Last September we talked to Bob Johnson, PhD, CFA, Senior Managing Director, CFA Institute, an organization created in the U.S. with a presence in 58 countries that sets the highest standards of ethics, education and professional excellence in the investment industry. The CFA Institute provides education to investment professionals using its Global Body of Investment Knowledge © (Body Awareness Global Investment Industry), which covers all aspects of the investment profession, including ethics. Today, CFA Institute offers two programs of education and accreditation: the CFA program, which awards the Chartered Financial Analyst © (CFA ©), and Certification Program Investment Performance Measurement, which gives the CIPM ©. Today the Institute has about 100,000 members in over 130 countries, more than 87 percent of them accredited as Chartered Financial Analyst © (CFA ©). Nearly 30 percent of the members are responsible for managing private client assets and 50 percent work in the markets for the next purchase. The CFA Institute is

Bob Johnson earned a Ph.D. in finance from the University of Nebraska, has an MBA in finance from Creighton University and a BS in Business Administration (BSBA) from the University of Nebraska. CFA was accredited in September 1990. Since September 1996, Bob is part of the Institute, first as Vice President in charge of the CFA program curriculum. In December 1998 he was promoted to Senior Vice President. Now Senior Managing Director, CFA Institute and is responsible for the following activities:education, advocacy and strategy development for the Americas, also serves as executive director of the Research Foundation of CFA Institute. The Centre for Financial Market Integrity, CFA also reports directly. Prior to joining CFA Institute, was a professor of finance at Creighton University, president of JBK Capital Management and financial consultant to the law firm of Kutak, Rock & Campbell.

How the CFA Institute built its reputation? How you did you expand this reputation outside the United States to become “The Standard” of the investment analysis profession and the most recognized accreditation around the world?

Bob Johnson meets, that’s a really interesting question. Surprisingly enough, our reputation has been built basically largely through word of mouth. You know we ask our candidates every year, after the examination, a lot of questions. And one of the questions we ask is how they learned about the CFA program, how they first learned about it.  81% of new level I candidates first learned about the program through word of mouth, that’s globally. In LA 89% of new level I candidates first learned about the program through word to mouth. And I think that’s a real testament of how CFA charterholders and CFA Institute members feel about the charter and feel about the organization. Just to give you a little bit of color, we have currently over 102,000 members in over 150 countries. The vast majority of those people, over 90,000, are CFA charterholders. In addition we have 135 local affiliated societies in 58 countries. Ana Cecilia is the president of the local society in Mexico; the CFA society in Mexico and what they do is very important in terms of building our reputation locally. They provide networking and local programming opportunities, and they really serve as one of the most important elements in terms of promoting CFA programs and CFA Institute activities. I would be remiss if I didn’t mention that we also, over the past 10 years, have been the subject of a great deal of positive media attention. In 2005 The Economist did a feature article on us that termed the CFA program “the gold standard”. Recently The Financial Times has referred to us as the industry’s benchmark and a global passport. In the last ten years we have also built terrific relations with regulators around the world and that has helped build our reputation in the financial marketplace. Many regulatory agencies accept earning the CFA charter or passing a certain level of our examinations as a waver to required competency exams. And then, finally, and you are very well aware of this, in 2006 we launched the CFA program partner initiative. The universities in the CFA program partner initiative are the finest universities around the world: Oxford, Cambridge, London Business School, NYU and we are really pleased that ITAM is one of our 128 CFA program partner institutions around the world. That is helping to build our reputation today.

Renata Herrerías comment. It also helps the constant review process of the curricula, how rigorous are the studies, the ethics, all those components that you ask which make very successful professionals?

Bob Johnson meets, oh, absolutely, and I can talk a great deal about how the program is built. It really is a testament to the unique nature of our program that it is one that is developed by working professionals for working professionals, and it is truly global. The CFA program is the same everywhere, so if somebody sits in Mexico City for the CFA exam, they’re sitting for the same examinations that people are sitting for in NY, in London, in Bombay, or any financial setting around the world. The other thing is that they are being judged by the same standard, so that, when somebody sees the letters CFA behind somebody’s name, they know what that means.

In the USA there is a very strong and well organized Association of Financial Analysts, but in Latin America (and in Mexico to be more specific) there is not. On the other hand, the number of CFA members in the region is progressively increasing. Could we see a new Association of Financial Analysts in Mexico (or in Latin-American) under the direction and leadership of the CFA Institute?

Ana Cecilia comment, from my point of view, the CFA society of Mexico has been growing steadily for the past years. For instance, last year we had a growth of 13% in the total members and for the CFA chart holders, it increased in 14%, so this is an indication of how we are increasing our presence in the local market. I agree with you; this is new: financial analysis associations here in Mexico. The CFA society of Mexico began in 2006, from a previous organization which was the SOMAF (Sociedad Mexicana de Analistas Financieros). We changed everything to make it more active, more in the market by people that should have a stronger presence in the local market, banks, regulators, etc. We have had this CFA Society of Mexico since 2006; it has been four years, so we are seeing an increase in the number of members as well as in the number of chartholders, so we hope that we are going to gain a stronger presence in Mexico. This is very beneficial for the local markets because we are trying to raise standards here; we try to bring up awareness of the benefits of these kinds of certifications and of the importance of associations among financial analysts. We tend to cover all kinds of financial institutions such as AFORES, mutual funds, brokerage companies, etc., and we are also trying to get more presence among regulators to awake this awareness a little bit more. But I agree with you; we have a lot to do here, there are a lot of things that must be done in order to get this, but we think we are on the right page to achieve this: more presence of national analysts organized in associations.

Bob Johnson meets,  And I want to add too, that from the CFA institute perspective in terms of the global organization, our board of governors recently approved a Latin America plan were by we are devoting more resources to developing our presence in Latin America. We believe that, and I’m sure you know this: we are a global, non profitable association of investment professionals, who are mission driven. Our mission is to raise standards in the financial markets around the world, and we believe that we are underrepresented in Latin America by any metric that you may use. For instance in Latin America we have fewer than 1000 members throughout all the region. That is less than 1% or our members. We have found out that about 1.5% of our candidates are from Latin America. I think one of the reasons why we are relatively underrepresented in Latin America is that we have simply been following demand in terms of where we go to provide resources. And you know, the demand increased very rapidly in the 90′s in Asia and has increased dramatically in Europe. We are making a concerted effort to try and increase our presence in Latin America. So I think you’re going to see lot more resources; we are opening an office in Buenos Aires, in the very near term, and you’ll see CFA Institute’s presence even more and more in Latin America.

Renata Herrerías comment, aAs Latin America markets are smaller than the US market, do you think that efforts to build financial analyst’s associations should be made as a region and not only from a national perspective?

Gabriela comment, well we are growing at some measure. We are growing our presence and are locating resources in order to kind of fulfill this demand from candidates, but with some differences in the countries within the region; we have seen that the members have been demanding more and more to participate, but then, through the society, we really believe that the societies have a lot to do in increasing the awareness in the CFA programs. We will be working with them together jointly in order to achieve the goal of growing this awareness with regulators and employers, and all the society, all the financial professionals within the region.

Bob Johnson meets, I don’t want to make it sound like we haven’t been growing in the region; we certainly have, and let me give you some numbers. In 2010 the CFA candidates in Mexico were up to 22% over 2009, in Chile candidates were up to 39% over 2009, and in Peru they were up to 27% over 2009. You have to remember that we’ve been immersed in a financial crisis, so to see numbers growing like that in a region, during a time period in which you may not expect the numbers to grow, I think gives you and indication of how strong the demand is for the CFA charter in Latin America.

Gabriela Comment, of course, considering the financial professionals within the region, the potential is really fantastic and we are trying to cover all the initiatives that are needed in order to grow that number consistently.

As you know financial markets in Latin America are much less developed, are less efficient, less liquid and, compared to other economies, a very small number of companies consider the capital markets a viable source of funding. In your opinion, which are the key elements that our markets are missing to overcome these limitations? In this sense, which is your opinion about the market efficiency and integration of Latin American markets with the rest of the world? Do you think that the CFA Institute has to develop a new curricula applied exclusively to these kind of markets? What should the CFA Institute do to improve both aspects (efficiency and market integration) in the region?

Bob Johnson meets, specifically to the Mexican market, I will differ to Ana Cecilia, but I do have some comments that reflect how we see the world and all markets. There’s no question that markets around the world are becoming more integrated, more interdependent, and less independent. To compete in today’s global market place, developed as well as developing markets must improve their operating efficiency and their ethical standards. I don’t believe that those of us who live in places where the financial markets are so called developed, necessarily teach the developing markets how to do things because things haven’t necessarily been done so well there; there are systemic problems in the markets, in the developed markets. I think the biggest crisis though facing the global market place today is a crisis of integrity. And what I mean by that is that investors are going to be reluctant to commit funds in the capital markets that they don’t perceive are fair game. Now, the strength of what we offer, the strength of a CFA program, and in fact, the foundation of the CFA program that we founded in 1952, when the program was first developed, is the code of standards; we determine our candidate body of knowledge by doing what we call a global practice analysis process; that is, we convene groups of local investment management practitioners around the world and we ask them what knowledge, skills, and abilities they need to know to do their jobs well. In fact, we are going to be convening one of these panels in Mexico City in the very near future, and Ana Cecilia and I will try to schedule a suitable time for that. We do these panels all over the world. What CFA charterholders study are global best practices, and that really prepares them to operate in a very competitive and increasingly globally integrated investment management environment.

Ana Cecilia comment, we have some comments about how capital markets in Mexico could be more efficient or could be more profound. Mainly I think it has to do with the size of the companies here in Mexico. We don’t have a lot of big companies who would be willingly accessing capital markets. This should be a false perception from these companies, middle size companies of the complexity of plain access to capital markets. They have this false perception, the complexity, difficulties, etc. So I think middle size companies traditionally rely more on commercial loans, approaching banks rather than going to capital markets. Therefore, this is what we should try to overcome, traditionally, what companies seek on funding. Another thing that I would like to say is that there is a general lack of financial education among these companies, so they rely on traditional funding and see capital markets as very complex, very sophisticated, and not for them. So I think that we have to work on this education part in these companies to show them that it is not that difficult to access capital markets. Other things we can comment are about regulatory issues. There have been important changes in regulatory issues. I think we have a sound regulation toward banks, towards risk management in financial intermediaries, but there are still some things to do about regulation.

We have the example of Comercial Mexicana. This could bring a little bit of fear on these companies to go into that sophisticated, difficult, not for them markets. So I think there’s a lot of work we have to do on education, and on to try to show them the benefits of capital markets. In the way that companies access capital markets, the markets are going to be more efficient because there will be more participants in them; of course, this could give way to a new way of funding, a new way of managing these companies, and I think they could gain competitiveness, maybe to access to global markets. The ethical part is also very important, in the way CFA charterholders, working in these companies, are going to bring as well their part of the knowledge they have, their ethical behavior, their sound ethical knowledge, and so they’re going to change the perception of capital markets from inside the companies. Those are the hurdles (ethics, and financial education) that we have to overcome in order to gain a more efficient and a more sophisticated market here in Mexico.

Renata Herrerías comment, so tell me if I’m right, I would see that the role of the CFA can be seen to be of significant contribution to the development of the markets. As more people become certificate, as more people become more ethical, have more global knowledge, can you contribute to make these markets, better markets? Is that the position that CFA is assuming? Do you feel this responsibility contributes to the sound functioning of Mexico, or Latin America, or the world markets

Ana Cecilia comment, certainly! That is the view we have. We are convinced that we have a lot to do in bringing high standards in financial markets, not only for the intermediaries but also for the companies participating in these markets. So we are convinced we have to do the job from inside the companies, going to employers, showing them about all these things, and showing that they have to let go these fears of markets. I mean, we are talking about middle size companies. You don’t have to be a big conglomerate to enter these markets, that’s the main thing we have to teach them, that you can be a middle sized company and you can gain access to markets and you can be more competitive. Indeed, we have a responsibility in this.

Bob Johnson meets, and that’s what we see as our mission in the CFA Institute: it’s raising the standards of markets in both the competence part and the ethical part. There are three critical elements to be a CFA charterholder, and that is that you have the requisite of competency, the second is that you agree to abide by a very stringent code of ethic standards of professional conduct. The third element of been a CFA charterholder is that you can’t receive your CFA charter until you have four years of work experience. We view those three elements all as extremely important and what we are doing is the same thing that’s happening in some Latin American markets is for instance happening in some of the Asian markets and some of the Asian markets may be a little bit ahead of the Latin American markets in some of these aspects, for instance, Singapore. We have a very high penetration rate in terms of the number of financial professionals who are CFA charterholders in Singapore and we feel that we have played an instrumental role in developing those markets in some of the premiere markets around the world.

Many explanations and / or justifications have been formulated to explain the recent global financial crisis, among them, issues regarding risk management practices and incentive schemes which motivated top executives within the organizations to assume highly risky positions in order to gain a short term and personal economic gain. How do personal and professional ethical standards counterbalance or balance out when the system imposes such types of pressures?

Bob Johnson meets, about that question; we really have a lot to say. I think the CFA Institute and the CFA society of Mexico are thinking about the crisis and how we can respond to it, and how we can change things. I really believe that there were three separate crises that combined to create this financial crisis; the first is a crisis of competence: just what we were talking about, there are many financial professionals that operate in securities in markets that they really don’t understand. One of the things that you’ll see in the financial markets is that all the innovation that investment markets have had exceeds the ability of many financial market participants to understand the innovation. One of the things that we all suffer, I think, to some extent, is that people don’t want to admit when they don’t understand something. And I think Warren Buffet, who we all know as one of the premier (market) testers has a great saying, and his saying is that is not how big your circle of competence is; it is that you know its perimeter. And I think that having more financial market professionals earn the CFA designation will help raise competence in the industry and effectively help people expand the perimeter of the knowledge that they have. So the first crisis was a crisis of competence, and you know, people going through the CFA program can help increase competence in the industry. The fact is that it was a crisis of ethics; there are simply some bad actors out there that opportunistically took advantage of investors. The free market, if left unregulated, does lead to abuse. We need strong regulators, we need strong regulations, and we also need the support and funds for those regulators. And those regulators really need to understand the financial market. They have to be trained in investment and not simply trained in the law. Let me give you an example: the SEC in US now is increasingly utilizing the CFA program as a preferred training program to their professional staff, and I as said earlier, financial markets are built on trust; once that trust is eroded, financial markets and then the underlying economies are going to suffer. We need to restore faith in the markets and we need to restore that trust. One of the things about the CFA institute is we do advocacy work with regulators all over the world. Right now we are working with regulators in Europe and regulators in the US in helping shape the regulatory reforms in those two areas. I think having more investment professionals abide by our code of ethics and standards of professional conduct will help raise ethical standards in the industry. The final thing, and it’s actually in your question as you talked about incentive schemes that motivated top executives within the organization; the fact is that people respond to incentives. I did my dissertation work, by the way, on executive compensation there is one truth: people do respond to incentives. There are many perverse incentives in the financial markets that need to be addressed; for example, banks have incentives to originate low income loans, and didn’t necessarily have incentives to originate good low income loans. Home owners in the US have an incentive to take out big mortgages because they get a mortgage interest deduction for income taxes. Executives have incentives to take on excessive risk because they essentially have a call option on the value of the firm; they get paid if their strategies are successful and the firm increases in value but they don’t share in the losses if these excessively risky strategies are ineffective. So all of those things need to be addressed but it isn’t just one crisis. In my opinion, it is a crisis of those three things, a crisis of competence, a crisis of ethics and a crisis of incentives, and I think we have something to offer in all of those areas, with the CFA program and with the advocacy work that we do.

Ana Cecilia comment, I would also like to add, Bob, if I may, that here in Mexico we are having changes in regulatory, concerning the incentives and risk management relations to top executives. It is expected to be implemented in one more month or two at the most. It is focused towards banks and stock broker houses. The main issues of these regulatory changes are that traders should separate incentives or their incentives should be calculated taking into account the risk that they are taking for the institution, and that the incentives of the risk management and control areas must be separated from the global results of the company. So this is a whole new way of seeing incentives, and it is going to impose a lot of changes among banks and stock broker houses in order to comply with these regulatory changes. This is motivated, of course, because these perverse incentives that we have seen in many institutions.

Gabriela comment, this is also true for the rest of Latin America

Renata Herrerías comment, You would agree of course, that the personal and professional ethics standards is what can counterbalance all this pressure of the market, despite of the fact that some of these pressures have to be eliminated, and that we have learned, as Bob said, with the three types of crises, that lot of things have to be changed: those perverse incentives, the ethics, and to restore the confidence. The CFA has a lot of work to do in that sense, to promote that the standards of ethics will counterbalance when new pressures arrive, because we know that a lot of pressures will come ahead.  It is the role of the CFA Institute to teach its members how to counterbalance those pressures.

The financial sector has been characterized in the recent past by unprecedented changes: mergers and acquisitions, new and highly sophisticated financial instruments, rising volatility levels and regulatory changes and intervention, amongst others. This environment demands that financial professionals prepare adequately so that they may generate appropriate strategies. From your perspective, what are the new and/or additional knowledge and abilities that a finance professional requires?

Bob Johnson meets, I think that a real strength the CFA has, as I indicated earlier, is the way we develop our body of knowledge by doing this practice analysis, and by asking practicing professionals what knowledge, skills, and abilities they need to know to do their job well. We also ask them what skills they believe are going to become increasingly important in future years and that is how the CFA program body of knowledge evolves. And I can tell you what has happened in the past. We have been doing this practice analysis for about 15 years and in the early days of the practice analysis in 1995, we were told that they believed that risk management will become increasingly important in the future, and of course that has happened. Part of what we do is that we look for what’s on the horizon, what do we need to understand on how the marketplace is working and I think there’s something there that is somewhat a misnomer for some people; some people think that if we put something in the CFA program, that means we advocate that and that is not necessarily the case. What the CFA program is meant to do, is to provide financial professional with the grounding in the topics they need to understand to operate in the financial markets. So for instance, credit derivatives are in the CFA program. Does that mean that we advocate that people increasingly use credit derivatives? No, but what that does mean is that operating in the financial markets, financial professionals have to have increased knowledge of credit derivatives. So if they are presented with those opportunities in their employment they know how to deal with those. We really believe that knowledge is power in the financial markets, and you can come out of the CFA program, as well as be educated in the topics and the body of knowledge, and an individual can come out and can be a momentum investor, they can be fundamental value investors, they can be quantitative investors. Basically, what they were doing is providing grounding and a foundation of base of knowledge; that base of knowledge evolves as the financial market evolves. I earned my charter in 1991 and I can tell you that curriculum in the CFA program is distinctly different in 2011 than it was 20 years ago. But it is that way, because people at the CFA institute decided we think this is important. It’s a reflection about what practitioners around the world told us was important, and that why we think the CFA program holds the place that it does in the investment management business.

Gabriela comment, I would like to add that in this year there will be an exam in December in Mexico, and other places within the region: Buenos Aires, Santiago, and Peru. We are seeing an increasing demand on that regard and this will be the very first year than we will have an exam in December.

Ana Cecilia comment, I would like to add something that has been pointed out. The CFA program and the curricula have changed over the years in order to adequate to the changes we are experiencing. So yes, we saw for instance more emphasis on risk management in order to adequate to the changes we are experiencing. As I see CFA shareholders must have great skills in analysis of economic threads and regulatory issues in order to understand what is going on in the market. For instance, we are foreseeing in the near future Basel III so Mexico is going be very active on this topic, so you don’t have to read Basel III nor to incorporate all Basel III to the curricula in order to understand it; the things and the skills you’re gaining must allow you to understand, to analyze, to criticize and to see the impacts of these new regulatory issues. You are going to gain a sharper mind to see the impact of these regulatory changes in the financial markets.

Bob Johnson meets, Ana Cecilia that’s a terrific way to put things. What I always say, is we can’t possibly put all financial instruments and all the financial innovations in the CFA program. It would take you 10 years to do it and you would be behind by the time you are done. What we do is that we give people the tool kit, the analytical skills to analyze anything that comes down, by innovations, by investment bankers, by changes in regulation and so forth. So I think, really, when you think of the charter financial analysts, because many people who get the CFA charter, they don’t work as an analyst, they work as portfolio managers, they work in investor relations, they don’t work as analysts. I always tell people: the analyst in charge of financial analysis is the skill set, is not the description of the job. What is the skill set of a charter financial analyst, well they can analyze something. They can analyze the security; they can break it down, and come up with some conclusions. That’s what we want to teach people, we want to teach people how to analyze different situations and come forth with a reasonable conclusion and I think that’s the strength of the program.

Renata Herrerías comment, tell me if I’m right, it’s as if you were providing a part of the body of knowledge, very good skills to perform those kind of jobs, like investor relations, CFO, financial analyst or a fund manager.

Bob Johnson meets, The other thing we provide is that people know when they get through the CFA program is that they have been trained in a very rigorous manner and it gives them confidence that they can do those kinds of things. The other things it gives you is a sense of community, one of the really joys of my job is that I get to travel all over the world and work with a lot of really good people, nice people, very confident people, and what we share is that we know we have a shared background. And I know when I’m talking to someone with the CFA charter I know what their baseline of knowledge is. And it really helps; it helps in so many different ways.

It is expected that the evolution of the financial sector within the foreseeable future will be centered or focused around the healthy operation of financial institutions by way of significant regulatory changes. What elements or issues should be considered within the regulatory framework as to not inhibit the growth and development of the financial markets?

That’s a terrific question, and that’s exactly where we need to go. You know the pendulum tends to swing, and the pendulum swung, I believe too far in the free markets, no regulation or low regulatory measures, I think what I would say is the severity of the recent financial crisis highlighted, gaps in both national in the US and global regulatory systems that really need to be addressed. The crisis demonstrated some of the perils of what I call light touch regulation, and we believe that reform offers both more effective regulation and support for the economic prosperity.  And I give a couple of examples, in the US we convened an investor working group in 2009 and that group identified systemic risk management as a key to restoring investor confidence. National regulators in the US are tightening the regulatory nets to assert oversight, over all systemically important financial institutions. In the US and the European Union, systemic risk councils are been established and, hopefully, can detect and mitigate these systemic risks before they threaten the entire system. One thing that’s going to have to happen because we are in this global financial environment is that we have to net this national measure together to offer global risk management. That’s what’s going to be essential to restoring invertors’ confidence, and the investor working group also noted, like I said earlier, that regulators must be offered the necessary tools and resources to do their job. Rules without teeth basically just blow bureaucracies. It is much better to have field staff that are paid competitively, that are using modern technology to stand eye to eye with the industry and enforce regulations fairly and consistently. Everybody blames the SEC in the US for the lack of regulation, and certainly there is some culpability there, but they were underfunded and they were undertrained. You couldn’t expect them to keep up with markets. On the other side, the industries were incredibly well funded and incredibly well-trained, so we are going to have governments to allocate more capital to regulators so as to have investors’ interest defended; that’s going to be in everybody’s best interest.

Ana Cecilia comment, I would have to say that for instance in Mexico, I think that we already have a good regulation concerning financial markets, banks, and financial intermediaries as the whole. The people at the regulatory authorities are very concerned, they have told me, about liquidity risk. They are moving towards liquidity risk; a couple of years ago we were concerned about personal risk, and more years ago we were concerned about credit risk or market risk, and etc. So they’re moving towards a tighter regulation, and I think they have to balance between a very tough regulation, which in Mexico was very beneficial, because all banks have a very strong capital adequacy so no bank had problems in the financial crisis, but this tougher regulation must be balanced with the concept if we are here to do business. So if we tight things very much operations are going to be very difficult. I think, for example, that the new regulation toward money laundry that has already been announced by the president this past week is going to be very beneficial. We have to stop this risk and all banks and all financial intermediaries are related to this risk; we’re exposed to this risk. This should be our contribution to try to restrain what is going on in Mexico nowadays. There are associations who are coaching financial regulation like the CFA society of Mexico, and giving them our point of view in these things. The society congregates different professionals in different institutions, so we have a say in things, we bring our comments to this issue, we applaud those regulatory issues that prevent the impact of financial crisis, but we also stress out that there must be a balance, so we are bringing our own opinions on this.

Bob Johnson meets, we are very pleased to be affiliated with your fine university and look forward to working with you in the future.

Ana Cecilia comment, I want to add that ITAM is my alma mater.

Ana Cecilia Reyes Esparza, CFA, FRM

Head Credit and Counterparty Risk Managment

Gabriela Franco

Directora Ejecutiva de Latinoamérica de CFA Institute

By: Carlos Osuna and Carlos Amtmann

The purchasing power of Mexican families has deteriorated during the last thirty years and has fallen dramatically due to the economic stagnation. México holds position 108 of the 134 countries in the Gini Index of the income distribution, and the international average is 40.34%. The Mexican index is at 48.2% – in 1950 it was close to 60%-. The trend is to improve, but it would take another 36 years to reach 26%. We fell in competitiveness from the 31st place we had in 1988 to the 66th and we had an approximate growth of 1.89% annually during the last 30 years. We have not reached cruising speed, which is the level Mexico deserves. However, there are ways and means to accelerate the pace.

The salary situation is extremely serious. This is reflected in the analysis of the pension systems: “The small number of workers registered in the social security systems are affected by the few years of contributions to the pension plans and, eventually, by the creation of a fund that is not large enough to be able to obtain an annuity. It can be seen that persons registered in their first working ages would spend most of their active work life outside the social security systems, and therefore they would be making contributions to their retirement plan of approximately twelve years for men and eight for women, which is very far from the minimum pension guaranteed under the IMSS Law in effect. Economic forecasting scenarios show that a constant 4.6% GDP growth rate would be required during a 30 year period (2000-2030) in order for the formal jobs with social security benefits to account for almost 85% of the PEA (Economically Active Population)

The National Technical Committee of the Instituto Mexicano de Ejecutivos de Finanzas (Mexican Finance Executives Institute) is convinced that compensations based on results can trigger domestic demand. It was agreed to consider productivity payments to the workers. “With an average annual 6% and 1.5% population growth rates, income per capita can go in 25 years from $7 thousand to almost $21 thousand dollars a year. But if the annual growth is 4.5%, it would take 37 years to get there, that is, 50% more time”

An agreement is being reviewed by the stakeholders – workers, businessmen and authorities – to amend the Income Tax Law and its repercussion on the IMSS Law. In the agreement, if a company has its workers registered in the IMSS with integrated daily salaries higher than the mean and they received a variable payment based on productivity, it would not be included in the base salary of the quotation. First, in order not to burden companies with more payments expenses and second because with good salaries already registered, the workers would contribute their fair and worthy participation of the IMSS contribution. The initiative has locks to guarantee: that the average salaries of companies vs those set by IMSS on an industry and company size as well as its corporate objective and region where they operate; that there is an annual profits increase and that the productivity payment is registered at the STPS (Secretary of Labor and Social Security).

Results Based on a Mature Strategic Administration Model

It is costly for companies to implement the necessary management systems to monitor objectives, goals and follow up on the results of workers, employees, managers and top management. This administrative cost may or should almost be subsidized to promote productivity and the corresponding payment.

There is a proven existing correlation between productivity payments and the profits of companies (82%). It also generates a higher remunerations virtuous circle, more consumption, higher profits and more taxes collected. It all derives from the same productivity increase, and therefore it would not be inflationary.

To achieve this is not something out of this world or space science. In accordance with the innovation definition, it is an issue of benefitting from the workers’ ideas. A simple example is to sell a shirt with your initials embroidered. This modifies the contribution in 9.49% ($50.00/$527.00) made by the shirt to GDP and also, the seamstress has a job. Use the same example with an ebenist that improves the carpenter’s work, the software, etc; it has to be stimulated, for it to happen!

Tax Incentive

The tax incentive to be promoted, to encourage entrepreneurs to set their own productivity metering systems, would be the Income Tax withheld from workers on the productivity payment – if he complies with the requirements – this can be accredited against the company’s annual income tax as follows: 100% the first year of the plan’s implementation, 75% the second year, 50% the third year and 25% in the fourth year and at the end of the incentive, beginning on the first year in which the company implements and registers it. For the IETU (Corporation’s Flat Tax) and IMSS laws, this payment would be treated as employee profit sharing.

In aggregated figures and also in the example given with real figures of a hotel – shown later – this tax incentive is not a cost for the government treasury. When calculating the average income tax rate on salaries is 7.8% with figures of salaries of the National Accounts System vs income tax collection on salaries reported by SHCP (Ministry of Finance) (2008), we may think that if a $1,000 productivity payment is made, there will be a $922 net amount for the worker. With figures we know that in Household Expenses (INEGI) we spend on food 34% and 3% in medicines that do not pay VAT, but 63% on does that do pay VAT. Then $922×0.63 = $580.86 with $80.12 VAT included, we can state that this amount collected is greater than the $78 income tax amount that the company will compensate with the incentive.

The VAT on expenses and the Income Tax withheld is collected by SAT during the year. The company accredits this vs its annual Income Tax on March of the following year and a small amount for VAT collected. In addition, in the second year of application of the productivity payment plan of the company, the accreditation of the income tax withheld drops to 75% and consecutively thereafter. This is the beginning of the virtuous circle of productivity-gains-payment-consumption and tax collection. An additional incentive is that with the productivity payments in the annual calculation the company improves its own Gini Index (income distribution indicator), and then it can keep 100% of the accreditation of the income tax withheld from the workers on the productivity payment.

Work intermediaries are included in this proposal – provided that the requirements on salaries are registered, the productivity plan increased profits refer to the Company that is the work beneficiary – so that they can implement the incentives mentioned.

Additional Idea in Favor of Severance Workers’ Funds

If the legislator approves the productivity payment method proposed -it can be achieved with two additions to Article 29 of the Income Tax Law- to do something in favor of pensions the proposal is to allow that part of it (for example, 33%) of the productivity payment may be destined to a labor welfare fund after the tax is withheld and remitted. The disbursement of those funds previously established in the plan registered before STPS could be due to three causes: one to offset the workers’ income in recessive cycles when their productivity income would decrease. Two, when they leave the company, and here a table in steps could be agreed upon and that includes the percentage they are taking and the percentage they leave in favor of the other workers to generate loyalty and permanence in the formal system, in accordance with the table that define them based on the workers’ seniority. And third, it is delivered to their Afore account where it will be saved for retirement.

This proposed model invites to a National agreement of all the stakeholders to revert thirty years of economic stagnation, where each participant, whether treasury authorities, entrepreneurs, workers and families will be benefitted by the productivity payment in a joint effort to have better quality of life and a more productive México.

Example, Payroll Accounting Cost

The example that shows the normal salary scheme cost, with 335 participants and several salary levels is taken from a 5 star hotel. The first Column A shows the normal payroll, including the $150 of help for food. In column B a productivity bonus is given to these workers of that amount so that they have a 10% net increase in their monthly income. Column C is the proposal referred to where the productivity bonus is added to their income for Income Tax calculation, but not for IMSS. The fourth column D is payment of the 10% through another Company as a fee that can be added to salaries (see Monthly Payroll Cost Chart).

Because the company wants to give its workers a net additional 10% payment, it has an 11.2% higher cost on the extra money workers receive. Instead the cost of the proposal is 9% more. If you compare the mechanism that pays through another company, we confirm that it is more attractive to take that risk, although there is a charge on the workers’ taxes and is on the border line of illegality. The Income Tax Law establishes in Article 117 that if additional income is added to the salary, an annual tax return has to be filed, even if it does not exceed the limit required, which is $400 thousand pesos.

In order to pay with the payments assimilated to salaries modality through the other Company that 7.7% bonus cost, and compared to the 11.2%, the orthodox modality is 45.71% more expensive and encourages tax avoidance and thus a bad thing is created that damages the worker and the IMSS.

It is better to give the proposed benefit to the company and encourage it to act legally, by allowing this amount to be accredited against the income tax payable by the company, as additional income tax withheld from the worker. It would be an incentive for it to adopt the measuring of productivity and to maintain its salary income at the IMSS at a good level.

As stated in the incentive proposal to make productivity payments. Let us remember that if we have to grow more than 4.5% a year, there are things that have to be changed. We propose a productivity payment because it is not inflationary, it generates a virtuous circle, forces to judge and be judged with ethics and it is paid if workers are more productive.

If the correlation between productivity payment and company profits is high, why the productivity payment does not naturally disseminate? We believe that there are two basic reasons. The first one is economic: the cost of setting up a mature administrative system that allows measuring individual or group performance, that links profits to operational processes. The second is emotional, businessmen are interested in making good profits, to live well and accumulate reserves that help face business or the economy volatility cases, episodes that became more severe after the elimination of the gold standard in 1971, of the issuance of excess money supply, expropriations, expansion of informality and the sudden commercial opening, combined with the armed riots of Chiapas.

The emotional factor shows this in a study of 120 entrepreneurs – bond agents with historical data on their expenses and income since their companies were created – and it reached the conclusion that it takes them between four and five years to reach a stable revenues level. Already stabilized, the increase of revenues stops, until approximately the tenth year in which they once again go to the market to get clients to recover their revenue level. They do not overburden themselves nor do they invest in motivating their personnel to make more money, nor in implementing mechanisms to achieve this, because it costs money.

The objective wanted with this proposal is to contribute with concrete ideas and incentives to stimulate businessmen to commit themselves with the increase of revenues of their companies when they have reached a stability level and they can invest to make them grow, increase their workers’ productivity and if achieved, they may also have access to profits generated by making a work effort to obtain them, and thus encourage the treasury authorities through the promotion of a tax incentive to motivate entrepreneurs to have productivity measuring systems that have to implement a mature strategic management system. This invites all stakeholders to make a national agreement and this creates a win-win virtuous circle where the necessary resources are generated to remunerate and to make both, the corresponding workers’ and the company’s tax payments.

Why Measure Productivity of Human Resources

The control of labor costs reduces variability of the processes, implies to know the availabilities of workers, their skills, their age, their talents and experience. To adapt them to the work line that better suits their persons. The increase in labor productivity is achieved when the supervisor is supported with the existing excess labor information if the resources are optimized.

When the allocation and consumption of resources is known during the production, the labor expense is better understood, as it determines where each labor peso is spent. And because they were realigned based on their skills, personnel improves adherence to the strategy, to labor standards, to internal regulations and to the corporate government quality standards.

Large companies may use sophisticated productivity monitoring systems where the position and performance requirements are measured. “Today digital technology facilitates this work; new lights have been generated to calibrate labor effectiveness of the performance and formulas indicators. For example, costing is based on activities (ABC) or on another one called Overall Labor Effectiveness(TM) (OLE: Uso Laboral Efectivo), which consists in combining through a mathematics formulation the results on the availability of labor, its yield and the quality of the work and products delivered”.

I To implement these techniques and to better allocate the resources, to make rules and results visible, and afterwards to measure the results achieves the combination of an improvement in the allocation of resources and provokes an increase in the profit margin. Here is an example of the sheet used by a small company to agree on the Objectives and Responsibilities for the period where the ratings by objective agreed upon come from concrete measurements and which are weighed based on their importance.

A Case as an Example

To install a sophisticated objectives and responsibilities system for a medium size Company, let’s say a 355 workers hotel, US$150,000 or $1.87 million pesos would be required.

This 314 room Gran Tourism hotel with two restaurants, a bar, a disco, swimming pool, gym and several conference rooms has a monthly payroll cost of $2.4 million and revenues for $12.0 million with a 60% standard occupation. Its gross operating income is between 40 and 45%, approximately $5.1 million before depreciation and taxes.

Following the example, a 3.2% margin increase, generates a monthly cash increase of $163,200; that adds up to $489,600 every quarter.

Let us compare the implementation cost and the productivity payment proposed, and also the tax incentive to catalyze the process due to the adoption of a culture to measure productivity and improvement.

In order to commit the workers to this improvement, we offer to make a marginal productivity payment. In this example we assume that the increase in productivity deserves a 10% net productivity bonus on the salary. The gross cost of the proposal by not accumulating it to the base salary level at the IMSS is $211.6 mil pesos.

We see that the cost of this 10% bonus would be $262.4 under the current system that is $50.8 thousand pesos or 24.1% more expensive. Instead, the tax incentive included in the proposal allows the compensation of the income tax withheld on the productivity payment versus the annual income tax payable by the company, if it has higher annual income in its tax return. Therefore, this quarter it would obtain a $38.2 thousand peso profit.

Quarterly Summary in the case of a Hotel

If the implementation cost of the improvement system is $1.87 million pesos, this investment is recovered in 5.7 months.  And the best is that the Hotel is able to instill an entrepreneurial spirit in its personnel.  And not only that, there is also a social impact with a multiplying effect that is summarized as follows:

Conclusion

To pay productivity under the plan proposed creates a virtuous circle where the workers and the entrepreneurs, trade and the government income increases and society becomes more organized. It is a social benefit that will be fostered if it is well understood and executed under the proper amendment to the law, and this can only be achieved if the groups interested in Mexico’s progress unite in a national agreement for development, and smooth the way agreeing on the necessary incentives to promote productivity payments.

Technical Note

Chart that explains how to calculate a company’s Gini Index.

The first step is to add the income of each worker in a year, including grocery coupons, punctuality bonuses, savings funds, that is cash equivalent payments. Second, they are in an ascending order, grouping the workers with the same income. Thus in column A the chart gives the amount of collaborators with the same annual income. Column B is the amount of money they make in pesos. Column C is the result of multiplying A x B. Column D is the percentage of workers in each row. Column N gives accumulated amounts. Column E shows the proportion of perceptions per row, while in column P the sums are accumulated. Finally in column Z the result of column N is multiplied by the result of Column O, deducting the previous (see formula). To obtain the Gini coefficient the results of Column Z shall be deducted from the unit.

Formula:

You can download here a pdf with the tables

By: Victor Esquivel and Khalid Daruich

When speaking of Mexican companies, we must begin by pointing out that, according to the economic census, more than 90 percent are family owned. This fact is further substantiated when observing “public” companies that trade on the stock exchange: most of them are controlled by one or several entrepreneurs or by a family.

We mention this to emphasize that family-owned businesses should not be categorized by their size or focus, but simply we refer to companies in which the founder or group of shareholders maintain a strong hold on the decision-making process. This creates dependency on the founding member when establishing strategies and searching for opportunities for growth.

Many family-owned businesses have an area of opportunity in the establishment or strengthening of administrative, financial and accounting policies, as the role of the entrepreneur is more focused on the commercial or operational areas of the business than on its managerial aspects.  This becomes a barrier at the moment when the family business tries to grow: the lack of institutionalization of many of its processes and of management control creates problems when searching for financing alternatives.

Today, Mexican companies face constant changes derived from the globalized economy, the dynamics of the market and competition within a certain industry. The objective of this paper is to describe the general situation in which a Mexican family business finds itself in the framework of today’s economy, as it selects a financing alternative that is compatible with the company’s growth strategy.

Financing Alternatives

One of the major topics on the agenda of family organizations as they consider a growth strategy is how to finance it without incurring high costs and losing the flexibility in decision-making processes and control. Historically, family businesses have relied upon some of the following financing options:

1. If the company has a good operational history, it may obtain and qualify for a bank loan. This financing option is characterized by high interest rates and financial and legal restrictions that, far from stimulating growth and expansion, result in the organization making costly interest payments and allowing little room for flexibility in the operation of the business. In addition, it generally requires available assets for collateral backing the repayment to the financial institution, including personal guarantees by the shareholders.

2. In accordance with the size of its operations, the organization may look to the public debt markets. If economic conditions are favorable, this alternative provides additional resources to the organization without the loss of control.  However, on several occasions family businesses have eventually abandoned this type of financing because of the complexity involved in the compliance and preparation of the information required to be listed on a stock market, making it more costly than the economic benefits obtained.

3. Another alternative for family businesses is to consider sources of non-traditional financing, including:

1. Investment or strategic alliances. In this type of financing, a buyer has a broad time frame in which to obtain a return by means of capitalizing on its investment. The investor is usually interested in obtaining control over the decisions and direction of the organization and does not expect to divest in the short or medium term. In this way, its shares will be capitalized through dividends derived from the operations, by synergies with other existing operations or by the simple appreciation of the company during the period of its participation in the organization. When the participation of the investor is considerable, the family organization incurs the risk of losing control of the decision-making processes, especially when groups that were initially minority, now hold a substantial portion of the company.

2. Financial investment from private equity funds. Here an investor hopes to establish a portfolio through various investment projects with the primary objective of increasing its value. At the end of the investment period (that regularly is less than in the case of strategic investors), they seek a liquidity event to exit its investments. This type of investment seeks to institutionalize the company and increase its value in the short and medium term – through growth of the company – in order to proceed to some type of exit mechanism where the investor will try to obtain a return for the successful sale of its investment.

In this way, private equity funds have emerged as an alternative so that companies can obtain the resources they need to finance their growth. The normal process of financing is carried out through an analysis of the type of investment, which may go from obtaining a minority stake, forming a joint venture, or selling partial or total control of the company. Defining the characteristics of the types of investment that exist is a topic beyond the scope of the present article. Instead we point out some of the benefits and features presented by family businesses that have proven to be attractive in the eyes of private equity investors, among which we stress the following:

• Private organizations regularly are purchased with a discount compared to companies listed on the public stock exchange in the same industry.
• They regularly correspond to business opportunities with the support of an entrepreneurial management.
• When growth in family businesses is limited, an injection of capital for expansion may result in returns above the market average.

Also, we have identified general characteristics that family organizations must take into consideration in analyzing a potential sale or incorporation of an investor, such as:

• Family Culture. In many businesses various problems may emerge within the family that are transferred to the companies themselves. For example, on several occasions family businesses may find themselves to be under-capitalized or underinvested, when resources have been diverted as a result of family issues. Another case might be when members of the family occupy key positions and management instead of handing these positions over to a professional management.
• Succession. When the founder or entrepreneur – due to its age, health or self-interest – decide to leave the company, turning it over to the next generation. This situation is crucial: during the process of bringing in a partner, private equity funds often have different visions or interests than those of the family organization. This situation becomes even more critical when the next generation does not have sufficient skills or interest to manage the business.
• Management style. Entrepreneurs or founding members are often the key people in determining the commercial strategy or operation of the company, and for that reason business decisions are borne by a single person. However, the complexity of adopting a growth strategy through mergers and acquisitions requires a strong management team, experienced in similar transactions and involved and encouraged to pursue the stated strategic objectives.
• From the point of view of the family business, the solution is to clearly state from the beginning what can and should be done by each one of the parties involved in this process. There are also opportunities for the company to advance by incorporating a professional management and a group of independent directors who are experienced in several areas, contributing to the value of the company through strategies and objectives.
• Loss of control. Many entrepreneurs believe that when it comes to a sale of a stake or the incorporation of a partner, they will automatically lose control of their company.  However, this does not necessarily happen. Each party in the transaction must understand what type of investment or funding the target company is looking for and establish from the beginning the control scheme that will be implemented by the organization.

Based on our experience, there is no magic formula to indicate the type of control that should be applied. However, it is advisable to leave management decisions and operation in the hands of a professional manager, and try to balance the participation of an institutional investor through means of joint control. This helps to prevent an internal power struggle within family organizations and in turn gives a perspective of personal value to the founding shareholders (mainly for members of the family who are in charge of the operation of the business post transaction).

In addition, various authors express their agreement in institutionalizing the company formally prior to the closing of a transaction. The logic behind this is that when a family grows, it is common for problems to arise when allocating resources among its members. In the same way, when a company grows, it needs to establish clear rules so that all members continue adding value to the organization, even more so if it is subject to a sales process and the involvement of new shareholders.

Finally, another situation that family businesses face while incorporating an investor is when the entrepreneurs themselves want to actively participate in the transaction. The key recommendation is to try to avert any sentimentality and leave the process in the hands of specialists who can objectively identify the strengths and weaknesses of the company. In this way, it will be in a better position to cope with the process in an unbiased manner.

There are a number of consulting firms that offer comprehensive services from financial, commercial, legal, labor and operational points of view. They contribute to guiding the transaction and the process of incorporation and analysis in an orderly and objective manner.

In a changing market, private equity funds have proven to be an efficient tool so that a family business may acquire the necessary funding to sustain the anticipated growth of the company. Family organizations are exposed to different situations when subjected to these types of processes, but it is necessary to understand that the better prepared they are, fewer errors due to improvisation will be made. The entrepreneur or founder is responsible for outlining the strategy and mission of the business. However, it is very important to consult specialists in these processes, those who are capable of offering objectively the solution to the real needs of the company and the sales process.

Private equity funds offer a solution to the problems of financing and institutionalization by moving into an organization with policies of management and control for the business. They present strategic objectives of growth and added value to the family organization and provide support to management by means of economic resources, human talent, knowledge, and industry contacts in order to achieve these goals.

“Let the person with business knowledge run the business” is the fundamental rule guiding financial schemes via private equity funds. By establishing clear rules and adequate conditions of control resources can be provided to an organization without the disadvantage of losing the strength and vision of the entrepreneur or founder in the operation of the business.

References

Reed Lajoux, Alexandra and Elson, Charles M., (2000) The Art of Due Diligence, Mc Graw Hill,

Pearson, Barrie, (1989) Successful Acquisition of Unquoted Companies (Third Edition), Grower,

Brealey, Richard A. and Myers, Stewart C., (2000) Principles of Corporate Finance (Sixth Edition), Mc Graw Hill.

When writing about SMEs – so glorious and yet forgotten – one must include two basic concepts and a pretty evident consequence.

The first point, fatally obvious, is that if we cannot see the problems happening under our very noses and in our companies, it will be very difficult to find effective solutions.

The second one, shockingly obvious, refers to the possibility that a well-made product might not sell very well.

The consequence of this story can be summarized in one word: information. It might be absent or present, broad or reduced, useful or not, systematic or improvised. Market information, buying process information, all this produced by that capricious, vague, and errant daughter called communication.

Having mentioned that, I am left to emphasize that companies are the products of human beings. As man, unique among animals, frequently abuses his intellectual resources (brain, mind, intelligence), Mexican companies known as SMEs do not always use their intellectual resources to pay attention to their surroundings.

Such degree of awareness includes searching and finding opportunities, exerting control over our competitor’s daily actions, deeply understanding our personnel’s degree of motivation and, above all, to free ourselves from the mental fixation that academics call love of product, which indicates that consumer preferences are exclusively determined by the physical product and its appearance, ignoring all other factors.

SMEs which think that the product in itself is the cornerstone of the buying process is being enchanted by the melody of a mermaid singing “a good quality product is always bought and bought by itself.” The first of the four P’s is therefore flawed by this first injury to those clear and efficient marketing concepts that SMEs sometimes despise.

This enchantment is so dangerous that in the 1960s my old Marketing professor at Harvard School of Business, Theodore Levitt, warned us of this fact regarding large, medium, and small companies, as well as new ones by writing an article which is iconic today, entitled “Marketing Myopia.” To be myopic means that you can only see what is close to you (the product) and that means that you lack a broad field of vision. It is state of deafness where sometimes you can only hear what the Market sometimes whispers, occasionally murmurs and even sometimes screams at you. SMEs that are overly focused on their supply tend to overestimate some of their product’s features, characteristics that are not even perceived by the market, because it is busy sending clear messages about other characteristics of interest and satisfaction.

Let us assume that in a certain market there are 94.6 men for every 100 women.

S If we analyze this data correctly, it means that there is a 5.4% probability that women will have to share a man with another woman or, alternatively, be alone. Without it, we only know that, in this market, there are more women than men.

On a related sociological topic, many males complain that women are invading areas that were typically theirs. In fact, by analyzing the information INEGI (National Institute of Statistics and Geography) gives us, we can confirm that women have shown greater adaptability to the Mexican socio-economic environment, thus infiltrating the labor sphere and will continue to do so in other areas bringing down other ancient atavisms, almost all of them shaped by men.

On the other hand, there has never been a better time in history to be men.

Once liberated from their role as the exclusive protector and guardian of family life, implying a form of respect (control, command, demand, urgency) modern man can interpret the information he receives to develop a new role, less burdensome, more flexible and with greater freedom to choose his own path. It includes from monogamy to a nuclear family, a diminishing birthrate, and actively participating in markets classically associated with women, such as caring for people, exotic vacations, weekly regular purchases, and teaching.

The following proposition can be considered a derivation of the ones made so far: in order to understand the market in which SME operates (plans to enter) as well as the speed and the nature of its changes, the firm does not require complex instruments. Such sophistication is only necessary when business or corporate complexity demand other solutions and different resources.

What SMEs’ need to develop is a heightened sensitivity to those weak signals originated by market opportunities and to those current trends of interest and that facilitates growth. Without this reading or auscultation ability, the SME will remain in its golden mediocrity.

The competitive advantage always stems from possessing that small piece of information that the competitor lacks. In a broad sense, there isn’t any useless information. The fact that Malaysia has practically become a first world nation gives us a clue to how certain concrete and well-directed decisions could produce such a transformation. The fact that violence in Italy could end the extravagant world of “soccer” as drug addiction threatens the cyclist’s world, is information that can be translated into corporate decisions and market behavior. Saying “that it is not going to happen here” means we haven’t learned anything in life.

A computerized information and Market intelligence system is a SME’s best friend, only when it is a product of proper market segmentation and a profound understanding of the buying process. This implies the filtration and classification of useful information according to each firm’s specific need information.

Information should not be mishandled. It is extremely risky because it can not only affect the product, this article’s initial topic, but also the SMEs’ growth potential. A healthy memory stores and allows us to refer back to it as a dictionary does with words. . A healthy memory is a healthy business. It is important to remember. This is what the Navajo Indian Tribes thought when they looked up to the sky and sang these wise verses: “Remember everything that you have seen. Because everything that you forget is lost to the wind.”

As I mentioned previously, communication is the daughter of information. This is an extremely important topic for SMEs, because if information is considered food, communication is as important as water for survival and growth.

While it may be unpleasant to control the results of one’s communication, it is essential. In many cases, there are persons who prefer the illusion of informing well than the certainty of making a mistake. As we mentioned at the beginning of this article, some prefer to admire their product than pay attention to what the market is saying.

While they may seem to be slight errors, in fact, they are major mistakes made by SMEs who focus too much on product life.

By: Yaneli Cruz and Ana María Díaz

“The budget is the ruin of Corporate America. It should never have existed.”

Jack Welch, CEO of General Electric

Budgets are one of the accounting tools most widely used in the planning and control of organizations. However, there is ongoing debate as to the usefulness of the traditional budget. How can budgets be made more flexible? Who are the people who should be involved in drawing them up? What should be included and what should be left out? How often should information be revised or updated? These are just some of the questions that arise when faced with the need for financial planning systems that are able to respond to rapidly changing marketplaces.

Many companies are obsessed with drawing up precise, detailed budgets, but the recession and recent economic problems have led them to realize this is virtually a waste of time, because there isn’t enough relevant information at their disposal to make reliable forecasts.

Some concepts that are often used in financial planning and the drawing up of budgets include:

Budget

The quantitative expression of a plan of action proposed by management to help coordinate what is required in the implementation of said plan and that covers a specific timeframe (Horngren, 2004).

Financial Planning 

A process that traditionally contains detailed plans and budgets expressed in financial terms (Aberdeen, 2010).

Master Budget

An annual process that typically begins with information from the previous year and includes the drawing up of detailed operating and financial budgets that are indicative of the future performance of the organization as a whole (Aberdeen, 2010).

Rolling Forecasting

In a rolling forecast, the organization adapts to future expectations based on recent performance, resulting in an updated forecast. Predictions, re-forecasts or rolling forecasts may be made at different moments throughout the budget scenario (Bogsnes, 2009).

The traditional budget emerged in the 1920s as a tool for managing costs and cash flows at large industrial companies like Dupont, General Motors and Siemens. It has since become an invaluable tool for the planning and control of organizations.

The traditional budget operates hierarchically from top to bottom. Decisions, resources and rewards are directed downwards, while information flows back (Libby & Murray, 2007). This is a fixed, rigid type of budget that is generally linked to a compensations system (Figure 1).

Figure 1. Traditional Control Process. Adapted from Libby & Murray (2007)

Companies use budgets for several purposes, mainly to: make forecasts, help maximize profits, promote communication, assess performance, calculate compensation, motivate employees, control performance by researching budget variations and make pricing decisions.

The traditional budget has come under criticism because too much time is invested in its drawing up and it doesn’t respond well to changing, volatile environments. This is why it is only occasionally linked to an organization’s strategy (Figure 2).

Figure 2. Time Required to Draw Up a Traditional Budget. Adapted from Uyar.

Likewise, budgets can be conceived as a commitment or ‘performance contract’ between a subordinate and a superior, which can open the door to manipulating or ‘gaming’ the system to facilitate the reaching of targets. This is why there is some doubt as to whether budgets can be used to simultaneously assess administrative and financial performance.

Another interesting problem associated with the traditional budget is its inability to gauge the key success factors of an organization. The reason for this is that traditional budgets focus exclusively on operating and financial performance, but not on strategic performance, which means they have a hard time assessing the creation of shareholder value, customer loyalty and satisfaction, the quality of services and products, and intangible assets like brand equity and customer portfolios.

New Approaches to Budgeting 

These days, organizations need to be able to respond quickly to changing market conditions and make effective snap decisions. Consequently, calendar-based planning has to give way to a more adaptive form of budgeting, in which a new financial performance benchmark is more important than number crunching. This approach seeks to link the budget, forecasts and strategic goals, resulting in a financial planning process that gives general managers and CFOs a competitive advantage and allows them to look beyond their reporting and budgeting duties.

In light of the limitations of the traditional budget, both academics and professionals have sought new methods to help improve budget planning and processes. The fruits of their efforts can be seen in alternatives like Better Budgeting -which consists of incremental improvements to traditional budgets- and Beyond Budgeting -which implies radical budgeting changes.

Better Budgeting

There are five main approaches to better budgeting (Neely, 2003):

1. Activity-based budgeting
2. Zero-based budgeting
3. Value-based management
4. Profit planning
5. Rolling forecasting

Of these, the rolling forecast is among the most popular. This approach favors a revision of the budget instead of doing away with it completely and usually covers a forecast period of 15 months or five quarters, with monthly or quarterly updates. The advantage of the rolling forecast is that it affords managers the chance to rethink the process and incorporate relevant changes. In zero-based budgeting – another common approach- each cycle begins as if it were the first.

Beyond Budgeting

Created in 1997 in response to growing dissatisfaction with the traditional budget, the origins of the Beyond Budgeting Round Table (BBRT) are in the UK, but it has since welcomed members from Belgium, France, Germany, the United States and other countries. Borealis, Unilever, Ikea, American Express, Southwest Airlines, Charles Schwab, Wachovia and the World Bank are just some of the entities that have implemented this approach.

The creators of the Beyond Budgeting movement argue that today’s companies need to be more flexible and adaptable on a strategic level, as well as being able to respond more quickly to rapid, unpredictable and intermittent change on the markets where they operate. This translates into the need for more effective strategic management.

Budgets can still aid planning, coordination and resource allocation, but should not be used as motivational or performance evaluation mechanisms, since this would hold back an organization operating on today’s hyper-competitive marketplaces that are subject to constantly changing economic conditions.

Linking the Strategy with the Budget 

The first step in the search for greater flexibility and strategic adaptability was to separate performance management and financial planning and budgeting systems – simultaneously encouraging managers to reach for “stretch” targets and at the same time presenting an accurate picture of the company’s financial scenario. Companies like Borealis rose to the challenge and came up with a new, four-pillar budget-less management system (Boesen, 2000):

1. Rolling Forecast
2. Balanced Scorecard
3. Activity-Based Cost Management
4. Investment Management

Rolling Forecast

In this case, the sole objective of the rolling forecast is to provide as clear a picture as possible of the company’s expected financial performance. Since this forecast doesn’t affect managers’ compensation, there is little incentive to ‘game’ the system. Objectivity is the key here.

Objective data on prices, corporate planning, sales volumes, fixed costs, investment, depreciation, interest, inflation and financing rates is combined to come up with a fiver-quarter rolling forecast, which is revised quarterly to allow management to envisage a horizon of at least one year and in which performance in one period is measured against that of the previous. A good test of performance is a comparison with the company’s closest competitor every six months.

Balanced Scorecard

Directors who have experienced difficulties articulating the company’s strategic goals in a manner that can be easily grasped by employees have resorted to the Balanced Scorecard. This tool helps explain and measure corporate performance vis-à-vis established targets and key performance indicators (KPIs) instead of comparing it against, say, budgetary line items. In other words, the scorecard focuses on the drivers behind the numbers as opposed to the financial data, giving senior management much more leverage over the company’s future.

Activity-Based Cost Management 

It may sound contradictory to talk about cost management in the absence of a budget, but in this case, expenses are tracked using the 12-month moving averages of activity-based costs, which allows a company to monitor costs in terms of activities instead of budgetary line items, making it easier to talk to employees about how and why to control costs. It is also easier to understand product and client profitability levels when costs have been broken down by activity.

Investment Management 

The last pillar of a budget-less company is decentralized investment management, which puts control in the hands of people closest to the marketplace and customers. Although it is unusual to allocate this much control over capital spending decisions to front-line mangers, these employees tend to have a clearer picture of strategic priorities thanks to the Balanced Scorecard and decentralized profit accountability.

Figure 3. Breaking the Budget at Borealis: The Four Pillars of a Budget-less Organization. Adapted from Boesen (2000).

Conclusion

There can be no denying traditional budgets are becoming less and less useful and while there is still a lot to be done in terms of perfecting these new approaches, their efficient application will leave managers more time for analysis – time that would otherwise be fruitlessly invested in drawing up a detailed budget that will probably be obsolete before the ink has a chance to dry on its pages.

References

Boesen, T. (2000). Creating budget-less organizations with the Balanced Scorecard. Harvard Business Publishing Newsletters (pp. 1-3).

Bogsnes, B. (2009). Implementing beyond budgeting. New Jersey: John Wiley & Sons, Inc.

Horngren, C.T., Stratton, W.L., Sutton, W.O., y Teall, H.D. (2004). Management Accounting. Toronto: Prentice Hall.

Libby, T., y Murray, L. (2007). Beyond budgeting or better budgeting?. Strategic Finance, 89(2), 46-51.

Loeb, M., y Martin, T. (1995, 05 29). “Jack welch lets fly on budgets, bonuses, and buddy boards”. Consultado en http://money.cnn.com/magazines/fortune/fortune_archive/1995/05/29/203152/index.htm

Neely, A., Bourne, M., y Adams, C. (2003). “Better budgeting or beyond budgeting?”. Measuring Business Excellence, 7(3), 22.

Orlando, J. (2009). “Turning Budgeting Pain into Budgeting Gain”. Strategic Finance, 90(9), 47-51.

Quibria, N., y Jutras, C. (2010). Financial Planning, budgeting, and Forecasting. (2010). Aberdeen Group.

Uyar, A. (2009). “An evaluation of budgeting approaches: traditional budgeting, better budgeting, and beyond budgeting”. Journal of Academic Studies, 11(42), 113-130.

(2007). Harvard Business Essentials: Manager’s Toolkit–The 13 Skills Managers Need to Succeed (Hardcover). Harvard Business School Press Books.

By: Dr. Jorge Humberto Mejía

One of the most important activities of Strategic Management is to optimize the links between design and the implementation of the strategies. However, this task is not evident at all. Research and consulting activities have given me the opportunity to work with public and private organizations (small, medium and global companies) in Mexico and in France, and a set of experiences have allowed me to corroborate a recurring problem in literature.

Some very well known authors in the international arena such as Kaplan & Norton (2008) state that one of the main problems 21st century organizations face is the implementation of a strategy. There is abundant literature in strategic management and they mention this situation and show it in case studies (Kaplan & Norton 2008; Grant 2003). Notwithstanding the bibliography contribution, professional experience has allowed me to identify some characteristics that I describe in the following sections, and subsequently compare them to classic and contemporary literature on strategy. The objective of this article is to provide the reader some food for thought on the existing links between design and the implementation of strategies in organizations.

Below you will find two sections with two different ways by which organizations try to establish the links mentioned above. .

The Fragmented Implementation of the Strategic Management Activities

In this first section there is a synthesis of the results of research and other studies made of different kinds or organizations whose “strategy” emerges from “doing” daily operations. In these, most of the directors with whom I have had the opportunity to work, are in favor of a logic that they themselves call “the day to day”. Porter (1996), states that this logic can be classified within a set of activities that he calls ‘operating efficiency’. Two processes are described based on the ideas exposed by this author.

1. Daily transactions do not necessarily generate operational efficiency

To avoid confusions, we mention below what is understood in this article by efficiency. Based on Robbins & Coulter (2005), the term is defined as a capacity of the management team to obtain the ‘highest’ results with the minimum investment (p.7). When referring to investment, the word is also understood to mean other resources such as time, training, information to make decisions, amongst other.

The information that I have collected through magazines and direct observation in the organizations that I have studied, shows that not all organizations focus on operations are efficient. In them the daily operations and the ‘emergencies’ tend to consume 100% of their directors’ time. ‘Urgent’ matters take time away from what is ‘important’ and what is ‘important’ frequently becomes ‘urgent’. In this kind of organizations there are two parallel systems that contradict each other in practical terms. I call the first one, the ‘emergent’, and it allows directors to improvise and adapt to the multiple changing conditions of their environment. Efficiency over effective rules and therefore this kind of organizations face strong investments that produce erosion in terms of resources and personnel capabilities. In this kind of institutions the daily operation does not allow to foresee the contribution of operations to the organization’s strategy. As part of this category there are companies that surprisingly have found situations that put them in crisis. An example is a medium size company that had a significant dependence on the operations of Mexicana de Aviación; when this company stopped its activities in August 2010, the directors argued that this happening ‘had taken them by surprise’. They then started to hold meetings to begin their strategic design process. For this kind of organizations, strategic direction is an operational function whose added value is limited. It is important to highlight that the activities linked to the strategic direction are divided between the functional areas and there can hardly be integration amongst their multiple priorities. For the reasons mentioned, it is difficult for these organizations to optimize the links between daily practice and strategy.

The information that I have collected through magazines and direct observation in the organizations that I have studied, shows that not all organizations focus on operations are efficient. In them the daily operations and the ‘emergencies’ tend to consume 100% of their directors’ time. ‘Urgent’ matters take time away from what is ‘important’ and what is ‘important’ frequently becomes ‘urgent’. In this kind of organizations there are two parallel systems that contradict each other in practical terms. I call the first one, the ‘emergent’, and it allows directors to improvise and adapt to the multiple changing conditions of their environment. Efficiency over effective rules and therefore this kind of organizations face strong investments that produce erosion in terms of resources and personnel capabilities. In this kind of institutions the daily operation does not allow to foresee the contribution of operations to the organization’s strategy. As part of this category there are companies that surprisingly have found situations that put them in crisis. An example is a medium size company that had a significant dependence on the operations of Mexicana de Aviación; when this company stopped its activities in August 2010, the directors argued that this happening ‘had taken them by surprise’. They then started to hold meetings to begin their strategic design process. For this kind of organizations, strategic direction is an operational function whose added value is limited. It is important to highlight that the activities linked to the strategic direction are divided between the functional areas and there can hardly be integration amongst their multiple priorities. For the reasons mentioned, it is difficult for these organizations to optimize the links between daily practice and strategy.

In addition, for Leinwand & Mainardi (2010), this set of thoughts is a topic related to the organization coherence. It their article they state that an organization should focus in the competences (operations) they are good at, to then align them to the strategy and in this manner achieve links that generate coherence between the operation and the strategy, and its result would be (all other things being constant) a long term competitive advantage.

2. Daily operations do not necessarily result in integral strategies

The organizations which directors are focused on operational efficiency not necessarily have a strategy. There, strategy is conceived as a duality; on the one hand it is perceived as a complex, conceptual, multiphase notion and thus difficult to apply, but necessary to survive in the ocean of competitive complexity an organization has to face every day. Its directors repeatedly face the dilemma: strategy vs. operation. These generally choose operation, which in their opinion is what allows them to keep their organization alive. In this manner, the ‘strategic function’ category is created. The main problem here is that these functions are fragmented and are not necessarily convergent in terms of objectives and ‘functional’ interests. Leinwand & Mainardi (2010) state that it is extremely important that the incoherence derived from the fragmentation of the activities of strategic management in order to afterwards find the affinity that will allow them to develop sustainable competitive advantages.

Also, these organizations’ directors use the term strategy in a generic manner, and take for granted that all their members understand the same thing when they speak about ‘organizational strategy’. Unfortunately, this is not so, the discrepancies emerge at the different organization levels, and this creates confusion between the strategic activities and those that are not.

From this perspective, there are only a few organizations where their directors are able to enunciate their strategy in a clear, accurate and concise manner (Collis & Rukstad 2008). These organizations are prone to falling in the trap of setting, in general terms, some of the generic cases, the ‘path of the company’, scarcely identify the industry in which they participate, the mission and the vision are part of an unpractical philosophy in the reality they live in. Regrettably, their directors believe that if they have some objectives and plans, there is a strategy. Porter (2008) emphasizes some of the traps that analysts and persons responsible for strategic management must consider when doing the external analysis of their organizations. Some of them are: the preparation of descriptions instead of analysis, development of static analysis that ignores the key trends of the industry in which they compete, the confusion between cyclical and structural changes. The ‘strategic’ models used by these organizations are strongly influenced by the management fashion. Their directors think that the model or a certain methodology may be the solution to the problems of their organization. There are frequent changes of strategy and therefore the credibility of the members of the organization on new strategic proposals is definitively affected. Solidarity is achieved when there is a crisis. In synthesis, one can hardly find an organization that presents these characteristics that in turn has a strategy in accordance with the terms of Collis & Rukstad (2008).

The Design of Strategy and its Implementation

In other organizations, the author of this article has been able to prove the existence of protocols and managing committees focused on the design of a strategy that will be implemented later. In this category normally the General Director is considered to be the person responsible for the strategy. There are two modalities in this perspective: the organizations that design their strategy in cascade – where the General Management sets the strategy to be followed by the entire organization – and those where the design of the strategy emerges from the work of the members of the management committee with its subordinates and is subject to discussion at the General Direction in order to integrate the problems and comments of other members of the organization (other than the management committee members). Both processes are described below.

From the General Direction to the Rest of the Organization

The following characteristics, which basically coincide with Grant’s research (2003), are listed below:

1. The General Direction and its management committee identify the general plans and global strategic objectives and also the way to apply them.
2. A diagnosis is made of the resources and capabilities (personnel) required for each strategic activity.
3. Plans are set for each function; these to not necessarily detail their operation but they do detail their scope. Based on the design, the idea is to establish links between the strategy and the operation. Repeatedly key activities are identified that could limit the startup of the plan established.
4. With the two previous elements a proposal is submitted to the Management Committee. In the case of a corporation it will be sent to the highest level of the organization.
5. After having reviewed and approved the proposal pursuant to coherence terms (Leinwand & Mainardi 2010) a comprehensive plan is developed for the entire organization. The plan sets the key objectives and added value expected in each function to be contributed to the strategy.
6. As the case may be, incentives are set in order to make strategic achievements, and also the actions to be considered pertinent for that purpose.

In most cases, this kind of organizations has to what was called in the first section operational efficiency (Porter 1996). In them, links are established from the design and the daily operation. Some problems faced in the strategic process are related to the dynamic analysis of the stakeholders, when the formulation of a strategic statement is too complex and thus it is difficult to implement (Collis & Rukstad 2008). Lack of clarity that emerges from the design of a strategy consequently leads to the generation of endless execution problems. Here the design of the strategy is the problem and not only its implementation, as is stated by Kaplan & Norton (2008).

In these cases, complex tools are used and they are not properly explained to the organization members who should execute the designed strategy. In some cases, the dilemma between the strategy and operation surfaces again. Specially when there is little time to achieve the objectives and at the same time the General Direction demands reports and meetings on the strategic issues.

From the Operational Basis to the General Direction and from It to the Rest of the Organization

Organizations of this type have experienced members in their top management committees. These have known for a long time the ways in which the organization operates. In general these are persons that have gradually gone up the organization pyramid. This contributes some recognition by the persons who depend on them from the hierarchy standpoint, and this is derived also from the deep knowledge that these persons have of the organization’s management committee, its problems and current challenges.

Therefore, the members of the organization are the ones who repeatedly send to their superiors (top management committee members), analysis of the different hierarchy levels in order to state the strategic objectives and the operational methods proposed by the responsible persons and to be discussed at the strategic design meetings chaired by Top Management. These activities are carried out throughout the year in very short meetings (30 minutes at the most), and here top management committee members gather information from their subordinates.

Some of the benefits of designing and implementing the strategy in this manner are that it has been identified that in this kind of organizations the formulation of the strategy tends to be clearer according to Collis & Rukstad (2008). In addition, the implicit empathy and the commitments developed between the members of the organization frequently favor the implementation of the strategic proposal. Notwithstanding the benefits mentioned before, an objection raised by the organizations that have this kind of programs is the time they should invest so that the management committee members practically know the key processes of the organization’s operation and are able to develop close links with personnel.

Conclusions

The synthesis of the four groups of organizations analyzed in this article allows us to identify some of the key features to be considered if one wants to make a strategy based on any of the four groups. The lessons contributed to the last one could be of great value if the reader has the time and the resources required to implement it. I ask that you to be very careful with this article since it is based on the analysis of cases and one should be very careful when making general statements of the results obtained.

In order for each group or organizations described in this article, the strategic planning process is identified and as followed by these institutions is not necessarily linear as shown in most of the texts that study the strategy (Barney & Hesterly 2010; Hill & Jones 2008). In this way, the objective is to convey to the reader this set of thoughts hoping that they will be useful to him when making strategic decisions.

In order to favor strategic thinking in terms of the link between strategy design and its execution, at the ITAM business school we developed an integration proposal of several classical and last generation models. We provided a solid education on strategy topics from a theoretical-practical perspective. These are topics related not only to the reproduction of the classic models and last generation models, but also understanding them in terms of their organizational and ethical implications, where the complexity of the business to be faced as decision makers is considered. With this we hope to contribute to the development of a more fair and prosperous society.

References

Barney J., Hesterly W. (2010), Strategic Management and Competitive Advantage, Pearson Prentice Hall, 3ª Ed.

Collis & Rukstad (2008), Can you say what your strategy is? Harvard Business Review Vol 86 Issue 4 April pp. 82-90.

Grant M. (2003), “Startegic Planning in a turbulent environment: Evidence from the Oil Majors“, Strategic Management Journal, Vol. 24: 491-517.

Kaplan and Norton (2008), The Execution Premium Harvard Business Press.

Leinwand & Mainardi (2010), The Coherence Premium Harvard Business Review, Vol. 88 Issue 6 Jun, p86-92.

Porter M. (2008), “Las cinco fuerzas competitivas que le dan forma a la estrategia“, Harvard Business Review A.L., Enero, p1-15.

Porter M. (1996), “HYPERLINK “http://www.hbsp.harvard.edu/hbsp/hbr/articles/article.jsp?ml_action=get-article&articleID=96608&ml_page=1&ml_subscriber=true”What is strategy?”, Harvard Business Review, Nov/Dec, Vol. 74 Issue 6, p61-78.

Robbins S. & Coulter M. (2005), Administración, Pearson Educación 8^a Edición. p. 7.

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By: Carlos Alcérreca

The functions of the executive not only include formulating and implementing strategies, as the field of strategic management seems to suggest. There is a long tradition of studying this concept. The purpose of this paper is to present the main ideas that have historically been discussed on this theme and to try to integrate them.

We will examine here the main perspectives put forward on the functions of executives, with a focus on top management. The 10 main contributions that we will look at are those presented by Fayol (1916), Barnard (1938), Drucker (Lafley, 2009), Quinn (1980), Kotter (1982), Farkas & Wetlaufer (1996), Sull (1999), Garvin (2002), Mintzberg (2003) and Ricart, Llopis & Pastoriza (2007).

Fayol

Fayol was a French mining engineer. In 1916 he published his work Administration industrielle et générale which established management as one of the six functions of a company, in addition to financial, accounting, commercial, technical and security. The responsibilities of management included: prediction, planning, organization, command, coordination and control. Today some people synthesize this process into four functions: planning, organization, direction and control.

Barnard

Barnard was a U.S. business executive who published in 1938 his landmark work: The Functions of the Executive. For Bernard, executives must give priority to three types of functions.

I. Establishing and maintaining a communication system within the organization. Bernard is recognized as having given importance to the handling of the informal organization, which might be called today organizational culture. This function involves:

a. Designing an organizational scheme.

b. Selecting, providing incentives for and control of the executive personnel.

c. Managing the informal organization to obtain the compatibility of the personnel.

II. Securing essential services from its members — in other words, by management — is achieved by:

a. Establishing cooperative relations between members and the organization.

b. Encouraging the services of members through incentives, persuasion, and negotiation.

III. Formulating organizational purposes and objectives — curiously Bernard puts this at the end — involves:

a. Establishing the purpose of the organization.

b. Dividing the purpose into accomplishing concrete objectives and actions.

c. Delegating authority and assigning responsibility to achieve objectives and accomplish stated goals..

Barnard’s theory is very similar to that of Fayol’s, who was also an experienced executive and who came up with the well-known concept of administrative process. Barnard’s plan does not over-emphasize control, but gives great importance to motivation to achieve objectives with effectiveness and efficiency.

Drucker

Peter Drucker desarrolló sus ideas sobre las funciones y responsabilidades del director general (DG) a través del tiempo en múltiples libros. Afortunadamente, un director general de Procter & Gambe, Lafley (2009) las resumió con base en presentaciones orales que Drucker realizó para la empresa.

Para Drucker, las principales funciones de un DG incluyen:

1. Defining and interpreting the relevant/significant external environment. Making sense of the environment that surrounds us by defining which elements must be taken into account in decisions.
2. Deciding what company has an organizational scheme. Determining which one does not have one and therefore avoiding it.
3. Balancing current performance with the required investments for the future. Investing in the future reduces profit in the short term because many investments appear as expenses. For a time, investment results in an increase of assets without an equivalent increase in income, while the product is developed, installations are built and a market is created. On the other hand, profits obtained today are certain while performance expected in the future is always uncertain.
4. Shaping values and organizational standards. These are the basic ingredients of an organizational culture that must be channeled in a positive direction.

Drucker emphasizes that the work of the general manager differs from that of other executives in that he/she is the person who mainly can and must “connect the world outside the organization (society, economy, technology, markets and customers) with the world inside the organization. (The general manager) is responsible for understanding, interpreting and disseminating his/her perspective on the environment.”

The general manager has to understand all the groups involved with the company, identifying the interests in conflict and seeing how these may correspond with the capabilities and limitations of the organization. In addition, taking into account that costs are generated only inside the organization while revenue actually comes from outside, the general manager must relate and balance revenues and costs to maintain profitability.

Drucker believes that the general manager is the only one who can see the external and internal environment in a holistic manner. Other executives have biases as a result of their responsibilities: they have a narrower view and look more inward. The general manager sees opportunities others don’t see and makes the tough decisions. He/she is responsible for the overall performance of the organization: its profits, its sustainable growth and the satisfaction of all the groups involved in the organization or stakeholders.

Kotter

John Kotter (1982) is a professor at the Harvard Business School. He conducted an empirical study on the functions of general managers and discovered several patterns in their behavior: They spend most of their time (75%) with other people in addition to superiors and their subordinates; they talk about a wide variety of topics; they ask lots of questions; they rarely seem to make important decisions; they joke a lot and often talk about topics unrelated to their work; the issues they discuss often do not seem to be of importance to the organization; they rarely give orders in the traditional sense; they often try to influence others; they react to the initiatives of others; much of their day is not planned in detail; they spend a large part of their time with others in short and disconnected conversations; and they work many hours (60 a week on average).

Kotter found that general managers have two key roles:

* Setting agendas. Developing agendas for activities with multiple objectives and having the power to implement them.

*Establishing networks of contacts. Included in these network are people above, below and at the same level in the organizational hierarchy. They integrate any person who they can depend on at any given moment. They use direct and indirect influence so that their networks respond to their agendas.

The concept of agenda seems to replace that of strategy within Kotter’s framework, and although it is not clearly defined, it seems to list topics, objectives and actions to be performed, in addition to the specific times in which they will be carried out. The concept of networks as a source of information and mechanism of influence also has grown in recent years. Kotter was among the first authors to use this concept.

Although Kotter’s framework involves only two elements, it has the advantage of focusing on few aspects which are, at the same time, two key elements in executive work.

Quinn

Based on a review of the literature published on management, Quinn, a professor at the University of Michigan, uses a conceptual framework called “competing values” to establish four management models for executives. These management models are conceptual frameworks or ways of thinking about the administrative problems facing executives. These models differ to the degree in which they emphasize control versus flexibility, and to the degree in which they address topics that are external or internal to the organization. Each model operates through two executive roles and each one requires multiple skills. These models are:

1. Model of rational goals. Emphasis on control and the external perspective.
2. Model of internal processes. Emphasis on control and internal perspective.
3. Model of human relations. Emphasis on flexibility and internal perspective.
4. Model of open systems. Emphasis on flexibility and external perspective.

Table 1. Management Models

I. Model of Rational Objectives.  Executives who use this adopt two types of roles: director and producer. Each role requires certain abilities and skills.

Role of director (clarifies expectations, decisive initiator, gives instructions). His/her skills include being able to take initiative, establish goals and the ability to delegate effectively.

Role of producer (oriented to the task and job, high energy, accepts responsibility). This requires abilities such as self-motivation to achieve high personal productivity, motivating others, and time and stress management.

II. Model of Internal Processes.  These executives act as monitors and coordinators.

Role of the monitor (informed, they watch to see goals are reached, focus on detail, control and analysis). Involves skills such as receiving and organizing information, assessing data with critical thinking and presenting information effectively.

Role of the coordinator (maintains the structure and flow of the process, is reliable and facilitates the work). Requires skills in planning, organizing and design, and control.

III. Model of Human Relations. These executives act as facilitators and mentors.

Role of the facilitator (stimulates the collective effort, develops cohesion and morale, facilitates group solutions of problems). His/her skills include developing work teams, participatory decision-making, and conflict management.

Role of the mentor (develops personnel through orientation, concern for employees he may have protected). Skills include understanding oneself and others, interpersonal communication and development of subordinates.

IV. Open Systems Model. Includes roles as innovators and negotiators.

Role of the innovator (to facilitate adaptation and change, conceptualizes necessary changes, intuitive, visionary, creative). Involves skills such as knowing how to live with constant change, creative thinking and change management.

Broker/negotiator (maintains external legitimacy and obtains external resources, manages image, appearance and reputation, persuasive, influential, politically astute). Skills include developing and maintaining a power base, negotiating agreements and commitments, and negotiating and selling ideas.

The selection, conscious or unconscious, of a managerial model results in the executive becoming interested in certain topics while giving less importance to others. They face various challenges on the job that include using multiple models and points of view to observe the organizational world, learning how to exercise the roles associated with them, and using skills associated with the four models.

Garvin

Professor Garvin (2002) from the Harvard Business School suggests that the work of the general manager consists of handling six processes: strategic, resource allocation, decision-making, learning, and management and change

Strategic processes include:

• Strategy formulation. The process of developing the strategy.
• Strategic programming. The process of specifying goals, plans and policies in order to put the strategy into operation.
• Strategic deployment.  The process of implementing the strategy, to convert plans into reality.

Processes of the allocation of resources:

• Preparation of budgets and operating capital
• Processes of management control
• Decision-making processes
• Formulation of problems
• Development of alternatives
• Selecting the action to take

Learning processes:

• Organizational learning: acquisition of knowledge, interpretation of the information and application of what was learned.
• Knowledge Management: sharing what is learned to give it greater use.

Managerial processes:

• Establish direction: gather information, invent a new vision or business model and transfer the vision to tangible terms such as goals, strategies and resource allocation.
• Negotiation and sales. To achieve the commitment of the people and encourage their effort. Involves altering perceptions and deepening the understanding of the information.
• Monitoring and control. To ensure that the organization performs according to expectations.

Processes of change:

• Identification of the need for changing and designing a new system.
• Alteration of the elements of the system.
• Consolidation, institutionalization and revision.

A general manager must properly manage these processes in order to be successful. It is possible to detect a certain level of repetition or duplication in the various processes described by Garvin.

Mintzberg

Professor Mintzberg (2003) of McGill University began to study the functions of the executives in his doctoral thesis, and reached similar conclusions to those of Kotter. He has developed a classification of executive roles based on whether the person uses their time thinking, handling information, dealing with people or directly in action.

Thinking:

• Conceiving the frame of reference for the organization. This is achieved by defining the purpose of the organization (its mission), establishing a perspective of the organization (values and philosophy) and determining the competitive positioning of the products, services and markets (strategy of the organizational unit).
• Setting the agenda, closest to the programming of activities, indicating specific actions and times.

Information Management:

• Communicating information by disseminating data and analysis.
• Control, which in this scheme involves the design of systems, the development of structures and the imposition of direct orders.

Managing people:

• Leading at the individual, group and organizational level.
• Connecting, which means developing a network of people who can be used to obtain information and influence interest groups.
• Managing performance.
• Dealing within, the work done by the executive when performing tasks related to research, sales, production, etc. in the industry in which he participates.
• Dealing without, negotiate to acquire resources and tasks (for example, advertising) carried on outside of the organization.

Mintzberg suggests that there are various levels that result in different styles of executive work. Those who directly manage performance are actors or doers. Those who direct people are leaders. Those who manage information are administrators. You can also add to this list the level of designer of ideas, carried out by administrative thinkers. The level that the executive prefers determines his style.

Farkas & Wetlaufer

The Farkas & Wetlaufer consultants (1996) conducted empirical research among high-level executives and found they had different approaches to leadership. This is a coherent and explicit style of leadership that includes:

• The areas of corporative policy that receive more attention.
• Classes of people and behaviors that the general manager values in an organization.
• Decisions that the general manager makes personally or delegates.
• How they use their time during the day.

As a result of their research they found five approaches to leadership:

1. Strategic approach (18%). The executive sees developing a strategy or business model as his fundamental work.
2. Human assets approach (22%). Delegates tasks to people and sees his main work as ensuring that the right people are in the organization and that they are trained and motivated to do their work.
3. Style of competence (15%). This is a professional executive who is an expert in a field of great interest to the company and its industry (engineer, doctor, etc.)
4. Control Style (30). This is an executive with an interest in information, especially financial, who sees as his main task making sure that people do their work and obtain the planned results.
5. Approach to change (15%). This is an executive who thinks he was hired to transform the company, which is why he devotes his efforts to making changes that he sees necessary to achieve that change.

Sull

Professor Sull (1999) studied the commitments made by an organization. These types of commitments can be classified as:

Strategic frameworks. The set of assumptions that determine how the executives see the company. Can be converted into blinders.

• Resources. Soft and hard assets. They are durable, designed for a specific strategy, difficult to buy and sell, can give competitive advantages. The resources can be a burdon.
• Processes. How things are done. Can be converted into routines.
• Relations. The connections to employees, customers, suppliers, distributors and shareholders. Can be converted into shackles.
• Values. The set of shared beliefs that determine the corporate culture. Can be converted into dogmas.

Through the life cycle of the company, commitments are vital:

1. When an entrepreneur starts a business, decisions regarding commitments give an identity to the organization by defining what can and cannot be done.
2. When the company matures, executives reinforce the identity with new commitments.
3. When the company declines, the original identity may be insufficient or counter-productive. The company needs to transform the business with new commitments that may contradict the first ones.

Ricart et al.

The IESE professors, Ricart, Llopis & Pastoriza (2007), reviewed the literature of the team and interviewed a number of executives in Spain. They reached the following conclusions about the priorities of management:

1. Creating a future and communicating it. Necessary for establishing the direction of the company.
2. Constantly adapting the business model in use. In light of the constant changes in the environment.
3. Seeing people as the center of the organization. People are the backbone of management’s performance.
4. ntegrating with an institutional strategy, which involves establishing principals and organizational values, defining the institutional purposes and developing a philosophy of operation and performance expectations for the organization.

The framework of Ricart et al. manages to integrate several aspects of the literature in the field.

Integrative Framework

I. Exploration

1. Organizational learning. Understanding and developing a framework of the world or the external environment.

2. Developing a network of contacts. Establishing relationships with different audiences or interest groups. External relations. Developing key relations within and between organizations.

II. Leadership

3. Human assets. Recruiting and directing people.

4. Personal leadership. The values, skills, experiences, tactics and personality of those who exercise leadership in the organization.

III. Strategy

5. Setting values and principals.

6. Inventing and creating the future. Vision or image of the future that might exist. Deciding which businesses to work with. Purpose and objectives.

7. Developing and constantly adjusting the business model. Strategic framework.

8. Innovation and change management. Finding new ways to organize and create organizations.

IV. Resources and control

9. Development and exercise of key skills in the organization.

10. Resource management. Investment decisions and performance.

11. Control of information. Establishing expectations and performance evaluation.

V. Operation

12. Developing and maintaining processes and organizational structures. Philosophy of functioning and decision-making. Operative indicators. 13. Preparing and maintaining a schedule of activities. Actions to be taken personally.

Figure 2. The functions of the executive

It is necessary to make decisions about each one of these topics. We can identify at least five management styles according to the emphasis that an executive gives to these activities or themes: explorer, strategist, operator, leader and comptroller.

In a second level of integration we need to think about what will be the relationship between these elements. These can be (Pascale, 1990):

Synchronization and fit between the various elements to increase the synergy.

Fragmentation and autonomous specialization of each element to facilitate their administration. “Live and let live.”

Setting tensions or rivalry between the various elements and managing the resulting conflict. Handling the paradoxes that always result in a complex organization through balancing the opposites.

Moving beyond the dilemmas and finding ways to manage the resulting synthesis. This can be achieved by: changing the level of analysis, altering positions through time, orchestrating a dialectical synthesis to keep the set of tensions simultaneously in dynamic movement, or introduce new concepts to dissolve the paradox.

Organizations need to focus their energies on key topics, but should not be allowed to embrace a theme or area of emphasis and neglect its opposite. An imbalance — an overemphasis — removes healthy tension levels and resistance in organizations. This perspective results in organizations without distinction that do not have creative tension. Too much balance or an excess of consistency may lead to passivity. To maintain organizational vitality, it is necessary to avoid both excessive coherency as well as a lack of focus.

In a third level of integration, we should note that the different authors do not speak exactly about the same thing. The concept that they examine can be functions, management models, roles, processes, approaches to leadership, commitments and priorities of top management. After reviewing the concepts we can say that:

1. The managerial model is a conceptual framework in the minds of executives that results from their education, experiences and the influence of other executives in the organization.

2. Functions are specific tasks performed by executives.

3. Roles are coherent patterns of tasks that have similar criteria of effectiveness.

4. Processes are sequences of tasks that are usually performed by several people.

5. Approaches to leadership style are consistent and explicit, i.e., they are preferences in the roles adopted by an executive that result in certain priorities.

6. The priorities of an executive are preferences with regard to the areas of corporate policy that receive more attention, the people and behaviors that the general manager values in an organization, the decisions the general manager makes personally or delegates, and how he uses his time during the day.

7. Commitments are any action that an executive takes which requires the organization to engage in specific behaviors in the future. Commitments many times take the form of public statements or signing formal documents.

Each management model determines different tasks and roles. Executives adopt approaches to leadership with regard to these roles and set their priorities in relation to persons, activities, decisions, etc. As a result of these activities, commitments are made.

In conclusion, although the authors of the theme, the functions of the executive, do not all speak exactly about the same thing, we can say that their concepts are highly related and therefore reach similar conclusions. The use of different concepts enriches the theory on the subject, giving it different nuances.

References

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Farkas & Wetlaufer, The Ways Chief Executive Officers Lead, Harvard Business Review, May-June 1996.

Fayol, H. Administración industrial y general, El Ateneo, 1996.

Garvin, General Management: Processes and Action, Irwin, 2002.

Bartlett, W. & Ghoshal S., The Individualized Corporation, Harper Perennial, 1997.

Kotter, The General Managers, The Free Press, 1982.

Lafley, “What Only the CEO Can Do”, Harvard Business Review, May 2009.

Mintzberg, H. “The Manager’s Job”, en Mintzberg, Lampel, Quinn & Ghoshal,  (2003), The Strategy Process. Concepts, Contexts, Cases, Prentice-Hall, 2003.

Mintzberg, Managing, Berret-Koehler Publishers, 2009.

Pascale, R.T. Managing On the Edge: How the Smartest Companies Use Conflict to Stay Ahead, Simon & Schuster, 1990.

Quinn, Faerman, Thompson, McGrath & St. Clair, Becoming a Master Manager: A Competency Framework, Wiley, 4th Ed. 2006.

Quinn, Faerman, Thompson, & McGrath, Becoming a Master Manager: A Competency Framework, Wiley, 1980.

Ricart, J.E., Llopis & Pastoriza. Yo dirijo: La dirección del siglo XXI según sus protagonistas, Ediciones Deusto, 2007.

Sull, “Why good companies go bad”, Harvard Business Review, 1999.

Sull, Revival of the Fittest: Why Good Companies Go Bad and How Great Managers Remake Them, Harvard Business School Press, 2003.