The Role of PPM in Rebuilding Business and Industry

Causes of the financial crisis

“In the West, the break-up of the Soviet Union was viewed as a total victory … Western leaders were convinced that they were at the helm of the right system and of a well-functioning, almost perfect economic model …

The dogma of free markets, deregulation and balanced budgets at any cost was force-fed to the rest of the world. But then came the economic crisis of 2008 and 2009, and it became clear that the new Western model was an illusion that benefited chiefly the very rich …[it] turned out to be unsustainable. It was based on a drive for super-profits and hyper-consumption for a few, on unrestrained exploitation of resources and on social and environmental irresponsibility”.

– Mikhail Gorbachev, Sydney Morning Herald (June, 2009)

Causes of the financial crisis

“One of the things you're supposed to learn in economics is to avoid extremes … A big part of the reason for the global financial crisis …was the dominance of an extreme view that the market system could work well with minimal government supervision.

The problem comes when markets are seen as a ''system'' possessed of almost magical powers to never run off the rails and always deliver satisfactory outcomes without government interference …over the past 30 years, the intellectual fashion swung heavily in the direction of minimizing regulation. We dismantled a lot of the safety rails.

The events of the global financial crisis were a stark reminder that …markets are far from perfect. They need to operate within a government-imposed framework and be diligently regulated to ensure rules are obeyed”.

– Ross Gittens, Sydney Morning Herald (September, 2009)

Causes of the financial crisis

The free market ideology, and the liberalization and deregulation of national and international markets that it drove over the last 30 years, has gone too far.

Without adequate regulation and supervision, “fallible human beings, subject to greed, envy and fear, short-sightedness, gullibility and rapaciousness”, acted out their natural impulses and behaved in flawed and unscrupulous ways that ultimately affected us all.

Market mechanisms

Within a free market, property rights are voluntarily exchanged at a price arranged solely by the mutual consent of sellers and buyers. By definition, buyers and sellers do not coerce each other, in the sense that they obtain each other's property rights without the use of physical force, threat of physical force, or fraud, nor are they coerced by a third party (such as by government) and they engage in trade simply because they both consent and believe that what they are getting is worth more than or as much as what they give up.

Free markets contrast sharply with command and control markets or regulated markets, in which governments directly or indirectly regulate prices or supplies, which according to free market theory causes markets to be less efficient.

Market mechanisms

It is clear from this definition that free markets do, contrary to some interpretations, require governments to regulate certain practices in order to maintain the integrity of the marketo Anti-competitive behaviouro Collusiono Price fixingo Cabal behaviouro Market manipulationo Predatory pricingo Misleading and deceptive conducto Insider trading

Era of economic reform

Since the late 1970s, across the world, dramatic improvements in economic efficiency and unparalleled wealth generation have been achieved by liberalising command and control economies and moving toward market economieso From mixed to market economy in the Westo Glasnost, perestroika and the collapse of the Soviet Uniono Miracle in South East Asiao Liberalisation and the awakening of Indiao China’s transformationo The new game in Latin America

Keynesianism versus the Chicago School Markets are by no means perfect; however they are superior to command and control

systems in terms of efficient allocation of resources and assets, free flow and exchange of knowledge, and preventing of cronyism and corruption (see for example Yergin and Stanislaw, 2002).

Environmental policy

In recent years governments have started to use market mechanisms to enact environmental policy – o Market-based instruments are regulations that encourage behaviour through market

signals rather than through explicit directives regarding pollution control levels or methods. Firms and individuals are encouraged to undertake pollution control efforts in their own interests.

o By way of contrast, conventional approaches to regulating the environment are often referred to as “command-and-control” regulations, since they allow relatively little flexibility in the means of achieving goals. Command-and-control regulations do this by setting uniform standards –

- technology-based standards specify the method, and sometimes the actual equipment, that firms must use to comply with a particular regulation

- performance standards set uniform control targets for firms, while allowing some latitude in how this target is met

Environmental policy

Examples of economic-incentive or market-based policy instruments include – o Charge systems – e.g., effluent charges, deposit-refund systems, user charges,

insurance premium taxes, sales taxes, administrative charges, and tax differentiationo Tradeable permit systems – e.g., credit programs and cap-and-trade systemso Reducing market frictions – e.g., market creation, liability rules, and information

programso Reducing government subsidies

Environmental policy

Market mechanisms have proven superior to command and control approaches in achieving the objectives of environmental policy. Holding all firms to the same target can be expensive and, in some circumstances, counterproductive.o Control costs can vary enormously due to a firm’s production design, physical

configuration, age of its assets, or other factors. Because the costs of controlling emissions may vary greatly among firms, and even among sources within the same firm, the appropriate technology in one situation may not be appropriate (cost-effective) in another

o Both technology-based and performance-based standards discourage adoption of new technologies that might otherwise result in greater levels of control as little or no financial incentive exists for businesses to exceed their control targets.

A fundamental flaw

“One of the great paradoxes of our time is that it is totalitarian, centrally planned organizations, owned by outsiders, that are providing the material wherewithal of the great democracies”.

– Charles Handy (Drucker, Dyson, Handy, Saffo and Senge, 1997)

A fundamental flaw

Handy is commenting primarily on the morality and political irony of prevailing organizational forms in a knowledge economy where intangible knowledge assets embedded in social networks are more valuable than an organization’s tangible assets (cash, plant, machinery, etc).

Put another way, how can outsiders own what exists only in people’s heads and which is embedded, and only accessible through, social networks of people within a community of practice.

A fundamental flaw

However, also implicit in his observation is an economic paradox. While free markets are generally accepted as being superior to centrally-planned economic systems, the workings of most business and government organizations still resemble Soviet-era command and control economies characterized by central planning, hierarchical control systems and rigid organization of resources and assets within silos.

The wave of micro-economic reform undertaken since the late 1970s to liberalize the operation of national and international markets and establish a global free marketplace has stopped short of reform of the internal workings and governance of business and government organizations.

Economic inefficiency

Lacking in modern market disciplines in their management and governance, our business and government organisations demonstrate a gross level of economic inefficiencyo Rigid centralized business planning – 5 year plans formulated by bureaucratic

management in isolation of supply and demand considerationso Hierarchical control of resources – lack of autonomy and flexibility for the resources

on the ground, inhibition of creativityo Segregation of resources by function – inhibiting the formation of networks and

collective action

Economic irrationalism

As is usual in command and control economies, our business and government organisations are prone to corruption and cronyism, and rife with market manipulation and other economically irrational anti-competitive behaviouro Rewarding management with bonuses for reducing pension fund liabilities – cabal

behaviour, price fixingo Executives voting themselves excessive pay packets without entering into a

bargaining process with organisational stakeholders – cabal behaviour, collusion and price fixing

o Rewarding of employees with large commission payments for selling as AAA rated investments mortgage-backed securities that were essentially junk– collusion and misleading and deceptive conduct

Pinpointing root causes

This fundamental flaw in our economic system is critical to understanding the underlying causes of the Global Financial Crisis (GFC).

The irrational investment decisions, driven by greed, short-termism, political expediency and incomplete knowledge, that were the immediate cause of the worst global financial crisis since the Great Depression, were not taken by individuals operating in a free market and merely following their own rapacious natures.

Rather, they were made by employees operating within, and subject to the direct control and incentive systems of, business and government organisations that are, in microcosm, Soviet-style militaristic, command and control economies.

Addressing root causes

It is my contention, therefore, that in order to address the underlying causes of the GFC so that future crises are less likely, rather than retreat from free market principles in favour of a return to direct regulation, it is necessary that legislators and business leaders continue and extend the free market reforms of the 1970s, 80s and 90s, which addressed inefficiencies, irrationalism and cronyism in national and international markets, to the internal workings and governance of large business and government corporations.

If such organisations receive taxpayer funded bailouts because they are deemed “too big to fail” then they are too big to continue to be run according to outmoded anti-competitive business practices and without being subject to modern market disciplines. This is the same argument used by the IMF and the World Bank when they have made financial assistance to developing nations contingent on their implementation of modern market disciplines.

PPM and internal markets

Project Portfolio Management (PPM), which aims to improve and optimize investment decisions by individuals and organizations (and the allocation of resources and assets), has a critical role to play.

While it is generally not appreciated that it does so, the implementation of PPM in an organization brings modern market disciplines, including logical decision-making criteria and techniques such as comparative investment valuation and investment triage and prioritisation, and transparency, to challenge irrational investment decision-making drivers such as greed, short-termism, political expediency, and lack of knowledge.

PPM and internal markets

PPM prioritisation schemes establish a pricing (value) mechanism based on broad, rational, decision-support criteriao enabling comparison of the relative merits (value and risk) of investment optionso providing the means to reasonably demonstrate that the best use of scare

organisational resources is being made, and that investments are otherwise prudento ensuring that the best resources flow to the most valuable projectso natural resource constraints ensure that only the most valuable projects are

favoured; less valuable projects and projects of higher risk are delayed or cancelled

PPM and internal markets

PPM benefits measurement schemes improve knowledge and provide a mechanism to track achievement (and non-achievement) of investment goals. This in turn provides opportunities for a more rational reward system.

PPM portfolio and investment governance bodies and PMOs areo Entrusted with a role similar to the remit to ASIC and the ACCC to prevent anti-

competitive behaviour and misuse of Company resources and assets by ensuring alignment of resource allocation decisions with prioritisation decisions

o Encouraged to behave as internal venture capitalists reinforcing their vicarious responsibility on behalf of stakeholders.

PPM and internal markets

Inspection and overseeing of project investments becomes a regular organizational routine, which improves transparency and broadens awareness.

The opportunity cost of not being able to proceed with a project due to resource constraints provides a more rational means of quantifying the cost/benefit of new resource acquisition.

If the organizational cost-base must be reduced the least valuable projects can be terminated first and, if retrenchments are unavoidable, the best resources are more likely to be retained as termination of projects occurs in order of least value first.

PPM and internal markets

We in the PM profession therefore find ourselves in a position where we can (and need to) play a key role.

PPM has a critical role to play in the solutions currently being developed by governments and businesses to the twin problems ofo How to most effectively manage the recovery from the Global Financial Crisis (GFC);

ando How to reform the world's organizations and financial markets in order to make

future crises less likely.

Questions and Answers