Monday, January 16, 2012

Efficiency expert Mitt Romney: "You're expendable."

Paul Krugman recently pointed out that the last two businessmen to live in the White House were Herbert Hoover and George W. Bush, and we saw what followed in the tragic aftermath of their terms in office. And they were both Republicans too. Now we have Mitt Romney, a corporate "efficiency expert" running for the Republican nominee for president.

I remember the days when "efficiency experts" were once called "axe men".

Does America really want a ruthless and cold-blooded "efficiency expert" as President of the United States; someone whose only concern has been about corporate profits, without any regard to real job creation? Or do we also want someone who's familiar with the human condition, feels genuine empathy for the middle-class, and cares passionately and compassionately about the other 99% of America? Mitt Romney spent his entire life-time being more concerned about increasing the value of corporate stocks, without any regard at all to the working-class.

Mitt Romney's experience at Bain & Company and Bain Capital has given Romney a business-oriented world view that centered more on a hate of waste and inefficiency, a love for data and charts, and a belief in analysis with Power Point presentations -- but he's lacked any real concern for most of us, those who don't fly around in private jets, but only want to pay their rents.

As MF Global inched towards collapse late last year, CEO Jon Corzine pre-occupied himself with a few other things -- namely securing a chateau for him and his wife in the ritzy south of France. At a party in Paris on October 15 (just two weeks before MF Global filed for bankruptcy, costing more than 1,000 workers their jobs) Corzine and his wife were discussing a house they planned to purchase in the south of France, according to a report in Vanity Fair.

As a former CEO of Goldman Sachs, the governor of New Jersey, and Senator, Jon Corzine was able to scrounge up the money for a possible chateau purchase, but he had a lot more trouble tracking down MF Global clients' money, much of which is still missing.

Earlier in 2010 Corzine told Newsweek that eBay's CEO Meg Whitman was either "deceiving us or deceiving herself" when she was vying for California's Republican gubernatorial nomination. Corzine was one of the few people in America who has tried to make the leap from running a business (in his case, Goldman Sachs) to running a government (the state of New Jersey). He had only scoffed when he heard Whitman arguing that deficit-ridden California desperately needs her corporate skills.

As a Democrat, New York Mayor Michael Bloomberg was perhaps the most successful CEO/politician in the country. Most of the others were conservatives: eBay's Meg Whitman thought she was ready to take over California, the world's eighth-largest economy; ex–Hewlett-Packard chief Carly Fiorina, who advised John McCain in 2008, had tried to replace Barbara Boxer in the Senate; Linda McMahon of World Wrestling Entertainment, tried competing against Richard Blumenthal for the Senate seat that Democrat Chris Dodd was retiring from. And we know how many jobs they outsourced as CEOs.

Now a corporate raider named Mitt Romney appears to be the GOP candidate in his second bid for a presidential run.

Jon Corzine also once thought that "a managerial skill set" would be helpful in politics. But after four grueling years as a Democratic governor that ended in a humiliating defeat, Corzine no longer believes that being a CEO prepares anyone for the day-to-day grind of governing. And now with the bankruptcy of MF Global, it appears that having the experience in both governing a state and managing a business doesn't guarantee success either.

Our economy went through a remarkable shift during the eighties as Wall Street reclaimed control of American business and sought to remake it in its own image. Mitt Romney developed one of the tools that made this possible, pioneering the use of takeovers to change the way a business functioned, remaking it in the name of efficiency. Steven Kaplan, a professor of finance and entrepreneurship at the University of Chicago, says “He came up with a model that was very successful and very innovative and that now everybody uses.”

The protests going on at Zuccotti Park now have raised the question of whether that transition was worth it. What emerged from that long decade of change was a system that is more productive, nimble, and efficient than the one it replaced; it is also less equal, less stable, and more brutal. These evolutions were not inevitable. They were the result, in part, of particular innovations developed by a few businessmen beginning a quarter century ago. Now one of them has a good chance of being the GOP nominee for president.

What Mitt Romney is bringing to the table now, is his experience as a CEO at Bain Capital, a part of his resume that he points to as his qualification for creating jobs as President of the United States.

But as former Governor/CEO Corzine had pointed out in that Newsweek interview, very little that happens inside a corporate boardroom is like governing a state or country. CEOs, like generals, can issue orders and expect them to be carried out. Jobs and budgets can be cut with little public controversy. It's not nearly as simple for governors or senators...even for presidents. Their authority is never absolute. They are constrained by the separation of powers and are forced to ride the tiger of public opinion.

Add to that, Corzine's track record compared to Mitt Romney's resume as both a governor of a state and the CEO of a private equity firm doesn't historically seem to support Romney's credentials as being the best suited for this country's economy...especially if Mitt is boasting of "job creation" at Bain Capital as one of his qualifications.

And wasn't Massachusetts rated only #47 for jobs during Mitt Romney's tenure as the state's governor?

Bain & Company (a global management consulting firm) was first established in 1973 by a group of seven former partners from the Boston Consulting Group headed by Bill Bain. The company was headquartered in Lexington, Massachusetts on Militia Drive. Bill Bain quickly recruited Black & Decker and Texas Instruments as his clients.

Two years later in 1975 Alonzo Decker Jr. retired as the CEO. This marked the end of the founding families' executive control of the company. In 1975 B&D also experienced its first break in postwar growth, and many employees were laid off. The firm's future looked dim. High turnover among the top executives also contributed to Black & Decker's woes.

In 1975, when Mitt Romney graduated in the top 5 percent of his Harvard Business School class, "consulting" was still a novel field. As Walter Kiechel documents, the three most prestigious consultancies (then, as now, McKinsey, the Boston Consulting Group, and Bain & Company) believed they were bringing a newly sophisticated, quantitative approach to business, using theories and techniques to help American industry modernize. They regarded themselves as intellectuals, and they also paid better than anyone else—this being a decade before Wall Street salaries started to really climb—and so Romney made what was, at the time, an obvious career choice. He became a consultant at the the Boston Consulting Group.

In 1977, Mitt Romney left the Boston Consulting Group to join Bain & Company and became a vice president of the firm in 1978.

PHOTO: Mitt Romney and Bill Bain

Bain's consultants preferred to work on increasing a company's market value, rather than simply handing clients a list of recommendations. To win business, Bain demonstrated the increase in stock price of Bain's clients relative to the Dow Jones Industrial Average. Their plan was simply to increase a company's worth, cutting the fat, and increasing the stock's value...and doing it quickly over the short term for a quick flip, without much regard to a company's long-term growth or future prospects). Their #1 concern was: increasing shareholder value.

In 1983 Bill Bain offered Romney the chance to head a new venture that would buy into companies, have them benefit from "Bain techniques", and then reap higher rewards than just consulting fees. Romney initially refrained from accepting the offer, and Bill Bain re-arranged the terms in a complicated partnership structure so that there was no financial or professional risk to Romney.

Finding outside investors wasn’t as easy. Romney went on the road, traveling to meet with billionaire families—an investment arm of the Rockefeller fortune, a Rothschild heir—arguing that Bain’s work in consultancy had prepared them to turn businesses around themselves. But Romney and his cohort were young men in their thirties with no experience investing money or running companies, and for nearly a year the pitch kept failing.

Romney finally found some takers from Latin America. Most important was the enormously wealthy Poma family (e.g. Salvadoran billionaire Ricardo Poma) and by 1984, Romney and six consultants he’d picked were staging a photo shoot for the brochure accompanying their first fund; grinning and geeky, they posed for an outtake with 20-dollar bills stuffed in their mouths, their sleeves, their collars.

The photo below shows Mitt Romney (center) with his colleagues at Bain Capital, which provided it to The Boston Globe. After posing for a company-brochure photo, Romney and his Bain associates snapped it again with $10 and $20 bills. (Eventually Romney led Bain Capital to grow from a staff of seven managing $37 million to a staff of 115 managing $4 billion, the Boston Globe later reported.)

Thus, in 1984, Romney left Bain & Company to co-found the spin-off private equity investment firm Bain Capital.

Meanwhile, Bain & Co. was formally incorporated in 1985 and over the course of two years, the Employee Stock Ownership Plan (ESOP) was established. Bill Bain's senior partners began borrowing against their equity for cash, eventually leaving the firm with a heavy debt load.

As business slowed, this debt load began to squeeze the firm. Bain & Co. ultimately found itself in non-compliance with Bank of New England loan covenants. The resulting debt write-off at the bank eventually resulted in that bank's failure in 1991.

Facing financial duress, Bain Capital partner Mitt Romney was asked to rejoin and lead Bain & Co. as interim CEO. Romney negotiated a complex settlement between the Bain partnership and the firm's lenders, including a $10 million reduction in the $38 million Bain owed the Bank of New England, which by that time had been seized by the FDIC and placed in Chapter 7 liquidation.

But as the co-founder and head of the spin-off company Bain Capital, the private equity investment firm became highly profitable as one of the largest such firms in the nation, and was where Mitt Romney has accumulated most of his wealth.

At first, Bain Capital had focused on venture capital opportunities. Their first big success came with a 1986 investment to help start Staples Inc., after founder Thomas G. Stemberg convinced Mitt Romney of the market size for office supplies -- and then Romney convinced others. The first store was opened just outside Boston in 1986. Bain Capital eventually reaped a nearly sevenfold return on its investment, and Romney sat on the Staples board of directors for over a decade -- when during its 10th anniversary in 1996, Staples became one of the Fortune 500 companies as sales surpassed $3 billion (and that was the same year that Staples and Office Depot had wanted to merge to compete against OfficeMax, with hopes of eventually becoming a office supply monopoly, but were ultimately denied by the FTC).

Romney and his team did this sort of thing again and again, sometimes in venture capital deals, but more often through buyouts, such as Brookstone, Domino’s, Sealy, and Duane Reade. In their more complex deals, they couldn’t rely on their own team to seek out every inefficiency. They needed a more powerful lever, and they turned to the solution that two men named Jensen and Meckling had begun to explore a decade earlier: offering CEOs large equity stakes in the company in the form of stocks or stock options.

David Dominik, an early Romney colleague, says "You have the total alignment of incentives of ownership, board, and management—everyone’s incentives are aligned around building shareholder value. It really is that simple.”

Besides Staples, in 1986 Bain Capital bought a struggling division of Firestone that made truck wheels and rims and renamed it ­Accuride. Bain took a group of managers whose previous average income had been below $100,000 and gave them performance incentives. This type and degree of management compensation was also unusual, but here it led to startling results: According to an account written by a Bain & Company fellow, the managers quickly helped to reorganize two plants, consolidating operations—which meant, inevitably, the shedding of labor—and when the company grew in efficiency, these managers made $18 million in shared earnings. The equation was simple: The men who increased the worth of the corporation deserved a bigger and bigger percentage of its spoils. In less than two years, when Bain Capital sold the company, it had turned an initial $5 million investment into a $121 million return.

Even by the standards of the times, Bain Capital grew tremendously fast: from $37 million under management in 1984 to $500 million in 1994 (and $65 billion today).

To other businesses, the buyout industry both presented a model for better profits and posed a take-over threat. “Having the private-equity guys out there disciplined other companies,” says Nick Bloom, a Stanford economist.

Some techniques developed in the "buyout laboratory" spread. Productive workers and managers were rewarded, while less productive or unnecessary ones were cut loose. Corporations realigned themselves to deliver more value to their shareholders, increasing dividend payments and stock buybacks.

Within a decade, ordinary businesses were giving large stock and option packages to CEOs. Executive compensation soared. “These Bain Capital guys,” says Neil Fligstein, an economics-sociology professor at the University of California, Berkeley, “were agents of the shareholder value revolution.”

By the mid-nineties, The Business Roundtable had changed its definition of the role of a company, winnowing a broad set of responsibilities down to a single one: increasing shareholder value.

In 1994, a machine operator named Harold Kellogg gathered five of his co-workers, borrowed a brown van from a used-car dealership in Marion, Indiana, and began to drive east on I-90, headed for Boston...where Mitt Romney was in his first political race running against Ted Kennedy. The narrative that the Kennedy campaign had been trying to build throughout that summer was that Mitt Romney was a Gordon Gekko type.

For eleven years Harold Kellogg had worked for an office-supplies manufacturer called SCM, but a few months earlier his plant had been acquired by a Texas-based company called American Pad and Paper, in which Bain Capital had a majority stake. AmPad fired all of the union workers at Kellogg’s plant, more than 250 people in total, then hired most of them back at much lower wages.

For years, Harold and his fellow employees had gotten health-care coverage as part of their pay package, but now AmPad asked them to pay half of the costs. The whole plant walked out.

The plant in Marion closed down six months later, and the machine operator went to work at a nearby glass company. Management had sent in Pinkerton guards and, according to a union source, took away machinery and moved it to non-union plants in Utah and Massachusetts. (Utah and Massachusetts? Coincidence?)

Marc Wolpow, who was at the time the Bain Capital partner who worked on the AmPad deal, said that the labor in the plants was only a commodity by-product. The only thing Harold Kellogg and his co-workers did was to move paper from one machine to another. This could be done more cheaply at plants in China or Indonesia.

"Those jobs were going to get destroyed internationally. That plant was going to go out of business, and there was nothing Mitt should have done, or could have done, to prevent it.”

By 2001, five years after the company had been taken public, it had filed for bankruptcy and liquidated its assets. But Bain Capital made more than $100 million from AmPad for itself and its investors.

Bain Capital's acquisition of Ampad exemplified a deal where it profited handsomely from early payments and management fees, even though the subject company itself ended up going into bankruptcy.

Dade Behring was another case where Bain Capital received an eightfold return on its investment, but the company itself was saddled with debt and laid off over a thousand employees before Bain Capital exited (the company subsequently went into bankruptcy, with more layoffs, before finally recovering and prospering).

It’s difficult to track the fallout of any one private-equity firm’s work, but scholars have been able to look at the consequences of the industry as a whole. These studies have consistently found that private-equity takeovers improve productivity, but shed jobs.

And private equity firms like Bain Capital started to provide an early warning of some broader changes. In three years during the early nineties, the Princeton economist Henry Farber had found that not only blue-collared workers, but roughly 10 percent of American white-collar male managers were losing their jobs too...and they were also replacing office workers with information technology.

For the first time, according to data collected through the General Social Survey, white-collar workers were nearly as worried about losing their jobs as blue-collar workers. Those white-collar workers who kept their jobs worked harder, and the compensation that had once been spread through the broader middle ranks of corporations now collected at the top.

In 1980, a CEO had earned about 35 times the wages of an average worker; by 1990, it was about 80; and by 2000, it was about 300. The portion of America’s gross national product that ended up in the hands of workers declined by more than 10 percent between 1979 and 1996; the portion that went to investors rose by a similar amount.

“What you end up with is a choice between a bigger cake less-equally split and a smaller cake equally-split,” says Bloom, the Stanford economist. “But that’s a social question.”

There is no doubt that the tools of this "efficiency movement" implemented by private equity investors like Mitt Romney during this time (going back 30 years) helped to build the current economy and income inequality that we see today.

That booming decade on the 90s, with unemployment declining by 3.5 percent and real GDP growing by nearly 4 percent each year during the Clinton administration, depended heavily on a spike in productivity, which itself had hinged on the wide deployment of computer technology to displace more expensive forms of labor.

Economists believe there was a clear connection between the labor-market changes in the early nineties and the great profits that soon followed. “Could we have had the productivity boom without displacement? My answer would be no,” says Frank Levy, an MIT economist.

The trouble, Levy believes, was that this new shareholder-value-driven system had no built-in mechanism of regulation, and its incentives geared CEOs towards their shortsightedness and recklessness. “Any profit-making organization was going to take advantage of the opportunities to lower costs and become more efficient by taking advantage of foreign producers and installing technology, both of which meant losing jobs,” he says. “But decision-makers fully exploited at every turn the market power that they had. The question is, why were we so willing to exploit everything?”

The obvious answer is financial reward. But there may have been a cultural component, too. By the time Mitt Romney left Bain Capital for good in 1999, American CEOs looked very different from the predecessors he had met in the seventies—the genial paternalists, spending their careers at a single company. More and more, they were pure meritocrats—well-educated, well-compensated, moving frequently between jobs and industries, trained to look ruthlessly for efficiency everywhere.

And every day these meritocrats look a great deal more like Mitt Romney. If you trace the public controversies over Bain Capital over time, you can see how the obsession over shareholder value and efficiency proved not just inequitable, but also destabilizing.

Five years after the machinist Harold Kellogg showed up in Boston, Bain Capital and others were sued by shareholders of Stage Stores, a Texas retailer, charging Bain Capital of helping to manipulate the stock. The lawsuit accused the company of giving misleadingly optimistic performance projections, which sent the retailer’s stock soaring past $50 a share, at which point Bain Capital unloaded virtually all of its stock. When more realistic earnings projections were released, Stage Store’s stock plunged 58 percent in a single day. The lawsuit was later dismissed. But then, shortly after Romney left came the KB Toys fiasco, in which, another lawsuit alleged, Bain Capital and KB executives took a dividend recap of over $120 million in just two years, right before the company collapsed into bankruptcy.

No court found that Bain Capital did anything illegal in these cases. But these episodes still give a glimpse of the evolving problems of the "shareholder-value model", and some consequences of the trade-off we made of stability for growth. In some economic moments, a program of radical efficiency can be good for society; at other times, when there is less fat to trim, the same instincts can lead a company to cannibalize itself.

“We’re living in a crueler capitalism,” Fligstein says. By some measures, he adds, “we’ve gone really quite a long ways. And nobody really knows what the tipping point is, or how you go back.”

The best evidence of how important Romney’s religion is to him could be how far he has kept it from view. Like Jon Huntsman (who just endorsed Mitt Romney) and Glenn Beck, most of his charity is designated to the Mormon church. But the character that remains visible is at once uniquely American and a little strange: a perfectly objective "efficiency machine".

Between 1977 and 2005, the years roughly overlapping Mr. Romney's business career, some 15% of all jobs were destroyed every year, even as total jobs grew by an average of 2% a year. Job creation and destruction are both relentless. (Romney finally left Bain Capital on Feb. 11, 1999 to run the Olympics.)

PHOTO: Thomas S. Monaghan, founder of Domino's Pizza, Inc., left, and Mitt Romney, then-managing director of Bain Capital, sign an agreement in September 1998.

How many jobs Bain Capital added compared to those lost under Romney due to these investments and buyouts is unknown, due to a lack of records and Bain Capital's penchant for privacy on behalf of itself and its investors. It's all we can do just to get Mitt to release his tax records.

But it's scary to imagine a Mitt Romney White House, inevitably filled with many former Bain colleagues, the clinical separation of decision-making from ideology, the detachment of those decisions from moral consequence, and a persistent blind spot for people as real people...not just as labor that's only a "commodity by-product". Or as a consumer, someone who's just an "income stream".

Jon Corzine and Mitt Romney created plenty of wealth for themselves...both as former politicians and CEOs, but can their type of personal success equate to millions of jobs paying a "living wage" inside the borders of the United States? Or will the rich just get richer as the poor get poorer when real people become too inefficient to compete with robots, and when all the "efficiency experts" like Mitt Romney decides we're all expendable because to Mitt, corporations are the real people.

PHOTO: Mitt Romney campaigning for the top 1%

The Bain Philosophy

In 1993, the head position of Bain was split into two roles – an executive head (Worldwide Managing Director) and a non-executive head (Chairman of the Board). Orit Gadiesh was named Bain’s first Chairman in 1993, and was fundamental in implementing Bain's goals from here book: Lessons from Private Equity Any Company Can Use

From Bain.Com - Private equity firms are snapping up brand-name companies and assembling portfolios that make them immense global conglomerates. They're often able to maximize investor value far more successfully than traditional public companies. How do PE firms become such powerhouses? Learn how, in Lessons from Private Equity Any Company Can Use.

Bain chairman Orit Gadiesh uses the concise, actionable format of a memo to lay out the five disciplines that PE firms use to attain their edge: Invest with a thesis using a specific, appropriate 3-5-year goal. Create a blueprint for change--a road map for initiatives that will generate the most value for your company within that time frame.

Measure only what matters--such as cash, key market intelligence, and critical operating data Hire, motivate, and retain hungry managers--people who think like owners. Make equity sweat--by making cash scarce, and forcing managers to re-deploy under-performing capital in productive directions This is the PE formulate for unleashing a company's true potential.

Orit Gadiesh's book was densely written and to the point, and chock full of good advice for executives looking to groom their company for a sale in 3-5 years at a multiple of its current value. Overall I would recommend it for anyone in an executive position at a mid- to large-scale enterprise who is looking to turnaround a business and flip it, or who is anticipating getting private equity investments and wants to better understand in advance what the PE guys are probably thinking.

Briefly, the six lessons are:

  1. Define full potential: Top PE firms generate high returns primarily by creating operating value. They start by building an objective fact base. They scrutinize demand, customers, competition, environmental trends and the details of how money is actually made. Only then do they pursue a few core initiatives to reach full potential.
  2. Develop the blueprint: PE blueprints are about action. They turn the few core initiatives into results, choreographing actions from standing start to the finish line.
  3. Accelerate performance: Top PE firms mold the organization to the blueprint, use a rigorous program, and monitor a few key metrics.
  4. Harness talent: Top PE firms create the right incentives for employees to act like owners, and they assemble decisive and efficient
  5. Make equity sweat: Top PE firms embrace leverage. This is perhaps one of the toughest PE disciplines to adopt, and one that CEOs and their boards should consider carefully, especially when credit is tightening. But CEOs, too, should get comfortable with leverage. Scarce cash compels managers to manage working capital aggressively, discipline capital expenditures, and work the balance sheet hard.
  6. Foster a result-oriented mindset: This lesson is about creating repeatable processes that spur performance improvements again and again.

Orit Gadiesh, chairman, Bain & Company, is an expert on management and corporate strategy. Hugh MacArthur, partner, Bain & Company, is the leader of the firm's Global Private Equity Practice.

Now more than ever, PE funds are sticking with a time-tested approach that generates big returns from dramatic improvements in operations. The results speak for themselves: the top 25 percent of U.S. private equity funds raised between 1969 and 2006 have earned internal rates of return of 36 percent on average, through good times and bad. That's close to 10 points higher than the equivalent S&P 500 top quartile.

Virgil Bierschwale of Keep America at Work prepared a chart to show you the differences in the compensation of wages for corporate, non corporate, and sole proprietorships. Guess where Mitt Romney is on the chart. (Click to enlarge)

1 comment:

  1. Informative article but way too much reading for the numbskulls who will vote for Romney anyways. You need short sentences filled with single-syllable words.