How to rebuild for the future

Niall FitzGerald is someone you may not have heard of. He’s Irish and a serious player in international business. Until recently, he was in charge of Unilever, one of the world’s biggest consumer companies

The Ideas Campaign was wowed by a speech he gave in December when he was picking up an award at an event organised by Business & Finance magazine in Dublin. So much so that we’ve decided to reproduce it here in full.

Why? Because it puts our problems in context and also because he doesn’t pull any punches about the failures about the financial systems, about government and regulators. But, most of all, because of how it was about the way he spoke about what we need to do to rebuild the economy - and regain trust.

A year ago, when Peter Sutherland spoke at this occasion, we all thought we were into hard times.

Looking back, and having seen what’s followed, we realise we were still in good times then. These are the tough times. Who would have imagined it? How did so many bankers, regulators, government ministers - everywhere, all around the world - wander into this with their eyes closed? And why did the rest of us stand by and watch? Or were we all just blinded by the money circulating in financial services?

How did the USA and western Europe in particular - with their long histories of innovation, entrepreneurship and business building - turn into financial playgrounds for traders and speculators, interested only in playing the markets for the greatest personal return? And all this with government and regulators compliantly standing back for fear of imposing rules that could make us less competitive.

What happened? What brought the financial world tumbling down? Who is responsible?

My good friend Tom Friedman, of the New York Times, put it succinctly when he described them as:

• “People who had no business buying a home, with nothing down and nothing to pay for two years
• “People who had no business pushing such mortgages, but made fortunes doing so
• “People who had no business bundling these loans into securities, but made fortunes doing so, and
• “People who had no business buying these bonds and putting them on their balance sheets but made fortunes doing so”

Hindsight and insights

Things are always clearer in hindsight. The Bank of England’s analysis of the crisis makes everything seem very simple. The problem, it explains, lies in:

• Heightened uncertainty about the value of banks’ asset portfolios
• Undercapitalisation of banks following a prolonged period of underpricing of risk
• High structural dependence on wholesale funding markets
• Underappreciated interconnections between firms in the global financial system

Underappreciated interconnections? Now there’s an insight. No wonder everyone has been longing for those old-style bankers, those cautious types who understood the beauty of a balance sheet.

Back in the 1960s, banking, broking and insuring accounted for just 10% of total corporate profits in most developed economies. By 2005, that figure was close to 35% in the US and Britain. Last year, one in five Britons was estimated to earn their living in finance.

Long-term value

In the rush to short-term reward, too many people forgot the importance of long-term value and the extent to which these big, fast rewards were a gamble. The truth is that, to feed the appetite for trading, the banks developed financial systems that no longer bore any understandable relationship with the world that we work in, the world of products and tangible assets and clear cash flows.

At times like these, I turn to the volume of Das Kapital that I keep by the bed. Karl Marx and I do not agree on all matters, but he saw this one coming. This is what he wrote:

“To the possessor of money capital, the process of production appears merely as an unavoidable intermediate link, as a necessary evil for the sake of money making.”

In other words, it is annoying actually to have to make something.

Marx went on:

“All nations with a capitalist mode of production are therefore seized periodically by a feverish attempt to make money without the intervention of the process of production.”

That seems to describe the most recent period well. We’ve witnessed a feverish spinning of money, through increasingly complex financial instruments that were beyond the understanding of the people actually running the banks. It is what happens when you set out to make money from trading, rather than business building.

The Irish economy

Now, here in Ireland, we’re not at the very centre of the financial world, but we are certainly feeling the impact. It’s becoming clear that the Irish economy is facing its most difficult period since those days of high unemployment and emigration 25 years ago.

Ireland took a brave decision to become an open economy - and we have benefited disproportionately. Now we are in a downturn, I fear we can expect to suffer disproportionately. We’ve had our own property bubble - house prices went too high and the construction industry grew too big for an economy our size.

It doesn’t help that America takes more than 18% of our exports and that we are a big centre for US multinationals. If they retrench, we shall feel the pain. But let’s not lose sight of positive aspects of the Irish story. Our strengths are:

• A young, highly-educated workforce
• An attractive tax regime
• An ability to attract high-tech investment

It would have been better if we had put away, for tougher times, some of the money those strengths created, instead of raising debt for property. But strengths they remain. If that is the mess, how do we clear it up?

Creating wealth

Well, this doesn’t need to be the end of capitalism - not as long as we learn the lessons. First, we need a fundamental change in attitude. We need to understand that there is a difference between creating wealth and making money.

John Rose, the boss of Rolls Royce, likes to say that there are only three ways of creating wealth: “You dig it up, grow it, or convert it to add value - anything else is merely moving it about.” Builders are the innovators, entrepreneurs and manufacturers who have developed our greatest companies. Traders are the investors who want quick money and will risk much to get it. It takes time to build a business. The men and women who do it look to the future. Trading promises instant returns and operates in the present.

So, traders make no commitment to the strategy of the businesses in which they invest. They want to know how they can leverage that organisation’s assets for gain in the shortest period of time. They don’t engage in shareholder activism to create long-term value. They push companies to take quick action to raise fast returns. Then they skim off that short-term value and walk away. All in the name of capitalism.

Building sustainable businesses

Compare that with the way that builders operate. They invest because they want to see a business grow over time. They invest capital and support in the belief that the company will offer greater returns through a period of growth.

Because they are investing for the future, builders expect to ride the economic tides. To ensure they can, they build risk management into their strategies. They understand the business from top to bottom, and have a vested interest in its underlying fundamentals, its market and its management. Through understanding and engaging in the business, builders contribute to the success of the business and those who invest in it.

So, builders are in it for the long term. And they have realistic expectations. But sadly, today we see too few builders.

It is ironic that the single most admired stock investor, Warren Buffett, epitomises the builder approach, yet so few see fit to emulate his style. Perhaps greed is a factor. When did building sustainable businesses become boring? Well, now is the time to make it fashionable again, to start valuing the builder mentality.

Now is the time to think of long-term, to think of legacy. One way of doing that is in our system of rewards. That’s the second thing that has to change.

Longer-term benefits

Over the last 15 years, we have seen the remuneration of chief executives and senior executives move to multiples of average workers’ salaries that are practically immoral in their excess. Compensation has been at a level that is beyond the imagination of many in society. And many of those who can imagine it find it morally unacceptable.

The escalating compensation packages have had two devastating effects: they have disconnected compensation from performance and they have created a chasm between the richest in our society and the rest. Both very unhealthy things. Where there is to be generous compensation, let us connect it to long-term value, rather than the short-term generation of profit.

Let’s cut back on short-term bonuses and have business leaders take their benefits in share ownership, where there is a clear relationship to that longer-term value and the shareholder.

Understanding risks

Third, we need to inculcate a greater understanding of risk, coupled with relevant supervisory regulation. People have been reluctant to own up to the fact that they didn’t understand the risks. Not in the board room, the regulator’s office or the government ministry.

There is a danger the pendulum now swings the other way, with new regulation that is ill-thought through. We need the regulation we already have to be applied effectively. We don’t want the Nicolas Sarkozy solution of national protectionism. We do want a solution that offers protection while allowing business the freedom it needs.

So,

1. Rewards for builders rather than speculators
2. A proper appreciation and presence of risk
3. A more efficient, but not stifling, regulatory regime

They, I think, are the necessary ingredients of a new capitalist order. Necessary, but not sufficient.

Rebuilding trust

If they are to work, we have to add something else. That something is trust. The rebuilding of trust may be the hardest part of the whole exercise.

We have come to the position where people literally do not trust their high street bank. That trust has to be won back. It will take time.

We have to be clear that the world of business is an integral part of the wider world and has the same, long-term interests of those communities in which it operates.

Our customers or clients are citizens who live in communities, and they expect us to behave in ways which are respectful of these communities. We have to operate not on the basis of ‘does the law allow us to do this’, but on the basis of ‘is it right to do this?

Values and ethics

Which brings me to my final thoughts this evening. How do we get our businesses through this? Well, the crisis is not just about banking; it is about real businesses who can’t find funds to run their businesses. Over the next few months, we will see well-run businesses that won’t be able to carry out the refinancing they need.

On nationalisation, we run a great risk if it becomes the norm that inefficient businesses, if they are big enough, get bailed out. On that basis, why bother to a successful business? Who’d go through all the hard work of bringing Toyota safely through this when General Motors is being bailed out by the US government?

We would also expect to see a flight to quality. People don’t want to pay more; they do want to be assured that they are paying for the right thing. Trusted brands will feel the effects less. There will always be a demand for good products, properly made. But that doesn’t mean we can sit on our hands and wait for the good times to come back.

Companies need to focus on fundamental value, producing what people really want to buy and building and investing for the long-term. We were all guilty of bowing at the altar of next quarter’s earnings.

And finally, returning to that important issue of trust, businesses and customers will be looking for partners they can really trust. If the effect of the global financial crisis is a more ethical approach to business, then some good will have come out of it.

By ethical approach, I mean not only the way in which we deal with each other and our customers, but the values that we bring to the wider picture. Some say that issues such as the environment and social responsibility go out of the window when money gets tight. I disagree.

They become even more important, for they can distinguish us from our competitors. So my fervent wish is:

• Let us use this time to rebuild our businesses as we want them to be
• Let us rediscover the value of building for the future
• Let us rebalance return and reward in favour of the builders of sustainable value
• Let us see the current crisis as an opportunity to return to fundamental values