The Bear’s Lair: Lessons from W. Edwards Deming

W. Edwards Deming (1900-93) was the statisticians and management consultant, famous for visiting Japan after World War II and introducing them to many elements of the superb Japanese management and production system. Nearly thirty years after his death, with Japan deeply unfashionable, he may appear to have little to teach us. However, when I examined his principles, more in top management than in production (about which I am no expert) Deming’s teachings seem to provide both a way forward and a fierce indictment of the funny money era of American business.

Deming is best known for introducing principles of quality management into Japanese business, enabling them to offer consumers failure rates far below those on U.S.-made goods. By optimizing each step of the production process for quality rather than speed or minimum raw materials costs, rework percentages are greatly reduced, consumer satisfaction increased and the available market pricing also increased. For example, the better secondary market price performance of Japanese-brand automobiles over U.S.-brand automobiles is largely a result of Japanese companies’ faithfulness to Deming’s principles.

Deming’s principles relating to production are however less interesting to non-specialists than his principles relating to the management of the business as a whole. Whereas the last 50 years have seen a move towards his production principles (helped by some very clever software and other IT help) U.S. companies have if anything moved away from his overall principles of management. It is thus not surprising that U.S. economic performance has been second-rate, in terms of productivity growth and in the growth of welfare for the workforce as a whole.

For a start, Deming, writing as long ago as 1993, was highly critical of U.S. economic performance itself. He pointed out that the country perpetually ran balance of payments deficits (it had only been doing so for about a decade, at that stage, now it has been doing so for 40 years). He pointed out that the country was exporting raw materials and importing manufactured goods, the reverse of what an advanced, technologically-leading economy should be doing.

This tendency has only continued; for example the U.S. runs a massive trade deficit with China, which President Trump attempted to alleviate in January with massive forced exports of soybeans, the production of which is ridiculously subsidized by U.S. taxpayers. President Trump is correct to call attention to the huge U.S. payments deficits of $500 billion per annum, year after year, which makes the country ever more indebted. In the case of China, he is also right to have drawn attention to that country’s thefts of intellectual property and unfairly favorable treatment by the World Trade Organization, which together worsen the U.S. trade position.

However, as Deming would undoubtedly point out if he were still with us, mass sales of subsidized soybeans to China do not solve any of the trading relationship’s long-term problems. In reality, U.S. agriculture subsidies that enable excess soybean production should be terminated as quickly as possible, as part of an overall program to reduce the bloated size of the U.S. government and eliminate the budget deficit. Only by removing the bloat from the U.S. economy, most but not all of which caused either by excessive government and excessive regulation, can the country’s competitive position be rectified and the drain of $500 billion a year through perpetual trade deficits be eliminated.

For the corporate sector itself, Deming’s prescriptions are interesting. He opposes all quarterly measurement of results, or at least managing by using such results – he gives the example of bank loan production targets, which set a monthly amount of loans a division manager must make; needless to say, these are an infallible recipe for credit losses a year or two down the road. His reasoning is that measuring short-term results causes management to focus entirely on the short-term and ignore factors that pay off only over the long term.

Deming is especially opposed to large grants of stock options (which were not as common in 1993 as they have since become) as he believed such grants cause management to neglect the business entirely and focus on movements in the stock price. Indeed, he would be disgusted by the current practice in public companies, of paying top management primarily in stock options while allowing them to use the company’s treasury to buy back stock until the company’s capital base has disappeared. He would have predicted the combination of neglect of ordinary shareholders’ interests, pro-cyclicality and reward of management’s bad behavior which this system produces. He would also have forecast its effect on the economy, of hollowing out U.S. manufacturing, outsourcing key parts of U.S. business to low wage “emerging markets,” and neglecting entirely the business’s long-term future. Why, after all, should management bother with the long-term future of a company that is likely to go bankrupt in the next severe downturn?

Within companies, Deming disapproved of the standard appraisal system for staff. He believed that performance ratings led to bad performance, for three reasons. First, staff attempt to game them, hiding problems and producing showy successes before a performance appraisal is due. Second, appraisals are far too governed by the personal chemistry between the boss and the subordinate, so that eccentrics tend to get forced out of the company. Third, they tend to be self-reinforcing: if an executive gets a poor appraisal in his first year, when he is new and the manager does not know him well, he will tend to continue to get poor appraisals, whereas “stars” will continue to get good appraisals, moving rapidly up the hierarchy.

To these I would add a fourth problem: performance in a business, whether by top management or a middle manager, often depends on the market conditions for the year concerned. If nobody is buying your product or service that year, your performance will be down-rated even if there is nothing you can do about it. I have also been in the reverse position, where a very good year went completely unrewarded because an entirely different division of the company blew a huge hole in the income statement.

As Americans whose economy is governed by the performance of American corporations, reading Deming can reduce one to despair. There is just one consolation: some of our competitors manage things even more badly. A gushing ‘Economist’ profile of the new Chinese economy explains how the state and private sectors are working harmoniously together, so that even private companies have a committee of party functionaries, who “advise” on all projects undertaken by the company. To the ‘Economist’ (whose economic principles have come a long way from the simple Whig free-marketism of 1843) such a system bodes well for China’s future, and is almost certainly superior to what we have in the decadent West.

That should encourage us. We know that, provided we do not allow Chinese students to steal Western know-how through our colleges or Chinese companies to steal our companies’ intellectual property, we can out-compete China, because our economic system still bears some resemblance to a free market. We merely need to ensure that government is cut back, both in terms of size and regulatory enthusiasm, and that companies are not encouraged by either tax policy or worse still by monetary policy to commit corporate hara-kiri.

Even a modest enthusiasm for Deming’s teachings will ensure America’s long-run success. It’s a pity that both in our government and our large businesses, we have moved such a long distance from them.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)