Perspective on Public Sector Management
Senior Fellow, RIETI
What does the term "management" conjure up in people's minds? Probably, many think of "corporate management," assuming that a company needs to be managed in order to generate profits. Likewise, the term "executive" is mostly taken to refer to a "corporate executive." And when a certain company has a "excellent executive," the executive becomes the talk of town.
Meanwhile, what about the "management" of non-corporate entities, particularly those in the public sector such as organizations in the fields of education, medical care, welfare, and culture? To what extent do people recognize the importance of management for those entities? More to the point, do the top executives of those entities seek reputations as "excellent executives" and do they find it honorable to have such a reputation?
Every Organization is Subject to Management
A series of collapses of third-sector projects in the 1990s illustrates the current state of public-sector entities. It is easy to blame external factors for the failures. Indeed, it would be so easy to be an executive if one could blame everything on deterioration in external environment. This, however, is not the case for corporate executives. Top executives in the private sector must overcome whatever conditions they may find themselves in, which is how "management" is supposed to be. If they see sales falling, they must cut back on expenses. Losses and capital deficits cannot be passed on to someone else. (In this sense, banks' waivers seen in recent years on loans to certain corporate borrowers are not justifiable.) The ongoing discussion over reform of the medical system and the privatization of public highway corporations encompasses a grave misconception that needs to be corrected, i.e. that there is a "irreconcilability between public responsibility and profit responsibility." For instance, some people argue that public services - that need to be provided broadly, universally and equally - cannot be provided under private sector management which, by its very nature, seeks profits. Opposition is especially strong to having a type of management similar to that in a private company. But such arguments, which are not grounded in the reality of today's corporate management, are very immature. These immature arguments mostly come from public-sector organizations and entities, and either stem from their ignorance or reveal their wish to protect vested interests, or can be attributed to both factors.
We must return to square one and agree on a common-sense understanding that all organizations and entities are subject to "management." All entities - be they countries, municipalities, public corporations or companies - must be "managed." Even a tiny entity such as a household needs to be "managed". Regardless of its size, an entity requires "management" in order to remain a going concern and to develop.
Some people may say that public services are there to provide critical services and should function as if they were governed by consensus, and that such tasks must be undertaken even if they may make no economic sense. These arguments might have had a sympathetic hearing in the past, but no longer. Though gaps exist between regions, the civil minimum - or the national minimum - in public service standards has been achieved all over Japan. It has been a long time since poverty stricken districts with extremely backward public infrastructure existed in Japan. The Japanese public sector has apparently entered a new phase. In an era such as this, it is unacceptable to think that public services can be provided without regard to their economic viability.
Having said that, however, we must acknowledge that the phenomenal depopulation occurring in rural areas is posing new and difficult problems for the economics of public services. Some 40 percent of municipalities in Japan fall into the category of "depopulated areas" as defined by the Law for Special Measures for Revitalizing Depopulated Area. This percentage is bound to increase as Japan's population is certain to decline in the future. Whether or not it will be feasible to provide public services in an economically viable way should be discussed. However, in this regard too, private-sector companies elsewhere in the world are thinking hard and employing innovative ideas. Let me introduce one such example.
A Win-win Approach is Key to Long-lasting Management Success
Wal-Mart Stores Inc. of the United States, the world's largest retailer, is known for "Every Day Low Prices," a management philosophy invented by its founder Sam Walton. The initial idea was to unconditionally replace any item returned - even half-consumed instant coffee powder - if a consumer was dissatisfied.
Major Japanese supermarket chain operators such as Daiei Inc. and Ito Yokado Co. grew in their early years, riding on the development of suburban areas around major cities in the postwar high growth period. Around the same time, Wal-Mart made its modest start in Rodgers, Arkansas, a thinly populated town with little prospect for future growth. Given its environment, Wal-Mart had no choice but to try to grow by increasing its sales per unit floor space, rather than by expanding its floor space, the approach taken by equivalent Japanese supermarkets. Improving the level of customer satisfaction by providing unconditional guarantees on goods sold was one way by which Wal-Mart tried to achieve that end.
In such a way, excellent private-sector companies contrive ways to make the best out of any given conditions. Wal-Mart's case illustrates that a win-win approach, in which both the company and its customers benefit, is the best way to bring long-lasting success. Companies finding themselves in sparsely populated areas come up with new ideas to thrive, thereby demonstrating a spirit of entrepreneurship. This example clearly shows how banal the argument that there is an "irreconcilability between public good and profitability" is. Because of their peculiar stance that the ideas of serving the public good and making profit conflict with each other, people in the public sector often lack a broad perspective and are therefore unable to think up creative solutions.
Today, it is an absolute must for companies to seek to improve customer satisfaction. It is no exaggeration to say that competition for customer satisfaction is the essence of inter-company competition. Corporate executives know firsthand that devising ways to secure repeat orders will lead to cost reductions and ensure long-term stable company operation.
Some may be concerned that my argument implies that unprofitable customer segments may be ignored. But everyone in the business world is aware of the Pareto Law, or the 80/20 Rule, which states that 20 percent of customers account for 80 percent of profits. Indeed, in many markets, some 80 percent of customers hardly contribute to corporate profits at all. It would be more efficient for many companies to simply discard such unprofitable customers. Yet, in reality, most companies do not.
In the banking business, more than 80 percent of personal accounts make losses for banks. But it is unheard of for banks to discriminate against small customers in terms of service because those customers' accounts incur losses. Banks provide an equal level of service to customers irrespective of whether their accounts are profitable or make losses. This approach by the banks is based on business experience, and not imposed by the regulating authorities. And as is widely known, the ongoing anguish of banks stems not from losses incurred on these personal accounts, but from the souring of loans extended to corporate borrowers.
Also, in the world of business, there are businesses that are structurally lucrative and those that are not. If the pursuit of profits were the sole goal, no companies would launch businesses in unprofitable fields. In reality, however, there are a number of people who find pleasure in demonstrating entrepreneurship and applying ingenuity to unprofitable fields of business.
Public sector management is thus essentially no different from the management of private-sector companies. Whether for profit or otherwise, projects and businesses must be based on the basic principle that expenses, including investment, should be paid off by project or business revenue. It has never been acceptable for nonprofit organizations to renege on their expenses.
Many nonprofit organizations have a "revenue" mechanism via which they are compensated for costs incurred. But this system should be modified by the introduction of a process to determine "transfer prices" for inter-organization transactions, to generate a disciplinary effect to make nonprofit entities conscious of price effectiveness. Without reference to detailed economic theory, it is clear that the concepts of "cost" and "price" are entirely different.
The issue of whether or not to generate profits is related to the governance of an organization and depends on what stakeholders (shareholders or other contributors of funds in most organizations) demand, that is, whether they demand dividends or something else. But even in cases in which stakeholders do not demand dividends, they expect the organization they have invested in to maintain an adequate level of retained earnings to ensure its continuity, even when management conditions deteriorate. Performance evaluation, an indispensable element for governance to function properly, should be conducted in one of two ways, qualitatively i.e. by evaluating an organization's mission, or quantitatively by evaluating its economic soundness. If evaluators devote sufficient time and energy, qualitative evaluation can be far more precise that one might expect. There is no difference between public-sector entities and private-sector companies in that quantitative evaluation alone cannot adequately describe the while picture.
A Challenge of Utmost Importance in Managing Highly Specialized Public Organizations
Experiencing the problems described above - a lack of understanding of the essential nature of private-sector corporate management and the time involved in carrying it out, as well as having no clear-cut governance mechanism or philosophy for performance evaluation - there are a number of public-sector entities that have yet to establish the discipline of "management." And it is not yet clear how these entities can improve.
The field of medicine is a typical example. The ideology that "medicine is a benevolent art" is misleading, suggesting to many that it is unacceptable to have professional "management" applied to medical services. Just uttering the words "company-like management" invokes a chorus of opposition. Those opposed to the idea believe that a hospital, if placed under such management, necessarily becomes profit-oriented and will fail to provide adequate medical services to patients. But as explained earlier in this article, such reasoning is childish.
What are the consequences of rejecting such ideas? As Japanese society ages, the "patient market" has been expanding, creating an extremely favorable business environment. Despite this, well over half of the hospitals in Japan are making losses. The loss-making hospitals blame restrictions imposed by the health insurance system and the rise in personnel costs. But there are a good number of well-managed hospitals that enjoy excellent reputations amongst patients and generate profits while operating under the same restrictions.
Hospitals in the latter group do not try to earn remuneration points (hospitals receive reimbursement for a proportion of the medical treatment they provide from patients' health insurance plans) by over-prescribing drugs that are not effective for their "customers", i.e. patients, or by hospitalizing patients for unnecessarily long periods of time. Instead, they are making efforts to increase customer satisfaction. I do not mean to say that I am totally supportive of the existing health insurance system, but I believe it is wrong to blame everything on the system. A lack of capable executives is the main reason why only a handful of successful hospitals exist in Japan.
The same arguments can be applied to the field of education. Many people seem to believe that "education" and "management" are concepts which have nothing to do with each other. With the rise in popularity of business schools and MBAs over recent years, Japanese universities are rushing to set up business administration graduate schools. Yet, the absence of faculty staff in any university capable of teaching "management" in universities themselves experiencing multidimensional and concrete management remains a major problem. There are a number of professors who specialize in macro economics. But there are only few who have studied "management" based on microeconomics and behavioral science.
The education environment is even less favorable than that for medical services. Needless to say, the traditionally defined education market is bound to shrink as the number of children declines. Even a well-trained, extremely capable executive from a private-sector company would find it difficult to make ends meet under such business conditions. But then, aren't the executives of educational institutions seeking training to acquire knowledge, new techniques and business know-how to cope with this difficult time? The answer is that executives from educational institutions are hardly ever seen in business schools either in Japan or abroad.
The era in which "no one wins and no one loses" is over and organizations in the public sector, including those in healthcare and education, will be forced out of the market if they are inefficient. Neither years of tradition nor high quality service will guarantee an organization's survival. Though unfortunate, even those with good reputations may go bankrupt. Some of them may be bailed out by taxpayers' money but many others will simply disappear. Consequently, only those capable of implementing good management practices will be able to survive.
The public sector needs excellent mangers now. But excellent doctors, educators and bureaucrats do not necessarily make excellent managers, just as star baseball players do not necessarily become great baseball team managers. Equally however, it is impossible for someone without experience in baseball to become an excellent team manager. How to solve this dilemma of finding good managers will be the most important challenge for running highly specialized public-sector organizations.
One way to tackle this problem is to seek support from personnel with excellent management skills. Indeed in many hospitals a management-minded director works in tandem with the chief of administration to co-run the hospital. However, Japan still needs to increase the number of management-minded doctors by providing education programs that teach practical management thereby broadening the skill bases of managers in medicine.
Educational institutions face a tougher challenge. Private universities are typically managed by a president and an administrative director, but decision-making authority resides with the faculty councils. Both the president and the administrative director may be management-minded and feel a sense of urgency over the future of the university, but it is extremely rare for the faculty councils to share that sense. In today's climate, all faculty councils should surely adopt an "issue awareness." The "issue awareness" may provoke a good deal of debate, but discussion is not enough to make people take action. It is a "sense of urgency" that prompts action. Thus, the "issue awareness" must be extended to include a "sense of urgency."
Two Ways to Improve Quality of Public Sector Management
What is required today are measures to improve the quality of organizational management in the public sector, that is, (1) reconstruction of governance, introduction of internal decision making mechanisms and performance evaluation processes to continually test management self-discipline, and (2) creation of vocational schools that provide future managers with several years of practical training and practice in management.
Because both these two points relate to "social system design," the theme of my research, I intend to discuss then in greater detail at the Social System Design Workshop, an online debate forum on this issue.
In concluding this article, I would like to underline an important point that must be kept in mind whatever goals one sets for oneself. I once asked a golf instructor what characterizes people who fail to improve regardless of how much time and energy they devote to lessons. The instructor's answer was "those who do not want to push themselves too hard practicing golf, thinking that golf, after all, is something they are doing for fun." The same analysis applies to managers. What is most important is that managers of public sector entities must themselves have a strong desire to become "excellent managers" and feel proud of acquiring such a reputation.
April 15, 2003
Article(s) by this author
March 30, 2004［Column］
March 5, 2004［Policy Update］
April 15, 2003［Column］