Modern management: Good for the environment or just hot air?

Nicholas Bloom, Ralf Martin 16 May 2010

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A growing body of evidence points to differences in management practices as an important factor in explaining variations in productivity and well-being across firms and countries (Van Reenen 2010). Well-managed firms tend to have better economic performance and offer a more desirable work-life balance for their employees. But in a world dominated by debates about climate change and energy savings, a broader question is: do these superior results come at the expense of the environment?

The relationship between management practices and energy intensity is, at first sight, ambiguous. On the one hand, better-managed firms should be able to reduce energy use through more efficient production techniques. On the other hand, the higher productivity that good management involves may also require more physical capital and higher energy usage.

To investigate this, we have gathered the first international evidence on how the quality of management relates to firms’ energy intensity, a key driver of greenhouse gas emissions (Bloom, Martin et al, 2010). To measure management practices, we use an interview-based evaluation tool that defines and scores from one (“worst practice”) to five (“best practice”) across 18 basic practices. The evaluation tool scores these practices in three broad areas:

  • First, monitoring: how well do companies track what goes on inside their firms, and use this information for continuous improvement?
  • Second, target-setting: do companies set the right targets, track the right outcomes and take appropriate action if the two don’t tally?
  • Third, incentives: are companies promoting and rewarding employees based on performance, and systematically trying to hire and keep their best employees?

We have applied the tool to thousands of medium-sized manufacturing firms around the world to compare management practices and energy use across firms and countries. We have matched this management data to information on energy intensity to examine the relationship between good management and energy efficiency.

We find a robust negative correlation between management practices and energy intensity (see Figure 1). In other words, better-managed firms are less energy-intensive. Of course this does not necessarily imply that better management practices cause better energy use practices. But this is an intriguing relationship whose mechanics we are exploring in work in India (Bloom, Eifert et al. 2010).

Figure 1. Well managed firms use less energy

Notes: Data from census of production (ARD) and CEP management survey. The graph shows a scatter plot of the residuals of a regression of energy intensity on industry sector binary indicators on the residuals of a regression of the management score on the same industry binary indicators. Management practices scored on a 1 to 5 scale based on firms use of effective monitoring, targets and incentives.

The reduction in energy intensity associated with good management is robust to a variety of controls for industry, location, technology and other factor inputs. And it is substantial: going from the 25th to the 75th percentile of management practices – moving from “bad” to “good” management – is associated with a 17.4% reduction in energy intensity. Given that carbon dioxide emissions are growing at about 3% a year globally, that reduction is equivalent to six years’ growth.1

Lean, green management machine

These results support the idea that well-run firms use energy inputs more efficiently, thereby increasing profitability and productivity, while at the same time reducing carbon emissions. We also find better-managed firms use fewer materials in their production process – they appear to economise not only on energy use, but also on other potentially polluting inputs.

What drives the negative correlation between energy intensity and management practices in our firms? One explanation is that better management reduces energy use through adopting systems like Toyota’s “lean manufacturing system”, which explicitly promotes waste reduction. Toyota employees are trained and rewarded for continuously reducing “Muda” (waste) throughout the factory. They do so with the aim of cutting costs and increasing profits, not from any strong environmental concerns.

In contrast, badly-run firms are simply not able to achieve energy efficiency. Think of the Soviet-era factories with their abysmal management practices producing huge amounts of pollution.

Many US firms are not using energy-efficient technologies such as low energy lighting or thermal lagging. But when they are provided with assistance from government programmes, such as the Environmental Protection Agency’s Green Lights scheme, they frequently adopt these technologies, making substantial savings. The failure to adopt profitable initiatives without outside advice probably stems from management problems, for example, senior management uninformed about best energy practices, and junior managers’ profit targets too narrow to include energy efficiency.

We have evidence on the relationship between management structure and energy efficiency from a wave of interviews with UK firms focusing on climate change. Interviewees were asked who – if anybody – in the organisation was in charge of issues relating to climate change. We find that the presence of a dedicated climate change manager is associated with greater energy efficiency, particularly if the manager is more senior. We also find that climate change investments require a longer-term perspective. Companies that adopt longer payback times for investments are more energy-efficient (see Martin et al. 2010).

Free markets and energy efficiency

How can governments help firms to improve management practices and reduce energy use? We identify several factors that play an important role in shaping management practices – and which can also play an important role in reducing pollution while delivering economic growth.

We find that product market competition is associated with significantly better management practices. In particular, the tail of badly-managed firms shrinks in highly competitive markets. Thus, the highly competitive product markets in the US have led to almost no badly-managed firms left in operation. In contrast, many product markets in Brazil, China, and India have limited competition due to entry barriers, trade regulations and high transport costs, which are the key factors that allow badly-managed firms to survive.

We also find that ownership matters. Family firms are generally badly-managed, particularly those where the family is second generation or beyond, so that they have inherited ownership of the firm. In many countries, tax rules still favour family-run firms.

Our results suggest that policies aimed at improving management practices – such as encouraging competition by removing barriers to market entry, reducing trade barriers and removing preferential treatment of family-run firms – could also improve environmental outcomes.

Thus, improving management may provide a way both to increase economic growth and to reduce environmental damage. And while the research discussed above focuses on the US and Europe, the potential appears far greater in developing countries such as Brazil, China, and India, where there is a huge tail of badly-managed (Figure 2) and presumably energy-wasteful firms. To investigate this, we have been running management field experiments in India.

Figure 2. Developing countries tend to have poor management practices

Note: Averages taken across all firms within each country. 5,850 observations in total. Firms per country in the right column. Management practices scored on a 1 to 5 scale based on firms use of effective monitoring, targets and incentives.

Managing energy efficiency in India

Our Indian experiments provide five months of intensive management consultancy to a set of randomly-selected large textile firms. We then compare the impact on their performance with a set similar control firms. Throughout this process we collect detailed performance and management data on all of these firms.

The first striking result is how badly-managed these Indian textile cloth firms are on average. For example, Figure 3 shows that the factory floors were typically disorganized with old machinery and tools often discarded. This reduces efficiency as materials need to be moved rapidly around the factory floor.

Figure 3. The factory floors were disorganized

Figure 4 shows that the firms’ store rooms are also chaotic with their yarn inventory – the main input into these textile firms – kept without any formalized system. This is wasteful because yarn rots in the damp atmosphere in these factories without protective covering.

Figure 4. The inventory rooms had months of excess yarn, often without any formal storage system or protection from damp

We also find that introducing very basic management practices had a large impact on firms’ productivity. For example, these firms have an endemic quality problem in that their fabric often requires extensive mending or has to be discarded altogether.

To address these quality problems, the consultants introduced quality management systems, which involved the firms keeping simple quality defects logbooks and analysing them in short daily meetings. Recurring quality defects – like oil stains on the fabric – could be eliminated quickly through these simple procedures.

Figure 5 shows the impact of these types of basic management practices on quality defects. These basic management practices led to a stunning reduction in quality defects, with these falling by over 50% in the treatment firms compared with the control firms. Since about 20% of workers are involved in repairing defects this led to a huge improvement in these firms’ productivity and profitability.

Figure 5. Quality defects index for the treatment and control plants

Notes: Displays the average quality defects index, which is a weighted index of quality defects, so a higher score means lower quality. This is plotted for the 14 treatment plants (+ symbols) and the 6 control plants (♦ symbols). Values normalized so both series have an average of 100 prior to the start of the intervention, plotted using a 5 week moving average. The 95% confidence intervals are plotted in dashed lines, calculated by block bootstrap over the plants. Timing based on weeks after the start of the diagnostic phase (positive values) or before the diagnostic phase (negative values).

At the same time, firms have also substantially improved their energy efficiency. This seems to have come through two main routes:

  • First, by reducing wasted input and quality defects, more usable textile cloth is being produced with less energy.

For example, reducing the amount of yarn inputs that rots or is crushed. reduces the amount of energy needed to produce and store these inputs. And reducing the amount of fabric that has to be thrown away due to severe quality defects reduces the amount of production needed to produce output.

  • Second, these management improvements have involved firms collecting detailed data on production inputs, outputs and quality, and setting up regular operations meetings to analyse this.

In these meetings several improvements to reduce electricity bills – such as regular oiling of machinery, replacing incandescent bulbs with fluorescent lighting, insulating dying vats, and purchasing energy-efficient generators – have been suggested and introduced.

As a result energy bills are starting to fall. This arises because these better management practices are inducing more systematic evaluation of the firm’s costs, including their energy bills, and the search for ways to reduce them. In our Indian firms there appears to be plenty of “low-hanging fruit” – simple energy saving ideas that better management practices should enable firms to exploit.

References

Bloom N, R Martin, C Genakos and R Sadun (2010), “Modern management: good for the environment or just hot air?”, Economic Journal , May.
Bloom, N, B Eifert, A Mahajan, D McKenzie and J Roberts (2010), “Does management matter: evidence from India”, Stanford mimeo.
Jaffe, Judson, Todd Schatzki, and Robert N Stavins (2008), “Free greenhouse gas cuts: too good to be true?”, VoxEU.org, 3 January.
Martin, R, M Muuls, L de Preux and U Wagner (2010), ‘Management Practices, Organizational Structure and Climate Policy: An Empirical Investigation’, LSE mimeo
Van Reenen, John (2010), “Measuring Management Practices”, VoxEU.org, Vox Talks, 5 March.


1 Our findings are consistent with suggestions that some progress towards reducing greenhouse gas emissions could be made without incurring additional costs – an assertion made, for example, in the famed McKinsey Cost Curves. The question arises however, why such gains have not been exploited already? This might imply that there are additional barriers that might make it difficult to realise this win-win potential, an issue that has been discussed for example by Jaffe et al. 2008 on this site.

 

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Topics:  Environment

Tags:  environment, energy efficiency, management practices

Professor of Economics at Stanford University

Research Economist, Centre for Economic Performance, LSE

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