Does good management really make a difference to profit?

Yes, good management makes a measurable difference. Companies that set targets, track their results and manage their people well are on average more productive and more profitable. A field experiment in India showed that better management habits raised productivity by 17% within a year.

For profit, however, the picture is more nuanced than for productivity. In Dutch research among industrial companies, good management was clearly linked to productivity, but not to the profit margin.

In this article

1. Do well-managed companies really earn more?
2. What do researchers mean by good management?
3. Is good management the cause, or do successful companies simply have more room?
4. Does this also apply to a small company?
5. What do we know about Dutch companies?
6. If good management pays, why does not every company do it?
7. Do new management habits stick?

Do well-managed companies really earn more?

On average, yes. Large studies in several countries keep finding the same pattern: the better a company scores on fixed management habits, the higher its productivity. For profit and growth the link is there too, but weaker.

The best-known study is by the economists Nicholas Bloom and John Van Reenen. They interviewed managers of 732 medium-sized manufacturing companies in the United States, France, Germany and the United Kingdom. Companies with better management practices turned out to be more productive, more profitable and more likely to survive (Bloom & Van Reenen, 2007).

Later research became much larger. Together with the US Census Bureau, Bloom and colleagues measured management at about 35,000 plants, in 2010 and again in 2015. Differences in management explained more than 20% of the differences in productivity between plants. That is as much as or more than what spending on research, on ICT or the education level of staff explains (Bloom et al., 2019).

Productivity here means value added or turnover per employee: how much a company produces with the people and resources it has. A more productive company has more room for profit, but profit also depends on prices, competition and costs. That is why the link with productivity is stronger than the link with profit.

What do researchers mean by good management?

Not charisma or leadership style, but fixed habits you can measure. It is about whether a company organises its work well, tracks performance, sets clear targets and hires, rewards and develops people well.

The researchers use a fixed questionnaire, the World Management Survey. An interviewer scores a company on 18 management practices, each on a scale from 1 to 5. Those scores are combined into four parts: work processes, targets, monitoring and people management (Van den Berg et al., 2019). Monitoring here means collecting performance figures, discussing them and acting on them.

What stands out is how large the differences are. In every country Bloom and Van Reenen studied, they found, alongside well-managed companies, a long tail of very badly managed companies. Poor management was more common where competition was weak. It was also more common in family firms where control passed automatically to the eldest son (Bloom & Van Reenen, 2007).

Is good management the cause, or do successful companies simply have more room?

Management is itself a cause. That is shown by an experiment in which chance decided which plants received help with their management. The plants that received that help became 17% more productive within a year.

The question of cause matters. A link between management and performance does not yet prove a cause. It may also be that profitable companies can afford better management. To rule that out, Bloom and colleagues ran a randomised experiment in 2008: a trial in which a lottery decides who gets the treatment and who does not. That way the two groups can be compared fairly.

It involved 17 large textile companies around Mumbai, with 28 plants between them and about 270 employees on average. Some received four months of free help from an international consulting firm to introduce 38 basic practices, such as measuring quality defects, routine maintenance and order in the stock. Within a year, productivity in those plants rose by 17% (Bloom et al., 2013).

Profit went up too. The researchers estimate the extra profit at about $325,000 per plant per year. The number of quality defects fell by about half and output rose by 9.4% (J-PAL). Within three years, the companies that received help also opened more new plants than the other companies (Bloom et al., 2013).

Does this also apply to a small company?

Yes, in small companies too, better habits are linked to better results. For small companies it is mainly about simple things: keeping records, watching the stock, doing marketing and planning ahead financially.

David McKenzie and Christopher Woodruff measured 26 of these business practices at micro and small companies in seven countries. Differences in those practices explained about as much of the differences in sales, profit and productivity as in larger companies. Companies with better practices survived more often and grew their sales faster (McKenzie & Woodruff, 2017). This is a link, not proof of a cause.

An experiment in Mexico goes a step further. There, 150 of about 430 small and medium-sized companies in the state of Puebla, chosen by lottery, received a year of advice from a consultant. The consultants came by for at least four hours a week and the companies paid 10% to 25% of the cost themselves (Bruhn, Karlan & Schoar, 2012).

Productivity and the return on assets rose. Five years after the programme, the companies still had about 50% more employees and a wage bill about 50% higher. The practices that improved most were marketing, financial accounting and long-term planning (Bruhn, Karlan & Schoar, 2018).

What do we know about Dutch companies?

In the Netherlands too, good management is linked to higher productivity. But in the Dutch research there was no link with the profit margin or with profit per euro of assets. There was a positive link with profit per employee.

Statistics Netherlands (CBS) and the University of Groningen linked management scores of 433 industrial companies with at least 50 employees to CBS data. Companies with better management were more productive, more often active internationally and more innovative. This applied to all four parts of management (Van den Berg et al., 2019).

Why not with the profit margin? The researchers point to noise in accounting profit. Many companies in the sample were a branch of a larger, often foreign group, and then the profit in the Netherlands says little about local management. In other countries too, the link with profit is weaker than with productivity (Van den Berg et al., 2019).

A follow-up study with 459 industrial companies from the 2018 survey, together about a quarter of Dutch industry, confirmed the link with productivity. The authors stress that their data cannot prove a cause (Aral et al., 2021). Such measurements do not yet exist for small Dutch companies. The research from other countries is therefore the best indication for them.

If good management pays, why does not every company do it?

Mainly because owners do not know what it delivers or that a habit exists. In the Indian experiment, a lack of information was the main reason why companies had not introduced the practices earlier.

For simple habits, such as recording quality defects or machine downtime, the owners did not believe it would improve their profit. Less well-known habits, such as a short daily meeting on the shop floor or fixed work instructions, were often completely unknown to them (J-PAL). The researchers call this an information problem and not a money problem (Bloom et al., 2013).

Competition plays a part too. Where competition is weak, badly managed companies can survive for a long time (Bloom & Van Reenen, 2007). There is then little outside pressure to do better.

Do new management habits stick?

Partly. Nine years after the Indian experiment, about half of the practices introduced had disappeared again. Yet the plants that received help still scored clearly better than the plants without help.

The researchers went back to the same plants and asked why practices had disappeared. The two most frequently mentioned reasons were managers leaving and too little time from the directors. Practices hardly spread to other companies, but did spread to other plants within the same company (Bloom et al., 2020).

For an SME, a small or medium-sized company, that is a familiar risk. If measuring and discussing figures depends on one person, it often disappears when that person leaves or gets too busy. Habits that are fixed in a regular agenda, a regular overview or a fixed division of tasks are more likely to last.

Sources

• Bloom, N. & Van Reenen, J. (2007). Measuring and explaining management practices across firms and countries. The Quarterly Journal of Economics, 122(4), 1351-1408. doi.org/10.1162/qjec.2007.122.4.1351
• Bloom, N., Brynjolfsson, E., Foster, L., Jarmin, R., Patnaik, M., Saporta-Eksten, I. & Van Reenen, J. (2019). What drives differences in management practices? American Economic Review, 109(5), 1648-1683. doi.org/10.1257/aer.20170491
• Van den Berg, M., Boutorat, A., Garretsen, H., Mounir, A. & Stoker, J. (2019). Managementkwaliteit en microdata: een dataverkenning (Management quality and microdata: a data exploration). CBS and University of Groningen, commissioned by the Ministry of Economic Affairs and Climate Policy, May 2019. cbs.nl
• Bloom, N., Eifert, B., Mahajan, A., McKenzie, D. & Roberts, J. (2013). Does management matter? Evidence from India. The Quarterly Journal of Economics, 128(1), 1-51. doi.org/10.1093/qje/qjs044
• J-PAL, Increasing firm productivity through management consulting services in India. Summary of the evaluation by Bloom et al. Abdul Latif Jameel Poverty Action Lab. povertyactionlab.org
• McKenzie, D. & Woodruff, C. (2017). Business practices in small firms in developing countries. Management Science, 63(9), 2967-2981. doi.org/10.1287/mnsc.2016.2492
• Bruhn, M., Karlan, D. & Schoar, A. (2012). Do matching grants programs increase firm productivity and growth? All About Finance, World Bank blog. blogs.worldbank.org
• Bruhn, M., Karlan, D. & Schoar, A. (2018). The impact of consulting services on small and medium enterprises: Evidence from a randomized trial in Mexico. Journal of Political Economy, 126(2), 635-687. doi.org/10.1086/696154
• Aral, E., Van den Berg, M., Garretsen, H., Mounir, A. & Stoker, J. (2021). Managementkwaliteit belangrijk voor productiviteit Nederlandse industrie (Management quality important for productivity in Dutch manufacturing). ESB, 106(4795), 150-152. esb.nu
• Bloom, N., Mahajan, A., McKenzie, D. & Roberts, J. (2020). Do management interventions last? Evidence from India. American Economic Journal: Applied Economics, 12(2), 198-219. doi.org/10.1257/app.20180369