by

John Wright

As the political heat begins to build about job loss due to international outsourcing, I find myself looking backwards in time to review the general evolution of business practices in the USA during my adult years. This morning I remembered a "watershed" event at work that occurred around 1977. A bunch of us were invited to participate in a computer programmed business simulation game developed by IBM®. For those of you unfamiliar with the term simulation, think of it as the creation and use of a model of a real life object or process that can be used and manipulated to test and refine ways of doing things to optimize results. The beauty of simulation is that it costs almost nothing compared to doing/building the real thing.

Computer simulations are used today for thousands of different applications, e.g. to test new aircraft designs. The old approach of building a model airplane and testing it in a wind tunnel is now ancient. In business simulations, models of the economy, competitor behavior, markets and interrelationships of variables used in running the business, like effectivity of revenue and cost/investment items, all come together so that strategies can be tested before committing real money. The idea is pretty obvious, but conceiving, designing and building realistic models is typically quite complex.

So, back to the story … Six teams of two people per team were formed to compete against each other in simulating the operation of businesses that all sold the same type of product to the same market. Each team functioned as a hybrid of a CEO and Planning Director to decide, by calendar quarter, how to spend the company money, whether or not to borrow money to expand the business, and what price to charge for the product and whether or not to pay a stock dividend or even buy back stock from quarterly revenues.

Certain assumptions were built into the model; e.g. the effectivity of money spent on research and the lag time before results of research would create a better product. Another example was the rise or decline of stock value based on earnings and on the decision to pay or not pay a dividend. Yet another was the advertising budget. Participants were told that customers would react to selling price changes in the expected manner, but gradually over time.

All things considered, the simulation model was a robust representation of real life. There was even a mild recession programmed to occur "somewhere" in the overall time frame and then gradually end. The decisions of each team were presented to the simulation model for six consecutive quarters, and the model developed the likely financial results at quarter-end for each team. Those results were the sales quantity and revenue data for the quarter, changes in cost of manufacture and capacity, stock value, earnings/loss, etc. The net value of the company was determined by a liquidation calculation.

Playing was a lot of fun and educational. At the end, my team came in second out of six. We were barely "beaten" by a team that absurdly increased their selling price in the final quarter, but by the embedded rules in the simulation model they only lost a small percentage of their sales volume within that one quarter.

I protested the declaration of the other team as "winner." My company beat out everyone else in every category, e.g. stock value, and would have taken first place except for the selling price trick used by the other team. I claimed that their behavior was irrational in the real world as they were damaging the future of their company. I was told that the game ended after six quarters, so my point was not accepted.

I left the event amused and angry all at the same time. How could the idiot instructor miss the point that in real life the objective is to grow the company for the long term? I found myself wondering whether our graduate schools were producing MBA candidates trained in simulations like ours to kill the long-term health of a company to get short-term high profits? I was too inexperienced at that time to suspect that many real businesses were evolving in precisely the wrong way.

Well, Lo and Behold! What I saw happen in the real world in the next ten years made me shake my head in disbelief. Management fixation on quarterly profits caused so many inferior decisions to be made that I saw one business after another go down the tubes. Failure to invest to keep businesses healthy and competitive was the biggest sin, and the bad results came faster than even I expected.

As we experienced the late 1980’s and beyond, stock market analysts gradually became an integral part of management fear, as a bad report from an analyst could drive stock values down substantially and quickly. This occurred in the same time frame as changes in the majority of executive compensation, taking the form of stock options. This meant that taking the long view for the health of the company would hurt executive income in the current timeframe.

The problems from this nightmare scenario are now really bad, for we are far less able to compete with other countries where heavy investment has been made in research and manufacturing, e.g. Japan. Our products are expensive to make and of lower quality. We continue to lose market share for reasons of price and quality.

Now here is the big kicker … international outsourcing was/is the logical and next suicidal move for a company that has wasted itself domestically. Simply walking away from old facilities, selling old businesses and dropping good wages for employees allows companies to move their heart and soul capital to foreign locations. By paying foreign workers dirt wages, the cost structure improves, temporarily. By investing in building foreign manufacturing facilities, the capital leaves the USA, likely permanently. Thus, the short-term profit fixation game continues … stock prices stay moderately high and executives get high compensation.

Now, where does all this lead as we experience the next ten to twenty years? For the moment, lets forget about the fate of American workers and look at the fate of the executives. First, the experience of having a lower cost structure will change in the wrong direction as foreign economies improve. Why? Wages will go up substantially, as will taxes, in countries where the executives have no legal power. Once their investment capital is committed, they have no sure way of recovering it. Competitors will arise in those countries as locals grow to get the requisite experience and education for going their own way. Short-term thinking will again cause executives to force profits instead of keeping facilities current.

Profits will go downhill because competitors will not focus on short-term goals, and in a mere ten to twenty years the local competitors will eat the lunch of today’s and tomorrow’s outsource oriented executives. The same judgmental errors made by executives here from the 1970’s forward will be made again. The difference is that there will be no pot of capital for them to move to yet newer undeveloped areas. Their foreign facilities will be comparatively old and of little value. They will contract and essentially lose their businesses.

At that point, we will have experienced ten to twenty years of drastically declining wages and be without capital to rebuild here. USA businesses will be only an empty shell compared to their former robust state. Then, I suppose foreign companies may come here and start to build facilities, due to our cheap wages. Hmmm … we won’t even be able to attract foreign investors due to workmans compensation, Social Security and employee medical benefits programs, along with other cost items that make doing business in the USA comparatively expensive.

Stupid, short-term thinking by USA executives, combined with idiotic federal and state government expenditures and tax structures will have cost American workers and downstream would-be executives the good life. Americans lose. That is the only result. Guess what folks? This isn’t a simulation! All of the entitlement programs that depend on high ongoing worker income will fail at a practical level. There will be no excess worker income to invest in a 401K plan to compensate for lack of pensions and very diminished Social Security income.

Lest I forget, think about the impact of declining federal tax revenues on programs like Medicare. Consider the decline of national infrastructure like roads and bridges. Ask yourself what magic we will have to pull out of the hat to regain our former glory? Chances are it will only be a simulation, not the real thing. Maybe its not too late to halt international outsourcing and force a long-term local view on USA based businesses. Then again, maybe it is too late, for they do own the people we "elect" to government. Where the hell is Teddy Roosevelt when we need him?! He sure didn’t simulate control of large businesses.