Gainsharing and Goalsharing: Aligning Pay and Strategic Goals : Aligning Pay and Strategic Goals 9780313059223, 9781567204926

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Gainsharing and Goaisharing

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Gainsharing and Goaisharing ALIGNING PAY AND STRATEGIC GOALS

Kenneth Mericle and Dong-One Kim

PRAEGER

Westport, Connecticut London

Library of Congress Cataloging-in-Publication Data Mericle, Kenneth S. Gainsharing and goaisharing : aligning pay and strategic goals / Kenneth Mericle and Dong-One Kim. p. cm. Includes bibliographical references and index. ISBN 1-56720-492-9 (alk. paper) 1. Gain sharing—United States. 2. Incentives in industry—United States. 3. Strategic planning—United States. I. Kim, Tong-won, 1960- II. Title. HD4928.G342U65 2004 658.3'225—dc22 2003060106 British Library Cataloguing in Publication Data is available. Copyright © 2004 by Kenneth Mericle and Dong-One Kim All rights reserved. No portion of this book may be reproduced, by any process or technique, without the express written consent of the publisher. Library of Congress Catalog Card Number: 2003060106 ISBN:'1-56720-492-9 First published in 2004 Praeger Publishers, 88 Post Road West, Westport, CT 06881 An imprint of Greenwood Publishing Group, Inc. www.praeger.com Printed in the United States of America

The paper used in this book complies with the Permanent Paper Standard issued by the National Information Standards Organization (Z39.48-1984). 10

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Contents

Illustrations

vii

Preface

xi

Acknowledgments

xiii

Chapter 1

Introduction: W h a t Is Gainsharing?

1

Chapter 2

Types of Gainsharing

7

Chapter 3

Review of Literature

23

Chapter 4

Gainsharing Plans in N o r t h America: 1992 and 1999

49

Chapter 5

Getting Started: Preliminaries to the Design Process

73

Chapter 6

Designing a Gainsharing Plan

93

Chapter 7

Administering a Gainsharing Plan

125

Chapter 8

Successful Gainsharing Programs

141

Chapter 9

Reasons for Failure of Gainsharing Plans

167

Chapter 10

Summary and Conclusion

189

Appendix A

Example of a Memorandum Scanlon Plan

Appendix B

of Agreement on a

A Rucker-Style Gainsharing Plan Based on Value Added

199 205

vi Contents Appendix C

An Example of a Goaisharing Plan

211

References

225

Index

231

Illustrations

TABLES 2.1

Determining Product Standards

14

2.2

Improshare—Measuring Output

14

2.3

Improshare—Measuring Inputs

15

2.4

Improshare—Measuring Productivity

15

2.5

Calculation of Gain in Multifactor Plans

18

2.6

Goaisharing

20

3.1

Summary of Gainsharing Studies by Period and by Type

24

3.2

Summary of Gainsharing Studies by Subject

24

3.3

Summary of Studies Investigating the Impact of Gainsharing

26

3.4

Studies of Factors Influencing the Performance of Gainsharing

31

3.5

Studies Formulating a Theoretical Framework for Gainsharing

38

3.6

Studies Addressing Issues Related to Gainsharing

43

4.1

Initiation Years of Gainsharing Programs

51

4.2

Industry Distribution of Establishments with Gainsharing Experiences

53

viii

Illustrations

4.3

Size of Establishments with Gainsharing Experiences

53

4.4

Objectives in Implementing Gainsharing Programs

57

4.5

Design Process of Gainsharing Programs

59

4.6

Size of Bonus Groups

60

4.7

Employee Share of the Bonus Pool

61

4.8

Number of Employee Involvement Programs Accompanying Gainsharing

63

4.9

Union Participation in the Operation of Gainsharing Programs

64

4.10

Measures of Performance of Gainsharing Programs

65

4.11

Impact of Gainsharing on the Union and Its Members

61

6.1

Measures of Productivity

98

6.2

Scanlon Reserve Funds

105

6.3

Linking Profit Rates and Shares

108

6.4

Customer Satisfaction

113

6.5

Improshare Capital Investment—Adjusting Standards

118

6.6

Improshare Capital Investment—Calculating Gain

118

7.1

Team M e m b e r Duties and Responsibilities

133

7.2

Integrating Gainsharing

135

8.1

Allowable and Excluded Cost Categories

156

8.2

Example of Bonus Calculations

157

8.3

Screening Team Structure

159

8.4

Yearly Records of Gainsharing Bonuses

162

8.5

Yearly Records of Employee Suggestions

163

8.6

Reasons for Success and Ongoing Challenges

166

9.1

Reasons for Failure of Gainsharing Plans

186

10.1

External and Internal Conditions Favoring Gainsharing Plans

196

10.2

Implementation and Design Factors Favoring Gainsharing Plans 197

10.3

Factors Associated with Unsuccessful Gainsharing Plans

197

B.l

Example of Gainsharing Calculations in a Rucker-Style, Value-Added Plan

209

Illustrations

ix

C. 1

Example of Monthly Waste Report

215

C.2

Dollars Gained for Reaching Customer Satisfaction Targets

217

C.3

Linkage between Profit Rate and Employees' Share of Gain

218

C.4

Example of Quarterly Bonus Calculations

219

C.5

Example of Year-End Bonus Calculations

220

C.6

Calculation of the Composite Profit Rate

223

FIGURES 4.1

Regional Distribution of Establishments with Gainsharing Experiences

52

Labor Intensity of Establishments with Gainsharing Experiences

54

Product (Service) Market Conditions of Establishments with Gainsharing Experiences

55

4.4

Union Status of Establishments with Gainsharing Experiences

56

4.5

W h e t h e r Employee Vote Was Administered to Initiate a Gainsharing Program

58

Approval Rates in Employee Votes to Initiate a Gainsharing Program

59

4.7

Types of Gainsharing Programs

60

4.8

Frequency of Gainsharing Bonuses

61

4.9

Reserve Funds in Gainsharing Plans

62

4.10

Types of Employee Involvement under Gainsharing

63

4.11

Outside Consultant Involvement in the Operation of Gainsharing Programs

64

4.12

Retention of Gainsharing Programs in the 1992 Survey

69

4.13

Retention of Gainsharing Programs in the 1999 Survey

70

4.14

Reasons for the Discontinuation of Gainsharing Programs

71

6.1

Controllable Expense per Ton, Monthly Calculations (Base = 2000-01)

100

Controllable Expense per Ton, Six-Month Rolling Average (Base = 2000-01)

101

4.2 4.3

4.6

6.2

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Preface

W o r k on this book really began in the mid-1980s when the School for Workers at the University of Wisconsin first began to offer training on gainsharing and high performance manufacturing strategies. Ken Mericle and his colleagues decided to move into these areas because they were convinced that the new ideas on quality, work organization, technology, and employee participation that were in circulation constituted a new paradigm for organizing production and overall business strategies. T h e y also felt that the new systems were disseminating rapidly and were being driven by powerful competitive forces. T h e y concluded that it was imperative that union and business leaders understand these developments and begin to develop strategies for dealing with the new systems. From the beginning, it was clear that compensation would be a key aspect of the dialogue on transformation. T h e old pay practices, based on the theories of Frederick Taylor, were not very compatible with the new production systems. Piecework and fragmented job structures composed of dozens of narrowly focused job classifications did not allow for the flexible deployment of skills required in the new manufacturing environment. N e w ideas on how to pay people in ways that reinforced and supported the production systems were as essential to success as cutting inventories or implementing just-intime principles. Gainsharing, although not a new idea, succeeded in reinventing itself and finding a niche in this brave new world. T h e practice of gainsharing evolved to capitalize on the opportunities presented by the new flexible and interdependent production strategies. Gainsharing began to incorporate new performance indicators to match the goals of the new production strategies. N e w

xii

Preface

concepts on measurement merged with new ideas on how to structure and mobilize employee participation to produce new and original approaches to gainsharing. As the gainsharing practices became more diverse, so too did its application, spreading first within manufacturing and then to the service sector. In this dynamic environment, Mericle's role evolved from classroom teacher to consultant/facilitator and troubleshooter. Most of his new projects involved cooperative endeavors between workers and managers to adapt gainsharing or goaisharing to their specific environments. In the early 1990s, D o n g - O n e Kim was pursuing a P h . D . from the Industrial Relations Research Institute at the University of Wisconsin. T h e topic of his dissertation was gainsharing. Kim did not know at the time that he was a participant in an intellectual renaissance on gainsharing that resulted in a large volume of creative research. This research utilized new methodologies to address old issues in new ways and to begin to explore new questions about gainsharing. Kim's work involved a large-scale survey in 1992 that he repeated in 1999 to create a rare, broad-scoped, longitudinal study. His data are invaluable as a source on the practice and evolution of gainsharing. Utilizing these two surveys, he conducted a series of empirical research projects exploring various issues regarding gainsharing such as (1) factors influencing the performance of gainsharing; (2) the impacts of union status and union involvement in gainsharing; and (3) factors influencing the survival of gainsharing programs. T h e present book discusses his empirical findings at various places and provides further practical implications based upon them. W e have attempted to write a book that synthesizes theory and practice. W e believe that our original research, and our review of recent research conducted by others, will be of interest to students of compensation practices in general, and gainsharing and goaisharing in particular. We have also tried to present the research findings in a way that will provide practitioners with practical ideas that can be used in gainsharing design and administration. T h i s book is also based on diverse consulting and teaching experiences acquired over two decades. While we obviously intend that the information presented on the practice of gainsharing will be useful to human resource managers, plant managers, union officers, and other individuals who are struggling to create and nurture gainsharing plans, we also intend that this practical information will be a source of ideas and issues that researchers can draw on for systematic study in future research. W e hope that our mix of theory and practice will lead to new theory that is enriched by practical insights, and new practice that is enriched by theory.

Acknowledgments

D o n g - O n e Kim thanks Ken Mericle, Paula Voos, George Strauss, Craig Olson, W. Lee Hansen, J o h n Lund, and Richard U. Miller for their inputs, stimulation, and encouragement during his intellectual journey, and acknowledges the diligent research assistance of Sang Jin Kim, Yoon H o Kim, H y u n Sik Yun, and other assistants at Korea University. His wife, Kwi-Ok, his daughter, Ji-Eun, and his son, Paul, have been invaluable for their warmhearted support. Finally, Kim would like to dedicate this book in memory of his parents. Ken Mericle thanks his colleague and friend D o n g - O n e Kim for suggesting this project and doing the early work that gave it momentum. Ken also wishes to thank his colleagues at the School for Workers for their support; his wife, Mindy, and his children David and Laura for their love; and Rick Lamb, Tom Steepy, and Shirley Geoffroy for their contribution to the "Seats Case." H e dedicates this book to the workers and managers who have taught him so much about gainsharing and so many other things in his 25 years as a labor educator.

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CHAPTER 1

Introduction: What Is Gainsharing? As global competition has intensified since the 1980s, the economic competitiveness of U.S. industries, both in the private and public sectors, has become a national concern. Recent widespread experimentation with innovative human resource programs represents one important response to this competitive challenge. These programs take many different forms, including employee involvement (El), quality circles (QC), quality of work life (QWL), suggestion systems, gainsharing and goaisharing, profit sharing, labor-management committees, autonomous work groups, employee stock ownership programs (ESOPs), job rotation, survey feedback, total quality management (TQM), and knowledge/skill-based pay (Appelbaum and Batt 1994; Appelbaum et al. 2000; Cotton 1993; Eaton and Voos 1992; Levine and Tyson 1990; Mericle and Kim 1999a, 1999b; Osterman 1994, 2000; Weitzman and Kruse 1990). According to most evaluations, gainsharing and team production systems are considered particularly potent among the various types of recent innovative human resource programs (Cotton 1993; Eaton and Voos 1992). Indeed, Kim (1996), based upon survey data from 269 establishments with gainsharing programs, found considerable evidence that gainsharing helped improve organizational performance. Specifically, 63 percent of survey respondents reported that their gainsharing programs were successful (42.9%) or very successful (20.3%). Over two-thirds of respondents (71.7%) reported that gainsharing improved labor productivity, while about half (51.6%) stated that gainsharing was very successful (10.4%) or successful (41.2%) in improving product quality. About two-thirds (65.1%) reported that gainsharing reduced production costs, while 89.6 percent of respondents reported that

2

Gainsharing and Goaisharing

gainsharing resulted in minor (40.8%) or major (48.8%) improvements in the production process. In a report evaluating gainsharing effectiveness in over 36 American companies, the U.S. General Accounting Office (1981) found that gainsharing resulted in labor cost savings averaging 17 percent, along with improved work relations, reduced absenteeism, reduced turnover, and fewer grievances. Bullock and Lawler (1984, 33) reviewed 33 case studies on the effect of gainsharing and concluded that in 74 percent of the cases, at least one indicator of overall success improved. In more than half of the 33 cases, improvements were found in five dimensions: organizational effectiveness, quality of work life, innovation, labor-management cooperation, and pay. In a survey by the American Productivity Center and the American Compensation Association, 81 percent of 170 firms with gainsharing programs reported positive overall program performance (O'Dell and McAdams 1987a, 71). Voos (1987, 1989) found that in unionized Wisconsin firms gainsharing was consistently found to have greater positive effects on productivity, flexibility in utilizing labor, and firm performance than other labor management cooperation programs, including profit sharing, labor-management committees, and ESOPs. As their positive effects have been documented, gainsharing programs have been adopted by American corporations at an accelerating rate. T h e r e is little doubt that more programs exist than ever before. Limited survey data suggest that by the early 1990s about one in seven American firms had some form of gainsharing. For example, the Society for H u m a n Resource Management (SHRM), in a survey of its members, found that gainsharing was being used by 13.4 percent of its affiliated organizations (219 of 1639) (Markham, Scott, and Little 1992). Osterman (1994), using telephone survey data from 694 U.S. manufacturing establishments that were considered representative U.S. establishments, found that 13.7 percent were using gainsharing programs. T h e adoption rate appears to be even higher among very large firms. Surveys by Lawler, M o h r m a n , and Ledford (1992) in 1987 and 1990 showed that the proportion of Fortune 1000 firms reporting the use of gainsharing increased from 26 percent (of 476 respondents) in 1987 to 39 percent (of 313 respondents) in 1990. Two surveys of the same 287 firms conducted by Towers Perrin indicated that 12 percent of the firms were using gainsharing in March 1990, and 21 percent were using it in October 1991 (Towers Perrin 1992). Recent evidence also demonstrates that gainsharing programs have spread from manufacturing corporations to sendee organizations (e.g., insurance companies, banks, airlines, the health care industry, and national restaurant chains) (Droste 1987; Forbes 1985; Jewell and Jewell 1987; Kazemek and Candrilli 1988; Lewis 1987; Markham et al. 1992) and the public sector (Miller and Schuster 1995; Ray and Altmansberger 1999). It seems likely that gainsharing will be adopted increasingly in the service and public sectors over time. T h e r e are also indications that the concept of gainsharing has spread to

Introduction

3

other countries such as Norway (European Industrial Relations Review 1996), N e w Zealand (Gibson 1995), and Canada (Kim 1996).

AN OVERVIEW OF GAINSHARING Gainsharing programs, such as the Scanlon, modified Scanlon, Rucker, Improshare, and goaisharing plans, are contingent compensation schemes often combined with an employee involvement component. U n d e r gainsharing programs, each member of a group receives a bonus based on the performance of the group as a whole, rather than on the employee's individual performance. While profit sharing provides employees with a company-wide bonus based on some percentage of company profits or profits beyond some fixed minimum, gainsharing can be implemented on a company, establishment, or departmental basis, and employees are generally paid a portion of the gains generated when group performance exceeds a predetermined level. Bullock and Lawler (1984) defined a gainsharing plan as "an organizational system of employee involvement with a financial formula for distributing organization-wide (or department-wide) gains." T h e essence of gainsharing is to share the responsibility for organizational improvement (e.g., cost, quality, and productivity) and the resulting rewards. Bullock and Lawler argued that the basic principle of gainsharing is to establish effective structures and processes of employee involvement and a fair means of rewarding systemwide performance improvements (1984, 23-24). G r a h a m - M o o r e and Ross (1990, 3-4) added an attitudinal element, the philosophy of cooperation, to the above two structural elements (employee involvement and financial rewards). According to these authors, gainsharing comprises three components: the philosophy of cooperation, the employee involvement system, and the financial bonus. Graham-Moore and Ross argued that these three components mutually reinforce each other. T h a t is, a higher level of cooperation leads to information sharing, which in turn leads to employee involvement. This employee involvement system, for example, the employee suggestion system, improves organizational productivity. T h i s increase in productivity then results in a financial bonus that rewards or reinforces the philosophy of cooperation. Although national interest in gainsharing has been increasing since the 1980s, the concept has existed in this country for nearly 100 years in a variety of forms. While H e n r y Towne coined the term gainsharing to describe his firm's group incentive plan in 1896, which was similar to modern gainsharing programs and differentiated from profit sharing plans, it was in the 1930s that the Scanlon plan, the most well known gainsharing program, was developed in the steel industry (Zalusky 1986). T h e Scanlon plan, developed by Joe Scanlon, was initiated in 1938 as a cost-saving, employee suggestion system at the Empire Steel and T i n Plate Company of Cleveland. T h e eminent success of the Scanlon plan at Empire Steel led to its widespread implementation

4

Gainsharing and Goaisharing

at other corporations (Gowen 1991, 77-78; Graham-Moore 1990, 19). While the Scanlon plan had gained substantial attention, the Rucker plan, a variant of the Scanlon plan, was devised in the late 1940s. T h e Rucker plan, which uses a productivity measure different from that of the Scanlon plan, was developed by Allan W. Rucker of the Eddy-Rucker-Nickels Company in Cambridge, Massachusetts, near the end of World War II (Fein 1982, 9; Zalusky, 1986). By 1968, approximately 180 Scanlon plans existed with 300 to 500 plants using some version of the plan (Lesieur and Puckett 1968). In 1973, Mitchell Fein developed Improshare, based on a new approach to measuring productivity (Fein 1976, 1982; G r a h a m - M o o r e 1990, 19). T h e 1980s witnessed the advent of goaisharing, a variation of the gainsharing concept. Whereas gainsharing rewards are based on a group's financial performance such as reducing labor costs or operating costs, or increasing sales value of production or value added, goaisharing takes a customized approach by adding a variety of nonfinancial goals such as quality, delivery records, customer satisfaction, and safety records within a unit of an organization (Garvey 2000). Interest in gainsharing among academicians and practitioners increased during the 1990s, because gainsharing better fits the current trend toward flatter organizations. Intensified global competition has led organizations to move toward reduced hierarchy in flatter structures, a wider span of control, flexible utilization of human resources, decreased job security, and weaker attachment of employees to the employer. Organizations experiencing this transformation hope to operate more efficiently and respond more quickly to rapidly changing environmental conditions. Because they have been moving away from long-term, bureaucratic relationships with their employees, it has become more difficult for them to motivate their employees through promotions. Organizations that have short job tenure and flat structures need to replace career ladders with other reward mechanisms. T h e y also need mechanisms to substitute for the reduced ability of supervisors to monitor employee behavior directly due to the wider span of control. Responding to these challenges, organizations rely increasingly on outputcontrol systems such as performance-based pay as an alternative reward system, because it is easier for supervisors to monitor outputs (rather than supervising inputs and effort in each task) of a larger number of subordinates (Mangel and Useem 2000). Among various performance-based pay systems, group-level systems such as gainsharing are most promising, because individual-level performance-based pay raises many problems in the current organizational environment. For example, it is increasingly difficult to measure individual performance, because most jobs are rarely independent under the highly interconnected flatter structures. T h e s e trends suggest that gainsharing will become an essential component of compensation systems in future organizations. In particular, gainsharing may be more appropriate in emerging business sectors such as venture enterprises that are characterized

Introduction 5 by fluid employment relations, flatter hierarchy, and an emphasis on performance-based control rather than bureaucratic control. In sum, gainsharing should continue to be an important compensation element in the manufacturing, service, and public sectors, as well as in the newly emerging venture businesses. We also believe that much of the upsurge in interest in gainsharing is a consequence of the introduction of high performance work practices, in particular the reorganization of work and the various forms of employee involvement. Work reorganization generally leads to production systems that are more interdependent and therefore more dependent on cooperative behavior and group, rather than individual, performance. Cellularization, continuous flow, focused factories and team production in manufacturing, and their analogs in other economic sectors, are examples of this development. As work evolves away from a model of individuals working alone on narrow and independent operations to groups working together in interdependent processes, pay systems like gainsharing that emphasize group motivation align more closely with the logic of the production system. A corollary is also true: pay systems based on motivating individual behavior in narrow job classifications, such as piecework or individual incentive systems, increasingly conflict with the logic of the new work systems. Indeed, the increase in interest in gainsharing has been accompanied by parallel trends on the disappearance of piecework and reduction in the number of narrow job classifications. Increased involvement in decision-making by employees also favors gainsharing by providing a foundation for mobilizing employees in support of the concept and by involving them directly in discussions about the business and the indicators of organizational performance on which gainsharing is typically based.

ABOUT THIS BOOK The uniqueness of this book can be summarized in three points. First, this book is research based, with primary emphasis on two nationwide surveys conducted in June 1992 and September 1999. These surveys included detailed information about firms with gainsharing experience: firm characteristics, environmental contingencies, implementation processes, details of programs in terms of bonus system and employee involvement, and various outcomes of gainsharing. These surveys produced the largest data set in the field of gainsharing (269 firms with gainsharing experience) and included the most detailed information about gainsharing. Based upon these two surveys, this book can provide analysis of various issues related to gainsharing: the choice of gainsharing formulas, determinants of the performance of gainsharing programs, the impact of unions on gainsharing performance, determinants of the survival of gainsharing, and a detailed description of the current status of

6

Gainsharing and Goaisharing

gainsharing in North America. In addition to the analysis of the survey data, we provide an extensive review of the vast literature on gainsharing. Second, this book is experience based. Drawing on two decades of consulting activity, we present a step-by-step guide to designing, implementing, and administering gainsharing programs. We start with a discussion of the various types of gainsharing and their advantages and disadvantages. We proceed to the practical problems of making choices about specific plan features and the analysis of practices that support successful day-to-day administration. Finally, this book includes an in-depth analysis of case studies of successful and unsuccessful gainsharing programs. By comparing successful and unsuccessful experiences, readers will be in a better position to determine the factors that lead to success or failure of gainsharing plans.

CHAPTER 2

Types of Gainsharing

Gainsharing is a variable compensation system that is based on evaluating group performance against key performance indicators for the organization and paying bonuses to members of the group that are funded by a portion of the gains achieved. Most gainsharing programs also include structures and procedures that are designed to mobilize employee participation in support of the gainsharing process. At a conceptual level gainsharing is relatively simple. The relevant group is defined (usually the entire facility); key performance indicators are identified; target or base values are set for each indicator; gains based on performance that exceeds targets or base values are quantified; formulas are established for dividing gains between the employer and group members, and distributing gains among individuals in the group; and a variety of committees and participatory mechanisms are created or identified to encourage employee participation in support of the whole process. The Scanlon plan, the first type of gainsharing to achieve widespread popularity in the United States, illustrates these points. Early Scanlon plans usually covered all of the hourly (bargaining unit) employees in an entire factory. The single performance measure was labor productivity, as measured by the ratio of payroll costs of hourly employees (inputs) divided by sales value of production (outputs). The target or base value for labor productivity was usually established measuring the actual ratio of payroll to sales value of production in a one or multiple-year base period just prior to the introduction of the plan. Gains were based on savings in payroll costs resulting from improvements in productivity. The gains were then split, usually 75 percent to plan participants and 2 5 percent to the employer, and distributed to individual employees based on relative earnings. This whole process was supported by

8

Gainsharing and Goaisharing

an elaborate system of production committees at the department level and a screening committee at the plant level whose purpose was to evaluate productivity enhancing ideas submitted on special forms by individuals and groups. T h e Scanlon plan is a useful benchmark for analyzing how and why the concept of gainsharing has evolved in the past several decades. Significant changes have occurred in both the formulas used to measure financial performance and the means by which employee participation is stimulated and harnessed. T h e new approaches to measuring performance have involved a rethinking of how productivity is measured, with an emphasis on addressing the alleged shortcomings of the Scanlon approach. By substituting value added as a measure of outputs for sales value of production under Scanlon, Rucker plans bring material costs into play. Any reduction in material costs, whether caused by reductions in price or usage, reduces outside purchases and increases value added and hence productivity for a given level of payroll cost. T h e Improshare approach to measuring productivity controls for price volatility of both the inputs and outputs by substituting a physical measure of productivity for the monetary measures used in Scanlon and Rucker plans. T h e multifactor or modified Scanlon plans attempt to address the criticism that traditional Scanlon plans based on measuring labor productivity are too narrowly focused on a relatively small share of total production cost (labor). Multifactor plans create a larger target for generating input cost savings by substituting "controllable costs—labor, materials and overhead" for payroll in the numerator of the productivity ratio. T h e y differ from Rucker plans by focusing only on the portion of outside purchases that are controllable by plan participants. Each of these approaches to measuring productivity has its strengths and weaknesses, and, contrary to the claims of advocates, none is universally superior in all contexts. Because productivity remains the most important measure of performance in nearly all gainsharing plans, it is imperative that organizations considering adopting gainsharing understand the strengths and weaknesses of all approaches to measuring productivity. A second way that measurement of performance has deviated from the Scanlon benchmark is the inclusion of additional measures of organizational performance. Scanlon relies on the single measure of labor productivity; many new plans, often referred to as goaisharing plans, incorporate additional measures of performance such as quality, on-time delivery, customer satisfaction, inventory reduction, and so on. T h e main impetus for including these performance indicators has been their growing importance in the market place and the emergence and diffusion of new production strategies. Customers are universally interested in quality, delivery responsiveness, and cost. T h e ascendance of these goals and the redesign of organizations to achieve them, based on new theories of production design (continuous flow, just-in-time, cell manufacturing, T Q M , etc.), has been well documented. It is not surprising

Types of Gainsharing

9

that organizations have attempted to align compensation practices in general and gainsharing in particular with these new production strategies (Mericle 1993; Mericle and Kim 1999b). Scanlon is also a useful benchmark for analyzing employee participation structures and practices. T h e participatory mechanisms in early Scanlon plans relied on a formal system in which individuals recorded their ideas on a special form and submitted them for evaluation. Scanlon deviated significantly from the prevailing practices of the time by empowering joint committees of labor and management to evaluate and implement ideas rather than reserving this power to management as was typical in conventional employee idea programs. T h e Scanlon practices predate the huge upsurge of interest in employee participation structures and procedures that occurred in the 1970s, 80s, and 90s. Participation is now focused much more on the role of groups in generating, analyzing, and implementing ideas. Nowadays most organizations have a history of experimentation with employee participation, and many have various structures already in place at the time that they are considering implementing gainsharing. U n d e r these circumstances it doesn't make sense to reinvent the wheel. An inventory of all employee participation, past and present, should be conducted and gainsharing participation should be integrated with the overall participatory strategy of the organization. Considerable choice on a range of important design issues is now available in selecting or designing gainsharing programs. This chapter reviews the advantages and disadvantages of the various approaches to measurement and participation. It also identifies the constraints an organization faces in making choices. O u r goal is to provide a framework for evaluating which choices are appropriate for your organization. Productivity is the most important performance indicator in most gainsharing plans because of its direct impact on production costs and profits and because productivity gains are easily measured and easily quantified. In this book we are using the term productivity in the broad and generic sense to mean the relationship between inputs and outputs in the production process. Productivity = Inputs / Outputs In common usage the term is generally used to refer to the relationship between labor inputs and a measure of output, for example, hours worked per ton of steel. T h e ratio is sometimes reversed and expressed as outputs divided by inputs. For example, cases shipped per hour is a common measure of productivity in the warehouse industry. T h e traditional approaches to gainsharing can be differentiated and classified on the basis of how they measure productivity. Many of the advantages and disadvantages associated with the traditional approaches are directly related to variations in productivity measurement. Starting with Scanlon and

10

Gainsharing and Goaisharing

using it as a benchmark, this chapter classifies and analyzes the main approaches to gainsharing based primarily on how they measure productivity.

SCANLON U n d e r the Scanlon plan, the measure of inputs is the payroll cost of the employees covered by the plan, and the measure of outputs is sales value of production. Appendix A contains the full text of a memorandum of agreement on a Scanlon plan. Payroll costs are determined by identifying eligible employees, usually hourly employees in traditional Scanlon plans, and calculating the total wages they received from payroll records. Sales value of production (SVP) is a bit more complicated to calculate. It represents an attempt to evaluate the sales value at current prices of output produced. SVP is a more appropriate measure of the value of output than sales because sales in any given period can come directly from production or from final goods inventory. H e n c e sales may overstate or understate the value of production depending on whether final goods inventory is decreasing or increasing. T h e formula for calculating SVP is as follows: SVP = (Sales ± Inventory Change) — Returns Customer returns are subtracted in order to maintain a focus on quality. T h u s SVP represents the value of output (product of acceptable quality to the customer, evaluated at current prices) of product produced during the same period that the payroll cost was incurred. O n e of the main advantages of the Scanlon plan is that it is relatively simple and easy to explain and understand. Suppose the base period ratio (target productivity value) of a Scanlon plan is 0.25; that is, the ratio of payroll cost to SVP in the base period was 1 to 4 or 0.25. This plan can be explained to plan participants as follows: "During the base period the company spent 25 cents on wages for every dollar's worth of product it produced. W e can earn a bonus under this plan if we can produce more than a dollar of product for each quarter spent on payroll." U n d e r Scanlon, both inputs and outputs are readily identifiable and easily understood concepts. Later we will see that the gainsharing plans that came after Scanlon sacrificed some of its conceptual simplicity in order to address perceived problems in the Scanlon approach. T h e Scanlon plan utilizes a monetary measure of productivity: inputs are measured in payroll expenses incurred and outputs are measured in sales values produced. T h e major disadvantage of the monetary approach is that the measurement of productivity can be influenced both by usage and price fluctuations. T h i s point can best be illustrated by disaggregating the Scanlon measures of inputs and outputs as follows:

Types of Gainsharing

11

Payroll = Hours Worked X Average Wage SVP = Units Produced X Average Price Productivity = Payroll / SVP Productivity = (Hours Worked / Units Produced) X (Average Wage / Average Price) T h u s the Scanlon ratio (and any other monetary measure of productivity) is composed of a physical measure of productivity that measures the usage of inputs (hours worked) in comparison to a physical measure of outputs (units produced), and a ratio of input prices to output prices. Because plan participants cannot directly influence the prices of labor and product, the influence of relative changes in prices can be considered uncontrollable noise in the measurement of productivity. T h e impact of the price ratio may be unimportant if prices are stable or if the prices of labor and product move in tandem. However, if wages rise while product prices remain stable, gains in physical productivity will be offset by the deterioration in the price ratio. Likewise, if product prices rise faster than wages, the change in the price ratio will lead to an overstatement of the increase in productivity. Viewed solely from this perspective of controllability, any monetary measure of productivity is less satisfactory than direct measures of physical productivity because workers can influence or control the usage of inputs for a given level of output, while they cannot directly influence relative price changes. A counter argument can be constructed based on the standard of "accountability." According to this line of thought the gainsharing plan must ultimately be accountable in the sense that it must be consistent with the basic business goal of making a profit. U n d e r the accountability standard, monetary measures of productivity are superior because, like profits, they reflect the relative movement of input and output prices and hence are more likely to correlate closely with profitability. From this perspective, productivity measures that incorporate price ratios reflect more accurately the monetary realities of the business world and hence are superior to physical measures of productivity. T h u s monetary measures like Scanlon are inferior or superior depending on the standard used for evaluation. T h e real value of this discussion lies not in establishing whether Scanlon is an inferior or superior approach to measuring productivity, but rather in identifying potential problems that m o n e tary plans face. T h e impact of relative price changes must be carefully monitored under these plans. Relative price changes should be considered in annual reviews of productivity targets. Price changes can result in overstatement of gains or conversely they can erode motivation when participants are working hard to improve physical productivity only to witness the fruits of their efforts being obliterated by adverse price changes. Periodic adjustment of the productivity target based on balancing controllability and accountability standards is essential under monetary plans. Another alleged disadvantage of Scanlon plans relates to the relative importance of labor costs in the overall cost of production. In many organiza-

12

Gainsharing and Goaisharing

tions labor costs represent a relatively small portion of this total cost. In a capital-intensive industry the figure may be 10 percent or even less. In other words, payroll may be a very small target for cost reduction activities, and even significant results like 10-20 percent reductions translate into a very small reduction of 1-2 percent in total cost. T h e small target criticism applies to all "labor only" gainsharing plans (Scanlon and Improshare). To the extent that productivity increases can be achieved by expanding output rather than reducing inputs, this criticism becomes less relevant. However, expansion of output is often constrained because stagnant product markets and market shares limit the ability to sell additional product.

RUCKER T h e Rucker plan represents a partial solution to the small target problem. Appendix B is a full text version of a Rucker-style gainsharing plan based on the value added measurement concept. T h e numerator of the Rucker ratio is identical to the Scanlon measure of inputs—the payroll costs of employees covered by the plan. T h e innovation introduced in Rucker plans relates to how outputs are measured. Rucker substitutes value added (VA) for sales value of production. T h e formula for calculating VA is as follows: VA = (Sales ± Inventory Change - Returns) — Outside Purchases. or VA = SVP — Outside Purchases Outside purchases include the expenditures on materials, components, energy, and other external expenses that are incurred in producing the product. W h e n these expenses are removed, the entity that remains represents the value that is created or added at the facility. Value added is assumed to represent a purer measure of the value of output of the facility. Value added responds directly to reductions in the cost of materials (and other outside purchases). If these costs go down relative to SVP, value added increases and the productivity ratio improves. T h u s employees can earn a bonus not only by reducing payroll cost relative to value added but also by reducing outside purchase cost relative to SVP. Because outside purchases may constitute half or more of total production costs, their inclusion means that the Rucker ratio provides a very large target for cost savings activity. T h e cost of outside purchases responds to employee efforts to reduce the amounts used for a given level of production but it also responds to price fluctuations. H e n c e the bonus potential is subject to the vagaries of price increases for materials, energy, and other potentially volatile items. Rucker plans are most appropriate in organizations that seek a comprehensive approach to controlling expenses and have relatively stable prices on their major outside purchases.

Types of Gainsharing

13

T h e major disadvantage of selecting Rucker over Scanlon is that the Rucker ratio is a harder concept to understand and explain. Value added is a more elusive concept, and the rationale for using it rather than SVP is not easy for the average shop floor worker to grasp.

IMPROSHARE Improshare uses an old concept in a new application and creates an innovative approach to measuring physical productivity. Physical measures of productivity are based on counting inputs and outputs and establishing measures of productivity that are unmediated by price ratios. Simple measures of physical productivity count units of labor inputs (hours worked, full-time equivalents employed, etc.) and relate them to units of output (tons produced, board feet, vehicles assembled, cases shipped, etc.). These simple measures of p r o ductivity differ greatly in terms of the units used to count labor and output, but they share a very important characteristic. In each case there is enough similarity between the units of output that it makes sense to simply count the units and use the total as a measure of value. In effect these measures assume that a ton of paper, an assembled vehicle, and a shipped case are enough like any other ton of paper, assembled vehicle, and shipped case that it makes sense to simply count the units produced and use the total as a measure of the value of outputs. T h e same assumption is made on the input side: an hour worked is enough like any other hour worked to justify using total hours as the value of inputs. By contrast, gainsharing plans that use payroll as the measure of input, weight the hours of labor according to their relative wages. Strictly speaking it is not necessary for inputs and outputs to be perfectly homogenous for physical measures of productivity to be workable. Some heterogeneity can be tolerated as long as the product mix and skill mix of labor are relatively stable. If a simple physical measure of productivity is workable, it should always be considered for use in gainsharing because the measures usually have a history within the organization and hence are well known and well understood. T h e y are also elegantly simple to track and to explain to people. Improshare is not a simple measure of physical productivity. T h e I m p r o share measure of inputs, total hours worked by plan participants, is easy to understand and straightforward to measure. T h e complexity of Improshare productivity measurement results from the approach used to measure the value of outputs. T h e concept of output measurement is not unique but the application is. T h e approach uses the cost accounting and industrial engineering concept of a standard hour of direct labor time to establish the value of output. Using time study and other work measurement techniques, industrial engineers estimate the standard hours required to complete each operation in the manufacture of a product. In the absence of engineered standards, historical data can be used to estimate standard hours. Product standards, or the total standard time to produce one unit of the product, can be obtained

14 Gainsharing and Goaisharing by adding the standard hours for all of the operations required to produce the product. W h e n this step is complete each product has a relative value based on its standard hour content. T h e value of output for each product is determined by multiplying the total number of units produced by the product standard for the product. T h e overall value of output is calculated by adding the total standard hours produced for each of the individual products. T h e overall value of inputs is obtained simply by adding the actual hours worked by the employees covered by the plan. T h e productivity ratio, inputs divided by outputs, equals total hours worked divided by total standard hours produced. A simple example in Tables 2.1-2.4 illustrates these measurement concepts. In the example, the company produces three products: A, B and C. Each of the three products is routed through ten distinct manufacturing operations. T h e gainsharing plan covers 500 employees, and the time period is one year. Table 2.1 shows the number of standard hours allowed to complete each Table 2.1 Determining Product Standards |

Operation Number 01

Product A Standard Hours 0.12

Product B Standard Hours 0.02

Product C Standard Hours 0.06

02 03

0.16 0.22

0.05 0.11

0.12 0.14

04

0.05

0.07

0.05

05

0.19

0.21

0.16

06

0.23

0.10

0.14

07

0.32

0.17

0.24

08

0.11

0.06

0.08

09

0.09

0.06

0.07

10

0.19

0.13

0.14

Product Standards (all operations)

1.68

0.98

1.20

Standard Hours Per Unit 1.68 0.98

Total Standard Hours Produced 192,192 229,320 187,200

Table 2.2 Improshare—Measuring Output Product Product A Product B Product C All Products

Units Product 114,400 234,000

156,000

1.20

608,7123

Types of Gainsharing

15

Table 2.3 Improshare—Measuring Inputs Employee Number 1 2 3 4 5 etc. 500 All Employees

Actual Hours Worked 1960 2156 1960 2352 1862 etc. 2068 1,011,000

Table 2.4 Improshare—Measuring Productivity Total Inputs Total Outputs Productivity Ratio

Actual Hours Worked Standard Hours Produced Actual Hours / Standard Hours

1,011,000 608,712 1.661

of the ten operations for each product. T h e last line in the table shows the total "value" of one unit of each product as measured in direct labor standard hours. Table 2.2 shows how these product standards are used to measure the total value of production; that is, all units of all products for the plant as a whole. Table 2.3 focuses on the input side of the ratio. It summarizes the actual hours worked by the 500 employees. Finally, Table 2.4 shows the calculation of the productivity ratio: inputs divided by outputs or, specifically, actual hours worked divided by standard hours produced. T h e Improshare approach to evaluating output is the same as that used in standard hour wage incentive plans. In these individual incentive operations, output of an individual worker on an individual operation is measured by multiplying the number of units completed by the standard hours allowed for the operation. Individual efficiency or productivity is determined by comparing hours worked to standard hours earned. In measuring the value of outputs, Improshare performs these same calculations for all operations on all products to arrive at the total value of output in standard hours produced. This figure becomes the denominator of the productivity ratio while total hours worked by all plan participants is the numerator. O n the input side, Improshare differs from standard hour incentive calculations by including hours worked by all classes of labor—direct, indirect and salaried—that are covered by the plan.

16 Gainsharing and Goaisharing Improshare works best in batch manufacturing and mass production where detailed standard cost data are generally available and sufficiently reliable for purposes of measuring aggregate productivity. Improshare is generally not applicable in process or quasi-process industries where the distinction between direct labor and indirect labor is less meaningful and the relationship between labor hours and output is difficult to standardize and measure. Improshare also doesn't work in job shop situations because of the absence of standards. Improshare works best in stable, standardized environments where the relationship between labor time and value created is relatively direct and uniform. The main advantage of Improshare, in situations where information systems and environmental conditions exist to support it, is that the plan does not respond to price movements. Wage changes do not influence the value of inputs (actual hours) and product price changes do not influence the value of outputs (standard hours produced). Improshare scores high on the controllability standard because it is based on the physical measurement of labor productivity. The main disadvantage of Improshare lies in the complexity of measurement. This is especially true of the standard written versions of the plan that are provided by Improshare consultants. The plan documents are very detailed and are full of jargon that obscures the underlying measurement concepts. This is unfortunate because Improshare is a complex plan even when the jargon is stripped away and the basic concepts are exposed. It is very difficult for someone who is not trained in engineering or cost accounting to grasp how the abstract concept of direct labor standard hours can be used to develop an aggregate measure of the value of output of an entire factory. Our experience has been that even workers who have been exposed to standard hour incentive plans have trouble with Improshare jargon, and in understanding the aggregation process in applying standard hour concepts in measuring productivity of the entire organization. As in the cases of traditional Scanlon plans, Improshare is a "labor only" plan that does not focus attention on other controllable costs. MULTIFACTOR OR MODIFIED SCANLON PLANS These plans are designed primarily to address the "small target problem" by expanding the scope of cost cutting activities. The denominator of the productivity ratio, sales value of production, is the same as in the Scanlon plan. The differences occur in the numerator of the ratio where other categories of controllable expense (controllable material expense, disposables, controllable overhead expenses, payroll expense of salaried employees, etc.) are added to hourly payroll to increase the size of the target. These plans are particularly advantageous where hourly payroll is a relatively small portion of total cost. They also have the advantage of tracking more closely with prof-

Types of Gainsharing 17 itability especially when they are very inclusive and cover a high percentage of total cost. As these plans incorporate a larger and larger portion of the total cost of goods sold, they begin to converge with profit sharing based on gross margin. In multifactor plans there is an obvious trade off between inclusivity and controllability: the greater the inclusivity, the larger the target and the greater the bonus potential; however, as inclusivity increases so does the likelihood that controllability will be sacrificed because less controllable elements of cost will be included in the productivity ratio. Multifactor plans also tend to be volume sensitive because of the greater likelihood of including some elements of fixed cost in the numerator of the ratio. As production volume declines, these fixed cost elements contract more slowly and thereby increase the difficulty of reaching productivity targets. Conversely as volume increases the fixed costs do not increase as fast and hence are spread over a broader base of production, thus increasing the likelihood of exceeding target levels of productivity. Because of volume sensitivity, bonuses under inclusive multifactor plans tend to be more volatile. As in the case of conventional Scanlon plans, the multifactor plans are easy to understand and explain to plan participants. Perhaps the greatest advantage of multifactor plans lies in their ability to raise people's awareness of the cost structure of the business, the areas where waste is occurring and measures that can eliminate waste. Companies can disaggregate the productivity ratio into major subcategories of expense, and each subcategory can be monitored independently. For example, an overall ratio of $0.60 of controllable expense per dollar of SVP might consist of $0.24 of wage expense, $0.06 of salary expense, $0.12 of operating expense, and $0.18 of controllable material expense. Disaggregated in this way, workers can monitor performance in more targeted areas and attempt to address specific cost problems. Companies typically show the loss or gain for each subcategory of expense as in the example shown in Table 2.5. In actual practice, expenses may be subdivided into dozens of subcategories rather than the four very broad subcategories shown in the table. MIXED MEASURES OF PRODUCTIVITY Many gainsharing plans do not use any of the traditional approaches discussed above, and consequently do not fit into any standard categories. For example, controllable cost per ton of paper is a fairly common measure of productivity in gainsharing in the paper industry. This measure resembles a multi-factor plan in its numerator and a simple physical measure of productivity in its denominator. As such it mixes the physical and monetary approaches to measuring productivity. Measures of this sort are adversely affected by any increases in prices of controllable expense, but they do not receive the benefit of any increase in product prices because of the physical

18 Gainsharing and Goaisharing Table 2.5 Calculation of Gain in Multifactor Plans Disaggregated Productivity Expense Category Wages Salaries Operating Expense Controllable Materials Total Controllable Exp

Ratio

$0.24 $0.06 $0.12 $0.18 $0.60

Allowed Expense $240,000 $60,000 $120,000 $180,000 $600,000

Actual Expense $215,000 $55,000 $126,000 $178,000 $574,000

Gain/ (Loss) $25,000 $5,000 -$6,000 $2,000 $26,000

Notes: (1) In the above example, the value of output (SVP) equals $1,000,000. (2) Allowed expenses are calculated by multiplying SVP by the productivity ratios. (3) Gain equals allowed minus actual expenses.

measurement of output. T h i s asymmetry in the productivity measure implies that the bonus potential of the plan will erode over time as input prices rise. O n the other hand, if product prices are falling, the physical measurement of productivity will actually increase bonus potential. Mixed measures are most appropriate in industries that face falling or highly volatile product prices. Care must be taken to periodically review input prices and adjust the p r o ductivity target to maintain a fair bonus potential.

GOALSHARING As high performance manufacturing strategies diffused throughout the economy in the 1980s and 1990s, organizations increasingly focused on quality, delivery responsiveness, and cost reduction as measures of organizational performance. Strategies to improve quality and on-time delivery frequently required reorganization of the production process based on the principles of continuous flow manufacturing. Inventory reduction became an important goal because of its direct contribution to cost reduction and because of its indirect contribution to both quality and delivery goals. In this new manufacturing environment productivity, especially narrowly defined labor p r o ductivity, became relatively less important as a measure of organizational performance, and gainsharing based exclusively on measures of productivity frequently seemed too narrowly focused. T h e result of these trends has been a rethinking of the gainsharing concept to include key performance indicators in addition to productivity, thus bringing gainsharing into vertical alignment with overall business strategies. T h e term goaisharing is frequently applied to these new plans that are based on several measures of organizational performance. It is certainly possible to measure performance, establish targets, and track improvements in key performance indicators such as quality or on-time de-

Types of Gainsharing

19

livery. However, estimating financial gains that result from improved performance is more difficult for these measures than it is for productivity How much is an improvement in on-time shipment attainment from 92 percent of orders to 96 percent worth? It is obviously worth something in that a good shipping record will make it easier to attract new customers, retain existing customers, and avoid extraordinary costs associated with express delivery or visits to the customer to repair a damaged relationship. The same point could be made about quality. If the reject rate falls from 30 parts per million to 15, how much is it worth? Establishing a dollar value for these types of gains usually involves looking at any data that are available and then making reasonable guesses. Goaisharing plans often include safety as a key performance indicator. Measures such as the number of reportable incidents or lost time accidents, OSHA incident rates, severity rates, workers' compensation claims or expenditures are available and targets can be set; however, as with quality and delivery, quantification of gain frequently involves informed guesswork. Goaisharing plans can incorporate any approach to measuring productivity that makes sense for the organization. This could mean using any of the traditional productivity gainsharing approaches such as Scanlon, Rucker, modified Scanlon, or Improshare; or, using less orthodox mixed measures. Because overall cost reduction plays a key role in most business strategies, goaisharing plans typically include the more inclusive measures of productivity such as controllable cost per sales value of production (modified Scanlon), controllable cost per ton (paper), and so on. Because productivity gains can be easily quantified, productivity is usually the most important performance indicator in most goaisharing plans in terms of its potential to generate bonus dollars. Table 2.6 shows the performance indicators, measures, goals, and payouts of a typical goaisharing plan. PARTICIPATION STRUCTURES Gainsharing is based on the assumption that organizational performance can be improved by paying employees bonuses based on measurable gains in key performance indicators and by empowering employees to contribute, directly and indirectly, to improve performance (Frost et al. 1974). The first step in this process involves determining how to measure organizational performance, establish targets, measure and quantify gains, and establish formulas for spitting gains and distributing the employees' share among individual participants. The second step involves determining how employees will be empowered to participate. There are many levels at which participation can occur. Workers can affect organizational performance by performing their individual jobs more effectively. Perhaps most important in this regard is the relationship between work-

20

Gainsharing and Goaisharing

Table 2.6 Goaisharing Performance Indicator Productivity Quality On Time Delivery Safety

Measure Controllable expense per ton Parts per million defects reported by customers % of orders shipped on or before schedule OSHA incident rate

Goal