How better managers can boost Australia's business dynamism

This article was first published in Company Director, the member magazine for the Australian Institute of Company Directors.

Business dynamism is a key feature of a healthy economy. As businesses start and fail, and expand and contract, productivity is boosted as firms seize new opportunities, innovate and put resources to their most productive use. A dynamic and productive economy is essential for job creation, income growth and ultimately the long-run prosperity and high living standards we expect. 

But Australia was suffering from a lack of dynamism and productivity growth long before anyone had heard of COVID-19. Treasury research shows that Australian firms fell further behind the global productivity frontier over the past two decades.^[1]

Debate about how to boost dynamism and productivity often focuses on the policy levers governments can pull, but business plays a critical role. A dynamic business sector requires dynamic leaders. This is where management capabilities come in. International research shows they are a key driver of performance at the firm level, and ultimately productivity and prosperity at the national level. 

Surveys indicate that the US has the best managers, followed by Sweden, Japan, Germany and Canada. Australian businesses sit in the second tier of countries, along with France, Great Britain and Italy.^[2] While most countries have some firms operating at best practices, lower ranked countries have larger ‘tails’ of weaker performers.

Bloom, Sadun and Van Reenen (2017), using data from the World Management Survey, estimated that management capabilities may explain up to half of the productivity gap between Australia and the US, which leads on productivity.^[3] 

An Australian study commissioned by the Department of Innovation, Industry, Science and Research in 2009 found that a single point increase in an Australian firm’s management score (on a scale of 1 to 5) is equivalent to a 44 per cent increase in the firm’s invested capital, or a 56 per cent increase in the firm’s labour force.^[4] These results highlight how by adopting best practice, firms can also have a meaningful impact at the macroeconomic level. 

The World Management Survey shows that businesses with better capabilities tend to be larger and older, with more educated managers and workers. External influences are also a positive. In Australia, as elsewhere, multinationals not only consistently demonstrate strong management capabilities, but also tend to transfer best practices to the domestic market through their commercial interactions with local firms..   Firms held to account by public shareholders or private-equity owners are typically much better managed than those that are family- or government-owned.

In a cross-industry study using ABS data, Agarwal et al (2019) found that Australian firms scored highly on strategic management capabilities, but were particularly weak on adopting and integrating digital technologies into their strategy and operations, and shifting towards environmental sustainability.^[5] These digital and environmental capabilities have been shown to add value, improve efficiency and boost resilience. They will become more important in an 

environment increasingly driven by rapid technological change and sustainability concerns. In addition, relative to their international peers, Australian managers lag the most on “instilling a talent mindset”.^[6]

One important finding from these studies is that most firms are unaware of their own management standards and how to improve them. But adopting best practices doesn’t require innovation or new ideas – firms simply need to acquire and absorb information that already exists. We need more firms to measure and critically assess their management practices, identify performance gaps and initiate improvements. 

Risk appetite and dynamic capabilities

To date, most Australian research into management capabilities has focused on ordinary capabilities. These are operational and focused on efficiency or “doing things right”.^[7] Strong ordinary capabilities can raise productivity at the firm level, pushing laggard firms closer to the productivity frontier. But they also assume a stable operating environment, and therefore can’t guarantee long-run success in an uncertain and rapidly changing world. 

Firms must be willing to tolerate some level of risk to operate effectively in an uncertain environment. Yet corporate incentives and control processes, particularly in large organisations, can discourage this. 

Firms can use risk assessment to make decisions amid uncertainty, but this relies not only on an appropriate risk appetite, but also on being able to assign probabilities to potential outcomes. This is not always possible, especially in the current environment of rapid technological change, geopolitical shifts, pandemics and natural disasters. 

To ensure survival and build competitive advantage, firms must therefore accept imperfection and take bolder decisions; in other words, they need dynamic capabilities. These are forward-looking, strategic in nature and are focused on effectiveness and “doing the right things”.^[8] 

Dynamic capabilities allow firms to sense new opportunities and threats, mobilise resources to seize these opportunities, and undertake renewal and transformation. Firms with these 

capabilities are more resilient and can manage their current business effectively while also preparing for the future. Dynamic capabilities support innovation, expand the productivity frontier and generate future economic growth. 

There has been little research into the dynamic capabilities of Australian firms, although this year’s IMD World Competitiveness Yearbook (WCY) provided some insights. CEDA is the Australian partner for the yearbook, which ranks countries using a combination of statistical indicators and a survey of executives. Australian executives scored themselves particularly poorly in this area, ranking Australia 60^th (out of 64 countries) for entrepreneurship of managers, 56^th for company agility and responding quickly to opportunities and threats, 43^rd for awareness of changing market conditions and 39^th for flexibility and adaptability in the face of new challenges.^[9] In contrast, Hong Kong and the UAE ranked among the top few countries on all of these measures. Similarly, Australia scored poorly in terms of attitudes towards globalisation (50^th) and foreign ideas (53^rd), yet international experience and exposure are associated with better management capabilities and outcomes.

Some questions for boards to consider

Investing in better capabilities can be a cost-effective way for businesses to boost productivity, competitiveness and resilience.      Critical areas for boards to consider in assessing and understanding the state of play and role of management capabilities include: 

• Are we putting enough emphasis on dynamic capabilities relative to efficiency and so-called ordinary capabilities? Too much focus on ordinary capabilities can hinder the innovation required to develop dynamic capabilities and pursue long-term competitive advantage.
• Do we have the diversity of experience and capabilities at the board and management levels? Teece and Brown (2020) point out that directors with experience in strategy, technology, brand and operations are important to complement those with more traditional legal, accounting and financial backgrounds.
• Are we building the right capabilities, culture and processes to enable timely and effective decision making in the face of ambiguity and uncertainty? As David Teece has emphasised, at times of high uncertainty leaders need a sense of urgency, and can’t afford to wait to have all of the information before making decisions. 
• Are management teams capable of effectively managing multiple phases of business activity simultaneously, from core to growth to exploratory? Firms with strong dynamic capabilities can manage the current business effectively while also positioning the business for the future. 
• Do we have the management capabilities to avoid the inertia that can come with success? Charles O’Reilly points out that structural and cultural inertia can hamper the ability to adapt and respond to new opportunities and threats. He argues that while companies are open to innovation and experimentation, many fail at scaling new businesses, especially if this requires cannibalising existing revenue sources.

These issues are ones that board directors and management may be reflecting on now. To add to understanding and consideration of these issues, and against the backdrop of a lack of data and evidence about the dynamic capabilities of Australian businesses, CEDA is undertaking a broad-based assessment of these capabilities in Australia. 

This work is the first of its kind and aims to inform efforts to improve performance within and across businesses in Australia.

For firms, the benefits of better management practices are clear. As the world emerges from the COVID-19 economic crisis, Australia’s future success must be underpinned by a dynamic and innovative business sector. Management capabilities will be critical not just for business performance and survival, but also for lifting Australia’s competitiveness, productivity and long-term economic prosperity.

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