The last world

This article was featured in MBA business, spring 2006

Donald Kalff: Author and advocate of a European enterprise model

What’s wrong with the US form of capitalism?

The very proper concept of shareholder value has been hijacked and replaced by shareholder return of investment. The majority of companies are focusing on their share price. As a result, the management of large, highly complicated companies is reduces to optimizing the profit per share ratio and this damages the quality of their decision-making. You look at share purchases and cost reduction and are more cautious about investing in plant and equipment or research and development. There is a general movement to reduce the risks faced by shareholders. You give the CEO a short-term contract and on average link two thirds of his income to either profit per share or the share price. They’re in a total straightjacket. The economic problem is that these policies ultimately destroy the value a business is supposed to create, raising the cost of capital and eating into future cash flows. The great paradox is that we’re now sacrificing economic value in the name of the shareholder, at the shareholder’s expense.

What are the main characteristics of your alternative European enterprise model?

Economic value has to be the sole objective of the company. What will your cash flows in five, six, seven years’ time be? Currently we ask European companies to pursue several interests: those of shareholders, customers, employees, the community at large. Then we build regulation in all four areas and import financial rules from the US. I replace all this wit a single objective: providing the economic growth necessary to meet society’s goals. Then you need to be clear about who’s generating this economic value. From my experience at Shell and later as a member of the executive committee of KLM, I saw that value was only added by the much maligned middle management. When I was holding talks about a KLM/Alitalia merger, for example, an integrated timetable with fewer people and a smaller fleet would have offered far greater efficiencies and a better service to the market. And it would have been the middle managers with commercial and IT expertise creating this new timetable and generating economic value. Middle management has been accused of resisting change, of everything that’s bad, but my proposition is that they have kept companies going while senior management was busy optimizing profit per share.

So how would this work in practice?

Senior management must adopt a new form of governance, a different management style. First they need to establish a vision for the company to make progress, defining what the markets and business concepts are. Their second task is to support middle management and provide the right conditions for them to develop and implement these ideas and run the company. You have to remove the present performance, evaluation and remuneration systems. These are extremely harmful because you increasingly depend upon co-operation among the middle ranks. I founded a biotech company and if you look at the patent applications, we have six inventors for each patent. People need to collaborate to achieve the business concept. But in the American system we pull companies apart, asking them to perform certain isolated tasks and control them by bonuses and options.

Is it realistic to expect companies to such a model?

No, the American enterprise model will always be there. All listed companies in Europe have embraced it and it’s extremely difficult to break away. There’s a web of expectation spun by investment bankers, the media, credit reference agencies, brokers and so on. Even corporate scandals such as Enron and WorldCom have been used as examples of the resilience of the system. But in Europe we have one big advantage. If you look at the capital requirements of US companies, 75 per cent is met by stock markets; in Europe’s that’s only 25 per cent. We still have an option to escape, and that’s why I keep focusing on the range of enterprise models that you see in Europe. From family companies in all shapes and forms to co-operatives and even properly run state-owned companies. And it will only be commercial and economic self-interest that will set them on the path – cultural of philosophical counter-pressure will be insufficient.

What’s the measure of a company’s success?

Economic value added. Period. 

Donald Kalff in brief

Career: Donald Kalff has a PhD form the Warton School of the University of Pennsylvania, US. After working as a assistant professor at the Graduate School of Management in Delft, Netherlands, he joined Royal Dutch/Shell Group in 1980 where he held a range of management positions in the Netherlands and the UK. Ten years later he joined KLM, Royal Dutch Airlines as a member of its executive board. Today he is co-founder and CEO of Immpact, a biotech startup company in the field of immunology, and adviser to strategy consultants Rolandberger.

Publications: An UnAmerican Business: The Rise of the New European Enterprise Model (Kogan Page, 2005). The book challenges the adherence of many European companies to the American approach to business and proposes a competitive European alternative.