less experienced personnel because they would be less expensive.
– One of the most damaging mental frames concerning a workforce is their general categorization as an expense. To a financial analyst, salary expense is gone, which is to say lost. It’s money that slips out the door as a cost of doing business. Employee overhead is justified mostly by its ability to generate increased sales and/or net profits. That’s fine in theory, but in large, complicated businesses, there are always steps in between. Headcount doesn’t create profits directly. It creates new software versions and patents, and improved internal processes, and higher morale…and THOSE things result in increased profits. Many of those in-between steps never make the balance sheet.
– This is the same thought process that governs the collective bargaining debates we’ve been having. The most popular metrics concerning educational efficiency are like financial statements in that they point to the workforce itself as the biggest burden. In each case, the workforce may not necessarily be the problem, but it’s hard to think otherwise because of the nature of the framing. Generous benefit packages, for example, seem excessive when compared directly to private sector benefits. One has to remember though, that those benefits were agreed to in lieu of meaningful salary increases, so as to kick the expense can down the road. Also, intellectual capital is very important in a workforce of teachers, but financial metrics do not provide a direct incentive to hire smarter teachers.
– Finally, we have to remember that we have all felt the squeeze of this recessionary age. Philip Seymour Hoffman is doing a Death of a Salesman revival on Broadway, which is a very fitting play for this audience and these times. The play is essentially about someone who wants to be an important man, especially to his sons. He was once pretty good at his profession, but now (largely because of aging and changing times) can’t do what he used to. Not surprisingly, he is fired by his much-younger boss (“You can’t just eat the orange and throw away the peel!”). The play is not an anti-capitalist manifesto, but rather a reminder of how easily we all can be similarly thrown away. Even consultants and investors.
Related articles
- Employee Engagement: Theory vs. Practice (themarlincompany.com)
- Why valuing your workers as assets makes financial sense (greenbiz.com)
- What a business degree is, and what it is not (theglobeandmail.com)