Key message 1 – Management practices have lasting positive effects on firm performance and growth.
Economists have long documented large differences in firm performance across and within countries, and even within the same sector. For example, India’s total factor productivity – a measure of how efficiently inputs such as labour and capital are used – is approximately 40% of that of the US (Caselli, 2011).
Additionally, firms in low- and middle-income countries have, on average, much worse management practices than firms in high-income countries. This appears to be due to a large number of very badly managed firms and big differences in management scores across firms. Figure 1 below illustrates this, showing results from a large survey of manufacturing firms that scores management practices.
The drivers of firm growth are complex, but recent evidence has shown management practices affect productivity (Bloom et al., 2013; Bruhn et al., 2013). These studies found that companies with higher management scores are significantly more productive, profitable, and grow faster. Well-managed firms
are also larger, survive longer, employ more skilled workers, and are more likely to export.
In an IGC-funded study targeting large Indian textile firms in 2008, 17 firms were randomly selected and divided into two groups:
- In one group, one plant in each firm received support from a consulting firm to implement business practices to improve management –based on basic manufacturing principles standard in high-income countries, such as regularly maintaining machines, addressing quality defects, organising inventory, and managing sales and orders.
- In the other group, firms did not receive any support to implement business practices.
Those in the first group (treatment group) saw an increase in output of 9% and a rise in productivity of 17% compared to the second group (control group). These performance boosts were driven by higher quality and reduced inventory, corresponding to an average increase of about $325,000 in profits per year per plant. Moreover, this average profit increase in a single year exceeded the cost of the consulting services used, making it a cost-effective investment for firms.
The practices also affected firm growth. Following the intervention, firms that received consultancy support operated a significantly larger number of plants compared to both firms in the control group and in the rest of the industry. This was due to improved management practices enabling firm directors to delegate more responsibilities to their plant managers, while still being able to monitor progress closely based on the additional data and channels available to them.
Eight years after the initial intervention, researchers revisited the Indian firms and found that the impact on management practices and firm performance persisted:
- While about half of the introduced practices had been dropped, firms that had received the consultancy support continued to perform significantly better than those that had not.
- Out of the 38 practices introduced to the firms in the original intervention, 14 practices, once adopted, were not dropped by a single plant eight years later. These practices enabled directors to delegate more responsibilities to managers, as seen in the short-term results.
- The practices that persisted for most plants related to the most immediate improvements in quality and inventory – including recording quality defects systematically, having a system for monitoring and disposing of old stock, and carrying out preventative maintenance of machines.
- The intervention had a positive long-term impact on firm performance. The follow-up study supplemented previously collected data with data on plant size and the number of textile looms. These revealed that treatment firms saw average long-run increases of 34% in production (as measured by the number of looms) and 9% in productivity (looms per employee) in their plants as compared to firms in the control group.
These lasting effects underline the importance of management practices in explaining systematic differences in performance between firms.