Governments around the world are committed to raising productivity to improve economic performance. As the research of the McKinsey Global Institute (MGI) has demonstrated repeatedly over the past decade, productivity at the sector level is driven by the degree to which companies are exposed to competition. Hence, the argument goes, governments should remove barriers to competition, such as excessive regulation, if higher productivity is the goal.

Do managers also have a part to play? It has always been assumed that good management increases productivity, but this proposition has never really been proved. However, a new McKinsey study of the manufacturing sector reveals clear evidence of a link between the two.

Three management techniques have long been thought to improve a company's performance: lean manufacturing, which minimizes waste; talent management, which attracts and retains high-caliber people; and performance management, which rewards employees who meet set goals. To assess and measure the impact of these management techniques, we interviewed the directors of operations or of manufacturing at 100 companies in France, Germany, the United Kingdom, and the United States.¹ The interview process was double-blind: subjects didn't know how their management practices were being assessed and measured, and the interviewers weren't aware of the companies' financial performance.

The companies were awarded a score for their use or nonuse of each management technique—scores ranging from 1 (which meant that it wasn't used) to 5 (reflecting best practice). We then compared each company's score over a period of five years (1995–2000) with several key financial metrics, the most important being return on capital employed (ROCE) relative to the sector.² The results showed that companies with the highest management scores outperformed their sector (Exhibit 1). The correlation between a company's management practices and its financial performance was significant (at the 95 percent confidence level): a one-point improvement in performance across all three management techniques, for example, generated a 5.1 percent increase in ROCE for companies, independent of sector. Over the same five-year period, this improvement would equal the creation of $400 billion in value for the US manufacturing sector, or a total of $700 billion for all four countries in our sample.

If management practices affect a company's financial performance, you would expect them to have an impact on sector productivity as well. Our statistics confirm this assumption. National differences in levels of total factor productivity (a combination of labor productivity and capital productivity) are well documented: the United States performs well, the United Kingdom relatively poorly. Our study showed a strong correlation between these national productivity rankings and management practices, with the US companies in our study earning the highest average management-performance scores and the UK companies the lowest (Exhibit 2). This correlation suggests that if the UK manufacturing sector were to increase its management-performance score by just one point, it could achieve an 80 percent increase in its total factor productivity—and a level of productivity far above that of the United States.

For companies pondering how they can increase their productivity, this finding is important. To boost their labor productivity, and hence their total factor productivity, manufacturing companies are now inclined to lobby for tax breaks on capital investments, but our study shows that the same goals could be achieved, at little or no cost to governments or the sector, if managers managed better.

How best to encourage them to do so? Since the US companies in our survey had the highest average management scores, it might appear safe to assume that plenty of competition in an economy promotes good management practice. Yet we couldn't find any direct correlation between the level of competitive intensity³ and the adoption of good management practices by the companies in our sample. Clearly, there are well- and poorly managed companies in both competitive and less competitive environments. But we did find a strong correlation between the extent to which management practices affect a company's financial performance and the level of competitive intensity (Exhibit 3). In other words, good management practices have a more pronounced impact on the bottom line in a competitive environment.

For managers in less competitive environments, the news is hardly encouraging: no matter how hard these companies try, their efforts will have little impact as compared with factors, such as regulation, that are more important in determining their financial performance. But there is a note of comfort. When a government does decide that the economy needs more competition, companies with sound management practices will be ready to move ahead of the pack. The highest productivity levels are likely to be achieved only when governments create the right competitive conditions and managers use the best management techniques.