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Jerusalem Letter / Viewpoints

No. 443   4 Kislev 5761 / 1 December 2000

ISRAEL'S MAJOR ECONOMIC CHALLENGE:
CLOSING THE GAP IN THE FIELD OF BUSINESS ECONOMICS

Manfred Gerstenfeld

Adopting Advanced Management Techniques / Patinkin's Legacy / Macroeconomic Measures are Not Enough / Explaining Business Economics / Benchmarking / Applying Business Economics to Ease Social Problems / Government Encouragement of Modern Business Methods / The Fragmentation of Business Economics / No Bees, No Honey / The State of Economic Consultancy / Investment Bankers, Venture Capitalists, and Business Schools / Israeli Multinationals -- The Teva Case / Influencing the Decision-Makers

Why is it that Israel's per capita GNP still lags substantially behind that of the leading countries of the world? Why is it likely to take decades for the Israeli economy to catch up? This is while the Israeli papers are full of news about very promising high-tech start-ups, and we even hear occasionally about payments of billions of dollars by major foreign firms to acquire Israeli businesses which were founded a few years ago and have at most several hundred employees.

It took many decades to build companies such as Bank Hapoalim, Bank Leumi or Teva, whose market capitalization is in the several billion dollar range. If there apparently exist shortcuts in the high-tech sector to create similar company values in only a few years, can one not extend the model to the whole Israeli economy and rapidly lift it up to the per capita income levels of the top performers of the Western world?


Adopting Advanced Management Techniques

No such country-wide miracle tools exist. A structural approach is required. While the achievement of peace -- a rather hypothetical assumption -- would certainly contribute to an acceleration of Israeli economic growth, the best means to achieve more rapid development of the Israeli economy involves the increased application of business economics methods, which are closely linked to the use of advanced management techniques.

Enhancing the spread of these methods and techniques will be Israel's main economic challenge in the coming decade. This is the major tool to lead the country from a per capita GNP of $16-17,000 to one of $25,000. Some important aspects of this process will have to be a gradual change in management attitudes toward labor, including greater sophistication in labor relations.

Israeli politicians and the media often claim that what Israel needs is greater efficiency. Another slogan is that people should work harder. Few people realize that to achieve greater outputs using less resources requires the integrated application of a multitude of advanced methodologies, in addition to business sense. Not many Israelis are familiar with these and hardly any of them hold positions which permit the effective dissemination of these concepts beyond a very narrow audience.


Patinkin's Legacy

Israel is much more advanced in macroeconomics than in business economics, ever since the late Don Patinkin, an important American economics scholar, started teaching macroeconomics at the Hebrew University about fifty years ago. Generations of his students, known as "Patinkin's boys," took up key positions in the finance and commerce ministries and helped determine the direction of the country's economy as they moved from academia to the government and back again. Patinkin's story proved, once again, that the physical relocation of professionals can be a major tool for the transfer of knowledge.

Later on, many of Patinkin's boys moved on from government to the business sector where they assumed top positions in several of the country's largest businesses, both state-owned and private. Retired generals were another professional category whose members relocated into similar positions. These government executives and military men were unfamiliar with business management and learned their new profession through trial and error, a costly education process both for their employers and the country.

These managers, however, had a way of compensating for their lack of appropriate background. Major companies in the socialist Israeli economy of the 1950s, 1960s, and early 1970s relied heavily on the government. The fact that a company chief executive had formerly been a top government official or a general enabled him to facilitate issues through his contacts in the political system and the bureaucracy. While lobbying skills are important everywhere in the Western world, in the centralized Israeli socialist economy of the 1960s and early 1970s they were a prime factor for success in business.


Macroeconomic Measures are Not Enough

Macroeconomic issues have been given constant publicity over the past decades. By now, large parts of the nation's elite, as well as many others outside the economic world, know what the main macroeconomic indicators are. They have heard about GNP growth, inflation, the Central Bank's interest rate, the percentage of unemployment, as well as the internal and external deficit.

Through the media they have been informed that the Governor of the Central Bank keeps the interest rate high, and the many conflicts on this issue between the previous governor, Yaakov Frenkel, and successive finance ministers have been well-publicized.

Substantial parts of the better-educated public know that the Western world nowadays believes in liberalization of capital markets and privatization, with American civilian economic aid to Israel predicated on the assumption that the country will liberalize. Government officials and the media have frequently told the public that monopolies are bad for the economy and that competition is good.

Citizens themselves have realized this long ago. They remember how the Bezek telephone company behaved when it was a monopoly and how the Israel Electric Corporation still behaves. The 1999 State Comptroller's report revealed that the IEC gives its workers bonuses if they finish their work on time. This is tantamount to saying that delays are considered normal. The Israeli public realizes that policy differences on economic issues between governments of the left and right are negligible.

The great strength of macroeconomics as a policy tool is that its basic concepts can be summarized in a few sentences and expressed through a very limited number of indicators. This, however, is also its weakness. If the government's economic attention is focused primarily on a few indicators, its understanding of what makes or breaks the successful development of the economy is very limited. In the last election campaign, economic issues were marginal and discussion was at a rather elementary level.


Explaining Business Economics

Business economics at the micro level involves many detailed activities, some of which are based on a methodology and management tools, others mainly on insight and judgment. Their application is not limited to the business sector, and they can be of great use as well in governmental services.

Some of the more simple and conventional business tools include: defining goals for a corporation or organization, formulating them in a "mission statement," developing strategies for achieving them, and installing a suitable organizational structure. Thereafter, the organization has to be staffed with the right people. Authority has to be delegated to deal with problems at the lowest levels capable of solving them. This should be accompanied by a greater openness of information so that employees have a good understanding of where the organization is going and why. The entire approach should be formalized in a business plan, a document which is regularly updated.

The best way to convey the essence of what business economics can do for the country is through the description of case studies. In several fields the key information required is quite easily accessible. One example of this is in corporate environmental policies. The leading international business organization in the environmental field is the Geneva-based World Business Council for Sustainable Development (WBSCD), which includes some 100 large corporations and maintains a policy of "learning by sharing." Its members share "best practice" cases from their own experience. Much of this information can be purchased easily at relatively low cost.

Another such area is the privatization of government services. Local municipalities may find many interesting examples of how to do this in former Indianapolis Mayor Stephen Goldsmith's book The Twenty-First Century City, in which he describes how his administration made city management more efficient, inter alia, through privatization. Other examples in this field may be seen from the experience of New York City, where the privatization of the management of some New York parks improved the rentals of adjacent buildings, or in Ashkelon where Mayor Benny Vaknin has encouraged the privatization of various municipal activities. These case studies have been documented in Practical Privatization: Lessons from Cities and Markets and Privatization and Increasing Competition in the Israeli Economy, based on a conference and forum sponsored by the Jerusalem Center for Public Affairs and the Milken Institute.


Benchmarking

Benchmarking, a common practice in the West, is another tool of business economics. It involves the definition of a specific business goal to be achieved, with analysis and definition of the components required to reach that goal. One then searches for other businesses or organizations which have advanced the most in the various component fields. A target is then composed based upon a composite of the best performances by others in each area. Thereafter, this ideal program is translated back into one's own culture or business reality.

Benchmarking is very different from its rather backward relative, "copying." Copying between situations which are unalike may just increase problems. Many ineffective shopping centers have been built in Israel because developers sought to invent the wheel themselves or copied unsuitable models. Copying blindly what the Ashkelon municipality has done in the field of privatization, for example, may not be automatically applicable in all other Israeli localities.


Applying Business Economics to Ease Social Problems

In one benchmarking example from this author's experience, the chairman of a major European company had reduced the number of his company's employees by many tens of thousands, mainly through offering major financial incentives. He still had to reduce employment by another 10,000 people, which was no longer possible on a voluntary basis. I headed a project team that was asked to develop a program to accomplish this.

Our team began by identifying major companies in four other countries which had dealt with large-scale employee reductions. These firms were systematically interviewed and their methods analyzed, including the criteria developed as to which people to lay off, and what could be done to place employees elsewhere in the company or to find jobs with the company's suppliers or other business connections.

The team composed an overall program based on a mixture of elements from the various companies studied. This was then adjusted to make it suitable to the company in question and to fit into the national labor-relations culture. The resulting program was much better than anything the team could have designed itself. It took two months to develop and cost much less.

Whenever a major Israeli corporation has to lay off several hundred people, there are tensions and strikes; usually money is all that is offered, and a struggle ensues about how much should be paid. In such a situation, if the company concerned offers the dismissed workers other types of help in finding alternative employment, which costs less money but requires more management effort, it has not only made an economic gain but created a social gain as well.

Such approaches can provide a good tool to reduce social tensions. With the rapidly changing Israeli business environment, several firms in old industrial sectors will have to shed many workers or may even go under.

The above-mentioned benchmarking example is fairly sophisticated, but others are more common and simpler to develop. Audit companies or consultants provide their clients with key cost structures of similar companies abroad, and applying these comparisons is not very expensive. In the petrochemical field, one UK consultancy has acted since the 1980s as a clearinghouse for cost data from most European ethylene plants. To take another example, two major European car companies have an agreement with each other to systematically compare costs. Many major multinational companies submit all their international subsidiaries to detailed comparisons in many fields.


Government Encouragement of Modern Business Methods

In the United States, government aims to do only what is necessary, i.e., public tasks which are not undertaken by anyone else. In this framework, the promotion of better management techniques in the public sector will lead to higher quality public service for less money. One can easily understand the importance of such an approach in the bloated Israeli public sector.

But why should the application of better business methods in the private economy be government's concern? Indeed, in countries such as the United States or The Netherlands, the government's role in promoting better management techniques is very limited. In Israel, however, the backwardness of business economics structurally burdens the government's task to guide the economy forward.

As in business management, the government has to use every tool which potentially can help, even if it is unlikely to ever be included in any textbook on modern business methods. Since Israel is a small country, there are important shortcuts available to government officials to improve specific situations. A minister who knows what he or she wants can achieve a great deal through private meetings with business counterparts.

One example from a rather backward economic sector, corporate environmental policies, illustrates this: one of the previous ministers of environment was invited to the Ramle plant of the Nesher cement company. The company had been criticized for many years for its pollution, and had spent much money to improve its environmental performance. The minister, who visited the plant, suggested that, to improve its public image, the company establish a visitors center where schoolchildren and members of the public could learn about how Nesher controls its environmental problems. The Nesher management did so, and the center now receives 1,000 visitors a month who are exposed to the issue of how a company can deal with the environment -- a subject that few Israelis are familiar with. The long-term contribution of this knowledge to economic education can be significant.


The Fragmentation of Business Economics

A major problem in accelerating the introduction of modern management tools is that they are much more fragmented than those of macro-economics. Business economics uses many methods and is often based on individual activities and experience. Its flexibility derives from the continuous quest to get more output of a better quality using fewer resources.

Although business economics has made considerable headway in Israel in the last decade, in most sectors it still lags far behind macroeconomics. Until Israel's new high-tech economic sector emerged, there was little of interest that Israeli micro-economists could offer to their colleagues abroad. Indeed, in many areas the Israeli economy was quite underdeveloped until the early 1970s. Prior to that time, for example, the Tel Aviv stock exchange consisted of about a hundred quoted companies, and on many days the total market turnover was a million dollars or less.


No Bees, No Honey

Three decades ago, only a few people in Israel were able to carry out a proper economic feasibility study which could be shown abroad without embarrassment. Industrial market research hardly existed; neither did consumer market research. For example, in the early 1970s when I sought to undertake research into the Israeli stock market, after a lengthy search process I discovered one person who had undertaken a few studies of Israeli insurance companies for the fund management company of a bank. The existence of these studies was a well-guarded secret and perhaps one or two people in the bank had seen them. It took well into the 1990s until there were sufficient stock market analysts in Israel to establish some kind of ranking system.

No major international audit firm had an office in Israel until the mid-1990s, which meant that their know-how, methods, and techniques were unavailable. International auditors and consultants have an effect similar to bees which fly from one flower to another. They fertilize the area with methodological knowledge and understanding which they have acquired elsewhere. These experts also have access to data from similar fields in other countries. Even if they are packaged in a way to avoid giving out proprietary information, these data can help Israeli clients very much in measuring their performance on an international scale.

One basic rule of business economics backwardness is that without bees there is no honey. If a country's economy has to reinvent various types of existing wheels, it is assured to stay forever behind.


The State of Economic Consultancy

In 1970 this author established a local consultancy joint venture between Eurofinance, a major European financial consultancy firm, and Bank Leumi. Although the foreign firm mainly had experience in stock market analysis and mergers, the Israeli subsidiary could deal with many other business research areas since the economic consultancy field was practically virgin and decades behind the West. Many businesses had no economic analysis capabilities at all. This lack of specialization in individual economic consultancy fields was a further indication of the backwardness of the clients served, who often were among the country's business leaders. When the foreign shareholders sold out in 1980, this ended the systematic flow of foreign economic and financial consultancy methods into Israel.

Since the mid-1990s, international management consultants have been occasionally invited to Israel to undertake strategy and organization studies of leading Israeli corporations. Bank Hapoalim is one of the Israeli companies which has undergone a major analysis and reorganization by McKinsey, a leading multinational management consultancy firm. Quite a few European banks, however, were already being restructured with broadly similar methods by the same firm of consultants in the 1970s.

This is further proof that Israel is at least twenty years behind a number of Western countries, where the disciplines of management consultancy and corporate strategy analysis have been established for many decades. Though there are some very good local individual consultants, the economic and organizational consultancy profession in Israel has never really taken off on a larger scale. Only now is McKinsey establishing an office in Israel.


Investment Bankers, Venture Capitalists, and Business Schools

It was mainly with the signing of the Oslo agreements and the flourishing of Israeli high tech that foreign investment bankers started to set up offices in Israel. Venture capital companies with foreign know-how have also proliferated over the past decade. Today there are also a number of business schools in the country, including branches of foreign universities.

Several advanced tools for propagating microeconomic know-how are now taught systematically in Israel. Many of those in power in the business sector, however, are not familiar with these new techniques. It will take a long time until the business school graduates reach the top decision-making levels outside the high-tech and venture capital sectors.

One important question regarding the advancement of business economics in Israel at present is how to ensure that this know-how permeates society more rapidly. Knowledge is often difficult to disseminate. During the 1970s, one major consultancy firm in Europe managed to live for at least ten years from selling one simple message: one should not try to sell what one produces, but rather produce what one can sell. Even thereafter, some well-paid European top executives of big firms did not understand the message. They continued to make mechanical typewriters which could not be sold at any price as buyers wanted word processors.

One is often told that the experience of Israel's high tech managers will permeate the rest of the economy. In this context it is mentioned that the investment decisions of venture capital companies have improved substantially over the last few years. It remains doubtful, however, how fast or even whether this experience from the new economy will at all influence the classical economy or the government sector.

Neither should we overestimate the management skills of the new high-tech sector. Many of these companies are research and development enterprises, which are sold or merged during the early stages of their existence. They do not have to develop the comprehensive management capabilities required by industries in the classic business sectors.


Israeli Multinationals -- The Teva Case

In the early 1980s, there was perhaps only one Israeli company which understood the systematic importance of strategic analysis for the building of a multinational corporation -- the Teva pharmaceutical company under the leadership of Chief Executive Eli Hurwitz. The company's shareholders have reaped the fruits of his foresight. Those who owned $100,000 worth of Teva shares in the mid-1970s and kept them now have holdings worth perhaps $25 million.

Teva was not entirely alone. Israel Chemicals, which was privatized a few years ago, had made major foreign acquisitions even earlier. A few other companies tried their hand at internationalization in a less professional way and paid a significant penalty for their lack of professionalism. The Elite food firm is one example.

It is in Israel's national interest that what Teva and other business leaders do becomes better known faster. Indeed, sophisticated corporate strategy is the norm in some of the high-tech sectors. There are, however, still many "old economy" corporations, where even a common tool such as a business plan does not exist. Even having such a business plan is not a guarantee for either its quality or its use. Many such documents do not express a clear vision of what the company should look like a few years hence.


Influencing the Decision-Makers

Cultural factors may also play a role in delaying the adoption of modern management methods by Israeli business leaders. Some observers believe that the individualistic nature of Israelis prevents them from addressing problems systematically in an integrated way, delegating authority clearly, or sharing information in an orderly way. This culture is not limited to the business world. One might illustrate it as well with the good preparation of the army for the recent riots, while this was not integrated at the same time with an adequate communications policy.

A further management problem involves not just the adoption of modern business tools in Israeli society, but making sure this type of thinking has an impact on the country's decision-makers and their advisors. The program on increasing privatization in the Israeli economy sponsored by the Jerusalem Center for Public Affairs in cooperation with the Milken Institute, which brings together leading experts from Israel and abroad to discuss these topics, often for the first time, can play a critical role in promoting a greater understanding of the importance of business economics as a key factor in Israel's future economic growth.

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Dr. Manfred Gerstenfeld is a Fellow of the Jerusalem Center for Public Affairs and Chairman of its Steering Committee. He is an international consultant specializing in business and environmental strategy to the senior ranks of multi-national corporations. His books include Environment and Confusion (Academon, 1994), Israel's New Future: Interviews (JCPA and Rubin Mass, 1994), and Judaism, Environmentalism and the Environment (Jerusalem Institute for Israel Studies and Rubin Mass, 1998). This Jerusalem Letter/Viewpoints is adapted from his presentation to the forum for experts on "Privatization and Increasing Competition in the Israeli Economy" sponsored by JCPA and the Milken Institute, held at the Jerusalem Center in October 1999.


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The opinions expressed by the authors of Viewpoints do not necessarily reflect those of the Jerusalem Center for Public Affairs.