Goals can Kill a Company Part II

By Rafael Aguayo

My intent is to discuss how we can improve, whether that be in our educational system, a company or ourselves. But goals and goal setting are so deeply ingrained in the psyche of managers throughout the world that before we can proceed we must dislodge their credibility. We need to root out poor ideas before we can build on solid ground and create something new. Goals as the way to manage and even assure progress is not limited to the West and capitalism. Think of the five year plans of the Soviet Union and China under communism. The West was frightened that central planning and ambitious goals would leave us behind economically and otherwise. But it did not turn out that way. The five year plans were a farce.

They might have worked once, but when targets were not reached the numbers to demonstrate their success were simply fabricated. While the Soviet leaders were confidently proclaiming on the international stage that they would bury the West, they were destroying their economies and their people. The same thing happens in business every day. WorldCom was the leading telecommunications company in the US in the 1990s because it met all its goals and had lower costs than any other firm. Enron was the leading energy company for similar reasons and Bernie Madoff ran a very successful hedge fund that generated regular, steady, predictable profits. Though at the pinnacle of American business in the 1990s, all three were frauds. In these three cases (and others as well) also in the case of the Soviets the vast majority of people believed the numbers. The relationship between an organization constantly and precisely meeting targets and promises and fabricated numbers is so strong that I propose a theorem. When a company is meeting its stated goals precisely for an extended period of time the numbers have been tampered with.

Even with a wealth of examples of fraud and fabrication (for those who prefer euphemisms) resulting from goal-led management, such as management by objectives or “fire the bottom 10%,” businesses still extensively use and rely on setting and meeting targets. Business schools still teach this nonsense. One of the best selling books of the last decade promised to give anyone who read it riches. What was the secret? Wishing and dreaming about success.

A Key Study

One justification often used to emphasize the power of setting goals is that of a study conducted on the 1953 graduating class of Yale. The study followed the graduates for 30 years. At the end of the period it was found that those who upon graduating had set down specific numerical goals were more successful in every way. In fact the income of the 3% who had written down specific goals had higher earnings than the whole rest of the class.

Another Key Study

This is a pretty remarkable story. I have never seen the actual report and have never examined the data, but here I will take it at face value. The study clearly establishes that goals can be important. Now consider another hypothetical study done on the entering classes for two schools Reed College in Portland, Oregon and Harvard College in Cambridge, Massachusetts. The study covered four years for the entering classes from 1972 to 1976. The study looked at the success of those who dropped out and those who graduated. Lo and behold it turns out that the handful of college dropouts earned more than the all graduates for both schools combined. This certainly makes the case that everyone should drop out of school.

The astute reader might recognize that these two classes had two dropout entrepreneurs Bill Gates, co-founder of Microsoft and Steve Jobs, co-founder of Apple computer. Between the two of them they made over $90 billion, and the two companies that they founded collectively earn tens of billions of dollars each year.

While there may be objections to this latter study it does bring up some of the problems with the first study.

1) A sample of one. The first study is but one study and a reasonably intelligent person might ask could it be duplicated? The study was conducted in 1953 when the US was in what today is considered a golden economic period. Further Yale University is one of the most prestigious universities in the country and many of the wealthiest families send their children there.

Would the study have found the same results if it had been conducted in a junior college in Alabama in 1932 in the midst of a depression? I suspect the results might change or be considerably less impressive. What if the study had been conducted in China or Africa in the 1950s among poorer people? Do you believe the results would have been the same?

It is possible that the circumstances may have something to do with the success of the Yale group in the study.

2) But a secondary point from the second study is that when it comes to money in the capitalistic system the distribution of wealth is not even. The most successful will by the nature of the capitalistic system make many times more than the others. Capital accumulates and winners have outsized gains. In addition the power of compounding or exponential growth of capital makes it possible, likely and probable that a small percentage of the most financially successful will earn more than all the others combined. Income and wealth distribution follow a power curve. A few of the most successful (financially) people will earn more income and accumulate more wealth than the many less successful.

3) Another factor to consider is that the people who made the effort to write down exact financial goals and time lines are the people whose main goals are financial. They are the ones focused on making money, searching out ways to make money and therefore those who will place their efforts on accumulating wealth and income. It is unlikely that someone who was moved to become a minister for instance would put down his monetary goals. That is not his aim in life. And one would not expect someone who was strongly attracted to teaching to also put down explicit financial goals. Yet the teacher and the minister may very well lead very fulfilling lives and contribute greatly to society. But they will also earn considerably less.

4) There is a hidden assumption that those who make more money than others are somehow more valuable. What does it mean that 3% of the graduates of Yale’s class of 1953 made more than all the other graduates combined? Does that mean they were more successful or more important than the others? I think that would be a stretch by any standard. In fact society could not function without those teachers and ministers. And the top earners also could not be successful unless society had those teachers and ministers.

5) In relating the story of the Yale study the phrase sometimes appears that they were more successful in every way. I have no idea what that means or what that could mean. There are numerous stories of very wealthy people who are estranged from relatives and friends. There are examples of people who did not achieve great financial success yet made the world better for everyone. Was Gandhi or Martin Luther King less successful than the local millionaire? And of course there are examples of poor people who were miserable as well as rich people who led very fulfilling lives. The point of course is that we need to delve further whenever we hear these stories of great success through goals. And we need to think.

6) One last point to close out this example. While the select 3% in the Yale study as a group may have been financially extremely successful that does not mean that all of them were successful. It is really too much to believe that they all reached their goals. More likely there were a few super winners like Gates and Jobs who skewed the results. And there were probably quite a few who missed their goals. There were probably some in that group who were failures in their own minds. It would be nice to look at the data.

If not everyone met their goals and some were failures then it was not just the setting of the goal that made the difference. There may be elements of luck, some may have done extensive research on a business or industry, some may have developed unusual skills and applied them to earning money more effectively. The differences may have been due to finding good mentors, or something else. We should all be skeptical when examining a study of this kind, especially when the conclusion is presented on silver platter as a given. Think, perhaps there is a lot more involved in success than setting a goal. There may be some additional knowledge required and even some luck as well.

One last example (I hope) is required to put the nail in the coffin of goals and targets being the sure way to succeed. We left out one key manager from the 1990s in the first paragraph in this article: Jack Welch. He set targets of 15% increases in profits every year for GE and he met those targets every year that he was Chairman. Or did he?

During his tenure Welch appeared to be meeting his targets like clockwork. Welch retired from GE in 2001 and soon after the problems in the company started coming out. Their reinsurance subsidiary ERC (Employees Reinsurance Corporation) was found to have been woefully under reserved. Insurance companies need to make estimates on their potential future liabilities when they book the business although they will not know for years just what their eventual liability on any policy will be. While there are standards it is management’s call concerning the level of reserves. Of course if management wants to show higher earnings in a given year it can under reserve. But eventually losses occur and the company must increase reserves and take the corresponding losses to income. That is exactly what happened at GE. In 2002 they began taking billions of dollars of losses on their insurance subsidiaries to increase reserves. Over the next few years they sold most of their insurance companies but not before taking major losses, which rightfully should have been taken while Welch was CEO.

The other blatant trick used to juice earnings was to increase the financial portfolio. In a rising market taking on greater leverage and making more loans can be profitable but it also adds considerable risk to the company. GE began to generate about 50% of its profits from finance. It became a bank with a mediocre manufacturing arm. Some of the more sophisticated financial investors noted this and sold their positions in GE. But the general public and the less sophisticated who were fooled by the Welch magic did not and the value of their investments declined precipitously.

It would be unfair to place GE in the same category as the companies we mentioned in the beginning of this article, Enron, World Com and Madoff. Investments in all of these companies became worthless. Enron lost $95 Billion in market capitalization. WorldCom lost about $170 Billion and Madoff investors lost $17 billion, for a total of $282 billion.

In 2008 when the financial crisis hit GE was unable to finance itself. While it is true that they make light bulbs, jet engines and many other physical products it was the loans on the books of GE capital that scared investors away. And Earnings at GE capital went from being 50% of GE’s earnings to being negative. GE was en route to a Lehman Brothers like bankruptcy but it was rescued by the Federal Reserve that guaranteed its borrowings. Yet even after the company was able to borrow again without a government guarantee the total loss in the value of its stock, its market capitalization, or market cap, had declined by over $400 billion, dwarfing the loss from the big losers of the first decade of the 21st century.

What makes this story so pathetic is that GE had incredible resources. It is one of the longest lived US corporations, it has an incredible brand, has been noted for training managers. Welch did many things right. He reinvigorated the training facilities of GE, introduced some key tools into the company like Workout and he was able to personally inspire his direct reports. But his iron clad insistence on meeting targets and his emphasis of managing by fear were enough to destroy this American icon and drive it to the brink of bankruptcy.

Insisting on targets for schools or corporations does not work. It exacts a huge toll that eventually becomes exposed for all to see. But the emphasis on the short term and blaming problems on whoever was in charge when the problem became evident prevents us from clearly seeing and understanding the very direct relationship between targets and failure.

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