The Lectern

Steve Kelman


By Steve Kelman

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Are contractors taking government to the cleaners?

When I returned home from traveling abroad a few days ago, a pile of annual reports of companies whose shares I own were waiting in a pile of mail. This is company annual report season. There was something in one report I read that caught my eye because of its association with longstanding debates about government contracting.

 The report was from a company called Oceaneering International, a provider of oil exploration equipment. (I actually bought 300 shares of this stock in 1981, over 30 years ago, when a stockbroker said I had no energy stocks in my portfolio and ought to have at least one. Over the 30 years, the value of my investment has gone from $3600 to $62,000 – I wish all my investments had done that well, but that’s another story.)

 It turns out that about 10 percent of Oceaneering’s business – called their Advanced Technologies segment – is with the U.S. government, selling engineering services to the Navy and some special-made equipment to NASA and the Defense Department. (I like the fact that they call this “advanced technologies,” as opposed to their other businesses, which are hardly low-tech. More importantly, I think it is good for government contracting to have successful private firms doing a modest portion of their business with the government, rather than leaving the government market for such services and products to government-unique defense contractors or other government contractors who have no experience competing in the hard commercial world.)

At the end of the report, there is data about the operating income as a percentage of sales for the company’s different businesses.  The bottom line?  Oceaneering’s oil and gas commercial business has an operating income of 22 percent of sales, while its government business’ operating income is 7 percent of sales.
If you look at the annual reports of publicly traded companies that have significant commercial and government business, and that report operating income on both groups of businesses – such as many of the IT consulting companies – you will almost always see a similar pattern.  Government business is less profitable in terms of operating income as a percent of sales than commercial business.
This fact, of course, gets little attention in debates about government contracting, which often suggest that contractors make huge profits ripping off the government. In fact, a mixture of often intense price competition and cost-based contracts with controls on markups over cost mean that the popular impression in the debate is inaccurate.
There is a more subtle way the government might get hurt, to be sure.  If on cost-based contracts there is insufficient attention to cost controls, the number of hours of contractor effort may be higher than really needed, and that will raise overall contractor profits, even though the return on each hour of work may be modest. This is a reason for favoring, when possible, fixed-price contracts or incentive-fee contracts with a cost savings line, or share-in-savings contracting; cost-based service contracting in the commercial world has some of the same problems. But, even if this is a problem, it is not the problem that the popular myths about contractors taking the government to the cleaners suggest.

Posted on Apr 19, 2012 at 7:27 PM5 comments

Eurozone crisis, luxury consumption

Shortly before resigning in disgrace as the Italian prime minister, Silvio Berlusconi famously made a remark that there didn’t seem to be any crisis in Italy, because the restaurants were filled. This does not seem fully to apply to Spain, with its 23 percent unemployment, or even to France, which I am also visiting and which is in better shape than Spain. One of the restaurants I had hoped to eat at while in Barcelona, recommended by the 2009 edition of my Fodor’s guidebook, had closed. A tapas place in Madrid, about which the same guide had said come early or you won’t be able to get a seat for lunch, was largely empty even at 1:30, by which time even the Spanish have begun to sit down for lunch. At 6:30 a Saturday morning, a taxi driver was waiting outside my hotel on the outskirts of Barcelona, patiently hoping for a fare. Nonetheless, luxury consumption is not dead, even in a crisis-hit Eurozone.

Nestle, the Swiss food giant, has in recent years developed a new coffee offering to supplement its longtime megabrand Nescafe, now going downscale and tired except in some developing countries. Called Nespresso, it is a single-serve upscale coffee pouch coming in endless flavors – some of which actually have vintages (!) indicating what year’s coffee crop they come from -- and brewed in striking modernistic for-the-home coffee machines, sold in special stores devoted only to all things Nespresso. (I believe there are now a few of these outlets in the U.S.)

The heart of Barcelona has the largest Nespresso store I have ever seen, with almost 30 counters and a take-a-number system like in deli departments in supermarkets. This monument to consumerism, which features a stupendous variety of gorgeous coffee brewing machines for sale, was very crowded when I went inside a weekday afternoon. Sales were brisk. One theory, I understand, is that these gourmet coffees are an affordable pleasure for people who can’t afford other pleasures – my understanding is that Starbucks sales held up well during the U.S. economic crisis in 2008 and 2009 for the same reason. (The Starbucks in Spain, although not ever-present as in some other countries, are also extremely crowded.)

The French daily Le Figaro ran a story about the continued sales growth of Hennessy cognac, still managed by the family of the Irishman Richard Hennessy who began the brand, though now owned by the French luxury conglomerate LVMH, which also owns Louis Vuitton, probably Asia’s most iconic French brand. One thing I learned from the article is its status among black musicians, starting with the jazz legend Miles Davis, who preferred it to Scotch, which he regarded as a white drink, and continuing through rappers such as Tupac Shakur and Jay-Z. In the last decade, U.S. sales of Hennessy have increased from 600,000 to 2 million cases a year, and each year the town of Cognac, France, where Hennessy is made, has a Blues Passion festival including blues and rap.

I had dinner in Paris in a trendy restaurant called Bistrot Paul Bert, which has sparked a foodie renaissance on a street of the same name in the downscale Paris neighborhood around Place de la Nation. It was a Saturday evening, and, not surprisingly perhaps, the restaurant was filled. My hotel had told me they had called the hotel and told them I’d be an hour late for my reservation, but when I arrived, the restaurant knew nothing of such a supposed phone call, but they let me sit by myself at a sort of small bar right where the maitre d’ welcomed new guests.

I was surprised how many people – mostly Americans – arrived without reservations, hoping to get tables. But I was also amused by a scene I never would have seen had I not been sitting at this small bar. This very French restaurant, of course, serves nothing but wine, French bottled waters, and some liquors to drink. However, at one point when things were quiet I noticed the maitre d’ stealthily take a big plastic bottle of Coke out from under the bar, inconspicuously pour some into a glass, and proceed to drink it up, in successive gulps, over the next few minutes.

Posted on Apr 17, 2012 at 7:27 PM0 comments

Will high unemployment create a "burning platform" to encourage government change?

I am in Spain for a few days to teach two executive education half-day classes for the ESADE Business School public administration program, in Madrid and Barcelona. Spain, interestingly, has some of Europe’s finest business schools. The topic: leading change in the public sector.

There is probably no more famous idea about how to get change initiatives started than the metaphor – famed from hundreds of consultant slide shows over the years – of the “burning platform.” The image comes from the idea that workers on oil rigs will feverishly resist any efforts to change how they do their jobs unless and until their rig catches on fire. The basic idea is that organizational employees will resist changing how they work absent a crisis – absent a situation where they must “change or die.”

Well, if this approach has merit, it would have merit here in Spain. Unemployment is officially running at 23 percent, though there is a vibrant underground economy that means these numbers are somewhat exaggerated. The country’s budget deficit hovers at over 10 percent of GNP. As anyone following news from Europe and the Eurozone crisis is aware, the tribulations of the Spanish bond market are the stuff of international headlines.

In the two executive education sessions I taught to senior public-sector managers who themselves are trying to bring change to their organizations to survive draconian budget cuts (mostly in local government rather than national), we talked about whether the fear of a crisis may induce is an effective way to gain employee acceptance for the need to change the way the organization does business.

The answer seems to be maybe – but maybe not.

In my discussions with them, many of these managers said they have been motivating their change efforts to their employees by referring to the crisis facing the Spanish public sector. Does it work? Well, the managers weren’t sure.

There are two kinds of problems. One is that many employees are skeptical of the message. Reflecting general human psychology, many argue back that the economic crisis isn’t their fault (it was brought about, they say, by the shenanigans of the speculative construction sector that collapsed, not by civil servants) or that, even if other government organizations are insufficiently productive, their own organization is performing well (the well-known phenomenon of “positive illusions,” whereby most people believe they are above average). So some, despite general talk of crisis, don’t believe it applies to them. Perhaps they are hoping that budget cuts will be reversed at the last minute, or that somebody else will figure out how to save money elsewhere in the organization.

 The opposite problem is that some employees believe the message too much and react with a kind of paralysis. One manager reported that his efforts to get employees to develop suggestions for business process improvements that could help the organization be more efficient have met with blank stares. There is research evidence that people who are frightened react by working harder at what they already do – so, for example, a crisis may be a good way to lower absenteeism from work – but that frightened people are less creative in coming up with new ideas.
As budget cuts kick in in the U.S., we are going to face some similar change management issues. I am inclined to think that federal managers should look for more creative ways to encourage employee support for changes than the old “burning platform” saw.

Posted on Apr 13, 2012 at 7:27 PM1 comments

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