Ridley Hall, Cambridge

Prudence in Business by James Allcock

Executive Summary

Prudence is practical common sense or wisdom. It involves the bringing together of thought, knowledge/experience and execution. Prudence is crucial in many areas of business but for a variety of reasons is often notable for its absence. Prudence should not be equated with caution; involves carefully calculated risks. It cannot be reduced to a technique because it is an essentially personal quality.

"The simple believes everything but the prudent looks where he is going" [Prov. 14:15]

I am reminded of the story of the little boy asked to write an essay in an exam on the subject 'Honesty is the best policy'. Rather to the astonishment of the examiner he handed in his paper after only two minutes. On it he had written: Honesty is not a policy, it is a principle. In talking about virtues in business we need to decide whether our topic is virtuous people doing business or techniques which, when applied by people to business bring financial success. Business is very good at talking loftily about principles and virtues in their mission statements but they tend to be abandoned when they become inconvenient. Then we discover that they only had a place as long as they were useful to the object of the business.

Clearing the Ground

Alllow me to begin with a few tangential remarks.

There are two temptations I have tried to resist. The first was to attempt a highly theoretical discussion about the meaning of prudence. I'm not capable of it. But I will take time to let one little bee that buzzes round my bonnet take flight. In The Theory of Moral Sentiments Adam Smith makes a distinction between Prudence and Benevolence. Put crudely, according to him, the virtue of prudence is about looking after number one, whereas the virtue of benevolence is about looking after the interests of others. I have often heard it said that Smith changed his position when he came to write The Wealth of Nations. The anti-capitalists say that he deserted a virtuous basis for economic activity when he wrote his famous remark: "It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner but from their regard to their own interest." I think he was simply saying, in complete accordance with his argument in The Theory of Moral Sentiments, that people exercises the virtue of prudence but not benevolence when they engage in business. I mention this here because there are those who hanker after a benevolent basis for the conduct of business and I think they are mistaken.

The second temptation I have resisted is to argue that prudence must be the most important of the virtues on the grounds that it is prudent for a man to act temperately, justly and courageously. To argue thus would be a mistake because it confuses temperate, just and courageous acts with the quality of a person as a whole. A man may on occasion do something prudent or courageous or just without essentially being a prudent, brave or just man. When we talk about a prudent person we are talking about the whole disposition of the mind. As Robert Solomon says, a virtuous person acts virtuously spontaneously. Richard Higginson was talking about this when he said that Victor and Victoria would not offer a bribe because it simply doesn't match the people they are. And this reminds us of an important truth. These virtues are not abstractions. Business can't be prudent or imprudent. It has no moral identity in itself. We are talking about the need for businessmen and women to be prudent, temperate, just and courageous.

Nevertheless, there is a lingering problem. Prudence seems to me different in kind from justice and courage. Let me put it this way. I can envisage an absolute obligation to do the just or courageous thing whatever the consequences. Maybe the business will go bust but that can't be helped. These are overriding obligations which must be accepted whatever the consequences. But it seems doubtful whether there can be an obligation in the same sense, that is a duty, to be prudent. I draw the tentative conclusion that in Kant's terminology some of the cardinal virtues are categorical imperatives and some are hypothetical imperatives.

Practical Common Sense

So much for ground clearing; now to business. I need a definition. What is prudence? I like the down-to-earth definition CS Lewis gave in his Broadcast Talks long ago. He said "Prudence means practical common sense, taking the trouble to think out what you are doing and what is likely to come of it." He went on to explain that it was not enough for Christians to be good; they must not be stupid. By that he did not mean that they had to be highly intellectual; he meant they must use their brains and not act naively or recklessly without thought for the likely consequences of their decisions and actions. John Adair in his new book Effective Strategic Leadership calls prudence "practical wisdom". Take your pick - practical wisdom or practical common sense. It follows that prudence is not a spectacular virtue and it is not a speculative virtue either, because it involves action. We are discussing the combination of thought and experience that issues in action. Thomas Aquinas took the same view of prudence. He said it involved three main elements: counsel [that is thought], judgment [bringing knowledge and experience to bear] and command [by which he meant application]. We are thinking of this as it applies to the creation and the operation of a business.

I fear that some may react by saying: is that all there is to it? Isn't it obvious that businesspeople should use their practical common sense? Well yes, but it is equally obvious to me that they often don't. Indeed, I believe from my own experience two things:

• There is not enough prudence about in business
• Such as there is, is often buried in ways that in due course I would like to explore.

But first to the three elements of prudence; thought, knowledge and experience, and execution.

Think about thought (as the Jesuit once said!) A constant theme of my remarks will be the need for businesspeople to see the wood and not just the trees. And thought may both help and hinder this. I don't believe that the successful businessperson needs a highly trained speculative intelligence. I shall have more to say about that later when I talk about business training. It has often been remarked that the observed fact in British society that the brightest and best educated go into the professions and the Civil Service is due to a deep-seated social snobbery. I disagree. On the one hand, I don't think that the best trained brains (which are always in short supply) need to be devoted to business; they are better deployed elsewhere. On the other hand, I think that a fine liberal and speculative education can drain away the capacity for decisive action. Hamlet knew it. Resolution can be "sicklied o'er with the pale cast of thought and lose the name of action".

I think of a good friend of mine. He was in my Sunday school class as a small boy and has been a lifelong friend. He came from a very humble background, left school with no GCSEs and is now an extremely successful property developer (by which I mean stinking rich) both in this country and abroad. It is clear in talking with him that his mind is not cluttered with the "what ifs", that endless catalogue of potential catastrophes that rob me of my sleep. He sees an opportunity to buy a piece of land in Portugal for x, build holiday condominiums on it for another x and sell them altogether for three or four x. So why not? What could possibly be the problem? In modern jargon I would say that he stays focused. This element of prudence is vital.

I am certainly not arguing against forethought. If we don't have a settled view of where we stand on moral issues, we shall not do well in the heat of the moment The prudent businessperson does make time for appropriate thought. A classic way to lose the plot is the constant round of activity that so easily consumes all the waking hours. I know the exhilarating feeling that proved to my own satisfaction that I must have "arrived" because my feet had barely touched the ground for weeks. New York this week, Europe next and weeks go by without reflecting on what one is doing or why. Indeed the question "why" is a real luxury. It would be enough to stop and ask oneself what on earth one is doing. My experience tells me that the business transactions that, in retrospect, embarrassed me, arose because I was borne along on a tide of invincible arrogance or a determination to get level with someone; a wrong judgment about the realities of the hand I was playing, or the perceived need to clinch a deal by a hopelessly unrealistic date because of an important press conference at which it simply must be announced.

So the prudent businessperson must leave time for thought, so long as his or her mind is focused and not allowed to roam in an undisciplined way.

But if thought is the first element of prudence, then knowledge and experience are the next. In business, they may to some extent be the same thing. Knowledge is gained by doing it - i.e. by experience. As often as not this means by trial and error. We find out what can and can't be done; what does and doesn't work. But I think the prudent businessperson in future is going to need more theoretical knowledge as well. The liability of directors is growing apace. At one time I was non-executive Chairman of two companies. If either company had been accused of falsifying the accounts I would not have had the slightest idea of the truth of the matter. One of the companies was producing oil from a platform 100 miles out in the North Sea. I visited the platform a number of times but not with a trained eye. If there were unsafe practices being employed I would have missed them. But the shadow of manslaughter charges looms more and more darkly over the director. The strictures of Lord Penrose about Equitable Life underline the point. He said of the directors: "The Board at no stage got fully to grips with the financial situation faced by the society", adding that "the non-executive directors were so wholly dependent on actuarial input that they were largely incapable of exercising any influence on the actuarial management of the society." If that that doesn't eventually cost them all a lot of money, I shall be surprised. Much more specific knowledge is going to have to repose in the prudent director himself than hitherto. I tell you I am relieved to be without the burden of it. The money was good but the risk was no longer worth it to me.

But what of the youngster starting up on his own with self -confidence borne of ignorance, boundless energy and a zany idea that he is sure will make him millions? Is he (or she: I think of Martha Lane Fox) imprudent? Yes, I think so if they go without a mentor. It may be a relative or friend, a bank manager or a shrewd and experienced private equity provider. I shall have more to say about the relationship between prudence and risk shortly.

The third element in prudence is execution. It is prudent in business to act. It is hardly an exaggeration to say that, faced with a finely balanced choice of actions; either of them is better than dither. Percy Barnevik, chairman of the ABB group of 1200 companies put it this way.

"I would say that in any business decision 90% of success is execution, and ten per cent strategy. And of that 10% only 2% is really analysis and 8% is guts to take uncomfortable decisions. The question is how do you mobilise people. How do you make 25000 managers move like a big army? It doesn't matter so much if you move in the right direction or not, as long as you move. I tell people that if we make 100 decisions and 70 turn out alright, that's good enough."

Of course this brings us to the virtue of courage. It takes no courage to mull endlessly in-house over the alternative strategies. It takes courage to cut the cackle and act. But prudence - practical common sense - is at a premium in the execution phase. You need to ask questions such as:

• Who is the executive team to whom you have trusted the implementation?
• Have they been presented with the right incentives to make a good job of it?
• Have you made sure that there are no road blocks in the way that they are not competent to remove?
• Are suppliers of goods and services to the company geared up to support the implementation?
• Are the publicity elements in the launch of the new policy well judged?
• Have the shareholders and the City been properly informed?

It is only prudent to see that all these things are looked after but it is surprising how often it is not the case. A friend of mine runs a consultancy business; he helps people who are unhappy in their present careers to work out what they should be doing and he works from home. One day his young daughter heard him on the phone advising a client who was actually a partner in one of the big six accountancy firms. In the irreverent way that only a daughter can get away with she said: "Dad, do they really pay you to tell them that? It's only common sense." "Yes", he replied. "Common sense is a very scarce commodity and scarce commodities have a high price". People in business, well-qualified people in business, often lack practical wisdom. They are imprudent.

I dare to say that prudence lies at the heart of the capitalist system. The essence of the system is to defer present consumption and invest what is saved. Or to quote Adam Smith "in the steadiness of his industry and frugality, in his steadily sacrificing the ease and enjoyment of the present moment for the probable expectation of the still greater ease and enjoyment of a more distant but more lasting period of time, the prudent man is always both supported and rewarded by the entire approbation of the impartial spectator." In modern jargon, the prudent man has a low social time preference or discount rate.

I shall now discuss areas of business where I believe prudence is very important and some of the temptations that lead to imprudence and disaster.

Where Prudence is at a Premium

I have been involved over the past year in putting together a business plan for a start up company to extract methane from worked coal seams, generate electricity with it and sell it to the national grid. The essential elements on which the prospects for the company depend are quite simply the estimate of the volume, quality and pressure of the gas in the seams; the cost of the compressors and generators, the cost of staff and administration and the wholesale price of electricity. But the frightening thing is that the profitability projections can be made anything you like. Forecast high wholesale electricity prices, lots of high-pressure gas of good quality, cheap compressors and generators - and the profit is astronomical. Forecast the opposite, low electricity prices, dodgy gas volumes and expensive equipment - and it is not worth doing. Prudence is at a premium. A prudent mix of estimates is essential and my point is this. The private equity backers to whom we hawked our prospect round did not themselves know this business. They cannot be expert in all the businesses in which they invest. What they wanted to find out was the sort of people we were. Were we reckless, over-optimistic or needlessly pessimistic? They wanted to know if they had prudent people on their hands.

Take another obvious example: the recruitment, training and management of staff. In my experience it is very common to find the best candidate at interview failing to get the job. Why? Because the recruiter is frightened that the candidate might be cleverer than he is himself. He felt threatened. I had many failings as a manager but that was not one of them. All the people who worked for me in key positions were cleverer than I was. My chief economist had a first from LSE, my chief analyst had a first in maths at Cambridge and my legal adviser was a scholar of Winchester and of New College and a first in classics. I was none of these things. But I was well served and I think that I was prudent to have them in my team.

Again, it is prudent to see that your staff is well trained. Only common sense you might say. Yes, but how many times have I seen people left to drown in jobs for which they had not been properly equipped. It is not prudent to do that because you will carry the can for their failure. Finally, prudence dictates delegation, which means that prudence involves trust. I only did the part of my job that no else could do, and I made my subordinates adopt the same attitude. It is so rewarding to see people flourish and grow when you heap responsibility and opportunity on them. You can do that if they trust you. They must know that you stand with them when things go wrong. I have seen bosses delegate and then hang their subordinates out to dry when things go wrong. It is not prudent to behave in that way. It corrodes relationships and erodes trust. Clive Wright in his recent paper for CABE put it this way: "Without trust, business cannot function and prudence identifies that need." A culture of mutual trust is the prudent course.

The prudent businessperson knows that the purpose of business is not to make profits; nor is it simply to create material wealth. It is to orchestrate a group of people in the creative process in such a way that they are fulfilled to the limit of their potential in the enterprise; that they own the result and that their daily lives are spent in comradeship in community. The nearer we can get to creating that atmosphere, the nearer we get to the ideal of work before he Fall. The prudent person knows that he or she exercises power for the sake of the whole enterprise. They don't believe that power can be preserved by deception or secrecy and, as William Pollard puts it in his book The Soul of the Firm "prudent leaders initiate a plan for succession and the development of future leaders." It is much more common in my experience for the present leader to adopt de Gaulle's aphorism "après moi le deluge." People who do that are seldom disappointed. The deluge followed Rooke at British Gas, it happened when Lord Weinstock retired from GEC and many other examples could be cited.

There are so many other areas where prudence is important. It is prudent to be realistic about the time it will take to turn round a financial position. It is prudent to look to the long-term health of the company and not to short term gains. In this connection prudent judgments need to be made about the demands of the stock market and the longer term needs of the company. It is prudent to make realistic estimates of the outturn cost of capital projects. It is prudent to limit the burden of debt so that the company is not broken in a market turndown. It is prudent to tell the truth at shareholder meetings and meetings with analysts. It is prudent to make conservative estimates of the company's oil reserves if you happen to be Shell! Yet, every day we read in the business press that apparently high-powered - and certainly highly paid - management has acted imprudently.

The Reasons for Imprudence

I believe the reasons for imprudence are of very different kinds. The first may surprise you. I think modern sophisticated business education has something to answer for. MBA courses train bright promising business managers in sophisticated analytical techniques, sophisticated psychological techniques, hairy theories of human motivation and manipulation, techniques of image development, and often a Darwinian view of both personal and company survival. I doubt that any of this makes them prudent or helps to keep their eye on the ball. Let me give you an example. I was presented every day with complicated calculations of the present value to British Gas of new wholesale gas contracts. The business decision as to the desirability of the contract seemed to be reduced to a calculation; no judgment appeared to be involved. If the numbers were cranked and the NPV positive we should go ahead. In truth the business judgement had been hidden. It had been reduced to a function in the equation. It was the discount rate used. The answer was only spuriously objective. A prudent judgment about the likely value of the deal had still to be made. Modern techniques can obscure as well as elucidate the issues. I saw Sir Ken Morrison interviewed on television the other day. He was asked by a bright young thing about Morrison's business strategy. He said "We try to provide good quality products people want at prices they will pay." It would be difficult to confuse him with sophisticated jargon or take his eye off the ball. He knows that business is just as easy and as difficult as that.

But imprudence often arises from arrogance too. And this is a complicated matter. At a conference at Ridley some years ago about different kinds of leadership I wondered aloud whether there was an alternative source of the confidence needed by big businesspeople. Be that as it may, arrogance is a common fuel for the engine of big business. Fatally, men driven by arrogance begin to believe their own propaganda about themselves and their company. They come to believe that they are invincible and they lose touch with reality. They so terrify their subordinates that they only get advice they want to hear. Maxwell was the best recent example of that. And then (I saw this at British Gas where we had a martinet at the helm) the subordinates begin to guess what the boss will want to hear. If someone is brave enough to try to tell them the truth they are put down. I saw a bit of Ken Lay in his heyday and have seen him slap down both in public and in private advice from Enron staff that he did not want to hear. Arrogance is a sure recipe for imprudence and imprudence a sure recipe for disaster.

Then there are the full-blown follies de grandeur. The empire that expands once too often. The step too far. The final takeover that breaks the group. The vaulting ambition that overleaps itself. The exercise of commercial power is a heady cocktail. The strict observance of the law becomes a matter for lesser mortals. The belief that enough money can buy anything and anybody; that markets can be rigged with impunity and so on. It is not intellect that fails or energy or knowledge. It is prudence that has been lost. The boss of World.com knows it now.

It interests me that the whole culture of regulation by the DTI, the FSA , Ofcom, Ofgem, the rail regulator and the rest seems to result from the privatisation of large parts of the economy in a moral climate where the management of these powerful companies cannot be relied on to do the just or prudent thing. So imprudent actuaries have bureaucrats looking over their shoulder; franchised suppliers who might imprudently exploit their market power have bureaucrats looking over their shoulder; a purveyor of dodgy financial instruments has a bureaucrat looking over his shoulder. Surely the truth is that they are poor substitutes for virtuous business leaders.

Calculating Risks

But what about the criticism that prudence leads to caution, and caution is inimical to the successful development of a business? Clive Wright, in his CABE paper stated categorically "prudence is not - as common usage suggests - a synonym for caution." Many years ago Blake thought so and went much further. "Prudence" he said "is a rich, ugly old maid courted by incapacity." That is the charge. Prudence is the enemy of business. It is the virtuous cloak that covers the incapacity to do any of the things that start businesses, grow businesses and make them flourish. Business is about identifying a market and taking big risks to supply it in the expectation of reward. Prudence is the last thing you want. Flare, vision, nous, energy, enthusiasm, determination, charisma; these are the virtues of the businessperson. Prudence, like a ball and chain will dog his every step.

I think this charge can be met. There is a caricature of the swashbuckling businessperson who would take little time to do the prudent thing or value prudence as a business virtue. But it is a caricature. Those who survive take carefully calculated risks. They don't take risks with the whole business. They take risks that the company can survive if a decision proves unwise. Decisions may go wrong 30% of the time as Percy Barnevik said but the 70% that were right will absorb the failures. They might prefer to be called shrewd than prudent but I think it means the same. They are, above all, people of practical commonsense. Indeed, because they handle the possibility of great wealth for themselves and are as prone to the temptations of greed as anyone else, the entrepreneur needs to take a very sober view of risk. Yes, the return on an investment opportunity may be 100 or 200% if it comes off but if the risks are too high and not wise to take it must be avoided.

But caution can be as costly to a business as undue risk. Business is no place for faint hearts. And it is precisely because undue caution will wreck a business just as surely as undue risk that prudence is required. It is prudence that steers him between undue risk on the one hand and caution on the other. Balanced minds focus with a steely determination, almost a menacing gaze, on the essential issues. They stare the consequences of action and inaction in the face every day. "Good quality products that people want at a price they will pay." It's not rocket science and Sir Ken would not claim it is. But I'm sure he thinks of nothing else than the product, the quality and the price. And I bet he didn't pay too much for Safeway.

Finally is it not interesting that money cannot buy the most important ingredients of a successful business? You want analytical advice, endless different cases run on endless different combinations of assumptions? Send for McKinsey. You want good commercial legal advice? Off to King's Bench Walk or Essex Court. You want good, obliging and, if need be, creative accountants? Ring PWC or Deloitte. You want advertising? Nip round to Saatchi. Take your cheque book with you and the problem can be solved. You can always hire brains and expertise. But don't ask your lawyers if their proposal is just. They will look at you as though they've seen a ghost; and you can't ask PWC for a ten page draft of prudence, McKinsey for a box file full of moderation or Saatchi for a campaign of courage. No, the vital ingredients of a business reside in the head and the heart of the management. Justice is one of them; prudence is another. And moderation and courage are still to come.

Money can't buy them. Business can't do without them.