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Paying for good management: But then what does it really do?

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Ask any long-term investor about the single most important reason to invest in a company. The answer starts with ‘good management’. It has been reasonably established that a good management does help ensure a good long-term business performance.

However, a management is not a concept to be looked at in isolation. The company doesn’t operate in vacuum. It has competitors, it has internal pressures to survive and, most importantly, it is run by ‘people’ who can also make mistakes. In the light of this, what’s the point of a good business management?

No matter who owns a business, it matters how well it is run. A business of any size is a complex machine. If we try to define the reason for a business to exist, it is because there is a customer willing to pay for what the business is selling.

The business is willing to coordinate the steps involved in providing something that the customer needs. This is possible by maintaining a network of employees, suppliers and logistics. If one of these steps doesn’t work well, the customer doesn’t get what they need and the business ceases to exist.

If we break down each of these further to the roles of owners, employees, customers, suppliers and the supply chain, they all have their individual complexity. An owner needs to find capital to organise the basic factors of production like land, labour and other inputs needed to make something. Employees need to ensure that their skills are relevant for the business and keep updating themselves as they grow with the organisation.

Suppliers need to provide reliable inputs and the supply chain needs to ensure these things are connected seamlessly in a cost-effective manner, from the factory to the customer. This seems oversimplified and it is, but only to illustrate how these things are connected.

We haven’t even begun to speak about external forces like competition, organisation design, corporate politics, obsolescence, business failure, diversification, capital allocation, corporate governance, the impact of global pandemics and many more stressors that are relevant for long-term survival of a business.

It is hard to find a business analyst who is not sufficiently amazed by how companies manage to survive and grow for a long time without succumbing to headwinds at any one of these points.

So it’s relevant to ask now, what’s the point of having a good management in any business? I think one of the important roles of a good management is to reduce uncertainty in running a business. Reduce, but not eliminate. It is impossible to eliminate uncertainty, because no one can see the future. That role also involves maintaining the complex links between all these connected systems.

It is hard enough to always coordinate these steps well to run a business, but at the same time also make sure the company doesn’t sink into disorder on the way.

Organisations survive by adapting to their situations much as we observe in biology. So a constant change in the environment can lead to a greater chance of failure. Hence it’s always interesting to see how fast-growing companies adapt to growth, how they consume capital, how they solve the problem of providing for such high demand. A good management can ensure that the systems are organised in such a way that they are most adaptable to sudden changes. Now, that’s a valuable skill when it comes to long term survival.

Lastly, as investors, we need to ask the vital question: how much should we pay to own a business that has these skills? If I have to guess, I’d say as much as is needed to reduce the uncertainty of failure of a portfolio of investments.

(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)

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