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The Bottom Line

Evan Davis gets to the heart of the big finance stories at The Bottom Line.

The showroom is dead! Long live the showroom!

Should this be the slogan of business leaders in a seemingly digital world, where the satisfaction of consumer needs and wants is only one click away from reality - and business performance with it?

Given the virtual revolution of the last twenty years should businesses be led by avatars from a second, third or fourth life thereby escaping the heart of darkness that can be the contemporary reality of running a business and dealing with customers?

Isn’t it better to deal with customers through the medium of packet-switching technologies like the Internet? As Sartre, the famous French writer, once noted “hell is other people”. Do business leaders really want legions of punters wandering into their showrooms, fingering their goods and cluttering the place up whilst asking banal questions with little intention of buying?

Jean Paul-Sartre stencilled on street furniture in Olympia [Image: dreamsjung under CC-BY-SA licence]

Fortunately, reality is a little more prosaic. Online shopping accounts for a small percentage of total sales in the United Kingdom. The web is a key showroom for businesses in which would-be consumers can search for goods and compare prices and quality of potential purchases. It is also a valuable marketing tool in which the transactions costs (the costs of running a business) are transferred from the producer to the consumer.

For weightless goods like airline tickets or insurance, among others, a dedicated shop or showroom is not necessary, although the quality of the travel or cover is affected by a number or real factors. For real goods, however, the showroom seems to be making a come-back which may seem counter-intuitive given that 25% of the world’s population has access to the web.

The showroom appears to be the site of the modern dance of status, and income, and quality, and price: where consumers and producers parade their characteristics in front of each other. Any iron in the soul appears to soften or rust in the face of the inducements of the showroom.

For manufacturers like Miele, the showroom provides the opportunity for customers to use and familiarise themselves with their products, whilst allowing the firm to market-test new products at first hand. For art auctioneers like Christies, the showroom represents the place where aesthetics and expertise come together with prestige and appreciation in a price-discovery process we commonly know as an auction.

I might consider buying a Robert Delauney painting online but being physically close to it, I suspect, may add to its lustre and the value I place on it.

Possibly, we are all boys and girls who never grow up, as the toy shop gives way to the car showroom, or the art auction house, in adulthood. Witness mobile phone shops and the way in which the merchandise is frequently caressed and played.

Toyshop for grown-ups? A car showroom [Image: SpAvAAi under CC-BY-NC-ND licence]

 If the showroom is not dead, does this mean the businesses and organisations that use them are strengthening the expertise of their management?

Should engineers run engineering companies; should bankers run banks, as the comment on fall-out from the financial crisis has centred upon?

It is clear that knowledge of your sector; the country and culture of the regions you operate in; and detailed knowledge of the market you serve is essential for management. Management for management’s sake will no longer do in large and complex businesses that seek to operate in international markets.

For small firms, not knowing your business is a death sentence. In universities, there is a tension between collegiate and managerial perspectives but these are false dichotomies.

It is about the relative expertise of the functional roles in these organisations, in spite of a tendency to the contrary. General management has been likened to a pigeon hole: information comes in and information goes out, but no process of knowledge enhancement is engaged in. It is the exploitation of knowledge and its dissemination that creates and sustains value in an organisation.

Although the former is a caricature and the latter commonplace, it does point to the importance of co-existing expert systems, functions and skills in a business - or any other form of organisation.

The bottom line is that business leadership and management are, however unwittingly, part of the showroom for their goods and services. Why would I buy a good or service from a company whose management knows little about their product, or attend a university where the management has limited knowledge of higher education?

The renowned German sociologist, Max Weber, distinguished between traditional and charismatic authority: the former which business leaders gain because of their formal position. But if they don’t know their industry, then the lack of display of charismatic leadership might be the difference between staying in business or not.

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This blog was inspired by The Bottom Line, week ending 06-02-10

About the author

Leslie Budd is Reader in social enterprise at The Open University Business School. He is an economist and has written extensively on the relationship between regional and urban economics, and international financial markets.

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Blogging about

The Bottom Line

Evan Davis gets to the heart of the big finance stories at The Bottom Line.

The slow recovery from the credit crunch and the global recession is still fraught with danger. The patient’s former robust outward health hid some serious acute and chronic conditions. In the event of it being discharged from clinical care to post-operative revival, what kind of preventative medicine is needed to prevent a future relapse?

The metaphor-turned-cliche of ‘green shoots’ [Image: timsamoff under CC-BY-ND licence]

Any programme needs to centre on the three R’s, which to anyone growing up in the 1950s meant Reading; Writing and Arithmetic. For the world economy, it means Re-structuring; Re-balancing and Reform.

But, what do these three R’s consist of? The challenges to the future of the world economy include geopolitical and environmental ones, but perhaps - more importantly - combating poverty and the sustainability of everyday existence in a world characterised by growing inequality of wealth and income. This inequality is often manifested in issues of basic food and water security.

The possibility of a post-oil world led the Gulf States (and others) to pursue the development of dream cities. In one case - Dubai - this has led to the possible outcome of a Dead Sea city: it floats on a pool of debt whicjh just about keeps it above water.

The problem with this kind of economic strategy it assumes that increasing the supply of the built environment is axiomatically beneficial to the economy, but it ignores the importance of effective demand (as we economists call it). That is, a sufficient number of individuals and organisations paying for goods and services in order to maintain the economy’s holy trinity of output, income and employment.

The same kind of argument applies to building new ‘green’ infrastructure – it may create a one-off benefit in increased construction employment and the multiplier effects from this additional income flowing through the economy. It may also create social benefits and learning effects. But unless this is part of a sustainable economic strategy this apparently simple solution may prolong the economy’s health in the short-term but ultimately fail to arrest its long term decline.

False dawn? Building Dubai airport in 2005 [Image: Makz under CC-BY-NC licence]

So “what is to be done?”, as the Russian revolutionary, Lenin, once asked.

• Restructuring: New public and private institutions, including national and regional investment banks, to provide resources to undertake new and long term investment in sustainable technologies and products underwritten by a commitment to global social justice in order to distribute the benefits of these outcomes;
• Re-balancing: A public commitment to full employment and a right to basic income, with the state underwriting a balance of economic activities, especially manufacturing;
• Reform: Strengthening international economic institutions at local and regional levels in order to ensure more consistent management of the financial system, giving more equitable access to capital for non-standard businesses and other organisations. The introduction of a Tobin-like tax on global financial transactions to fund appropriate infrastructure, education and health programmes in poorer economies.

But what has the future of the world economy got to do with the health of a business’s employees? There is a body of research on the relationship between economic development and well-being which shows that those societies with relatively high living standards and less inequality score well on comparative indicators of health. If the citizens of a nation or region are effectively employees of an economy, should the health and well-being of employees be a concern of the constituent businesses?

The three Rs seem to be equally applicable to health: Recognition; Robustness and Restitution. That is, define the problem; utilise consistently strong methods of diagnosis based upon evidence; and, maintain recovery. So if it is good for the economy gander, logically it should be good for the business goose. But, business leaders might opine that it is a systemic problem and that regard for the health of one’s employees merely increases the transaction costs of a business.

 Will businesses be like this lazy lemur and take advantage to get a free ride? [Image: Theyoungones1984 under CC-BY licence]

However, this leads to the economic problem of free-riding , in that some firms may rely on health systems maintaining the well-being of their workers, whilst competitors may spend more of their own resources to ensure well-being of their workforce, thereby making a net contribution to a stable and sustainable labour market.

At the macroeconomic level, supporting well-being of workers maintains employment, income, output and thus demand goods and services for all goods and services across the whole economy; creating a virtual circle from business to economy and back again. The bottom line is that the future of the world economy and sustaining the well-being of employees rely on preventative medicine, as clinical intervention is costly at all levels of society,

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About the author

Leslie Budd is Reader in social enterprise at The Open University Business School. He is an economist and has written extensively on the relationship between regional and urban economics, and international financial markets.

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Blogging about

The Bottom Line

Evan Davis gets to the heart of the big finance stories at The Bottom Line.

There’s a lot of mythology that surrounds the idea of creative accounting. Part of it stems from the misconception that the profits for the year, or the financial position at the balance sheet date, are identifiable sets of numbers. Creative accounting is seen as distortion of these for some nefarious purpose, such as misleading investors.

The reality is much more difficult. Neither the profit for a particular period nor the financial position at any date can ever be known with certainty, until a company has ceased to exist and (as the liquidation of Lehman Brothers in Europe demonstrates) possibly not for some years after that.

Accountants in discussion.

Picture © copyright Jupiterimages Corporation.

The problem is this: when an accountant sets out to draw up a profit and loss account and balance sheet (statement of financial position), there are many definite numbers, but there are also, in any large business, a number of unknowns. The accountant has to make estimates about these, or may even have to ignore some altogether because they are too difficult to measure.

To borrow from Dick Cheney, there are the ‘known unknowns’ – transactions that were incomplete at the end of a period for which you want to measure profit, and long-lived assets whose cost must be allocated against profits as the asset is used but whose precise future use is unknown. Business cycles do not necessarily have anything to do with the financial reporting year, and the accountant has to make estimates of what will happen in the future.

There are also the ‘unknown unknowns’ – things that may become apparent in the future and have been caused by past actions but which the accountant does not know about yet. This could be the employee whose health has been affected by their work, or a product that turns out to injure people when they have used it for a year or two.

The level of certainty with which the accountant can measure these things varies from one type of business to another, as also does the extent to which the business works in an environment where there are many unknowns, but it is sure that any set of financial statements includes, and is to an extent shaped by, estimates. Thus far, we have not been talking about creative accounting.

Where the mythology and the misunderstandings arise, is that it is in the nature of an estimate that it cannot be verified. Different accountants, armed with the same basic information, would make different estimates, each one perfectly valid. In a worldwide group there will be hundreds of individual companies, each with its own estimates, which all impact upon group profit. In closing the annual accounts, decisions have to be made about these.

As long as the final decisions are within appropriate accounting rules and reflect the economic reality as perceived by management, this is not creative accounting, this is normal business practice. Management must not undervalue the business (that would not be appropriate behaviour towards existing shareholders) nor must they overvalue it (that could lead to wrong investment decisions).

Where creative accounting, or management manipulation of profits, starts is when the estimates do not coincide with a reasonable view of economic reality. Of course, this is extraordinarily subjective, and almost impossible for the outsider to assess. Even if the outsider has a different view of the same economic reality, the test is always this: was management’s view reasonable from their perspective?

Creative accounting can also be a question of wilfully misinterpreting the accounting rules – this was certainly one of the problems with Enron, which misused accounting rules to exclude from its group accounts some activities that should have been included and which would have radically changed investors’ perceptions.

Can companies get away with creative accounting? In the end, the answer is probably not. Real cashflows and actual transactions are the bedrock of the financial statements and it becomes impossible to conceal a mismatch between this economic reality and the financial statements. The problem is that many investors may have lost money by then, and as in the Enron case, investors then lose confidence both in financial reporting and the capital markets. This can take years to put right.

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About the author

Professor Peter Walton is a member of the Accounting & Finance Unit at the Open University Business School. His research interests are in comparative international accounting and financial reporting in an international context.

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