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Sep 26, 2014

Removing America's Corporate Cancer

Removing America's Corporate Cancer


By Colin D. Baird


One of the more controversial recommendations-historically speaking, was for American leadership to remove and abolish the merit rating system. Thirty years ago, Dr. W. Edwards Deming described pay for performance systems as a fast spreading disease already "leaving people bitter, crushed, bruised, battered, desolate, despondent, and unable to comprehend why they are inferior. The basic fault of the annual appraisal is that it penalizes people for normal variation of a system." -Dr. W. Edwards Deming, The Essentials Of Deming


The merit rating system sounds appealing though. ""Increase employee's pay-they'll work harder,"  "give them more benefits-they'll produce more goods and services," but just what have we learned from our current method for rewarding hard working employees today? Working harder does not mean working smarter, or more efficiently, nor does it eliminate the most common cause of loss in any business- that is, variation.


Variation occurs anytime we deviate away from an optimum target. Dr. Genichi Taguchi, a Japanese engineer and statistician developed the Taguchi loss function theory. Dr. Deming praised Taguchi for making clear there is minimum loss at the optimum target, and an ever-increasing loss with departure either direction away from the optimum target. The causes behind, and economic impact from variation is real. Because the causes of variation drive a substantial portion of the losses businesses endure, the merit rating system does nothing to address the real causes behind losses in human productivity, yet claims it does.


Consider a situation that occurred between Ford and Mazda. Both were building transmissions for a Ford product using identical specifications. Ford was receiving failing transmissions back from numerous angry customers-all transmissions built by Ford employees. Ford however was not experiencing the same results from transmissions built by Mazda employees.


A root cause analysis found far more variances with Ford transmissions than with Mazda. Ford's variation away from the optimal target was still well within their engineer’s specs, but outside the near perfect conditions Mazda was achieving.  Mazda was constantly reducing variation by consistently improving the methods, materials, and machinery to constantly try to get closer to the optimum target. Ford’s production system, while stable, built transmissions within their own specs, but managers did little to reduce variation, and felt no need to continually improve the process to try hit the target.


Mazda employees achieved these objectives by working with management when conditions took them away from their nominal target. Management constantly removed any barriers that would have prevented employees from building to these optimal targets. Leadership did not remove people as they so often do in an under performing company, they removed barriers -there's a big difference.


As it turned out, Mazda built higher quality transmissions less expensively, had fewer defects, and built much closer to the ideal conditions called for in Ford's specifications. Because of Taguchi and Deming's ongoing work and collaboration with Japanese industry on issues relating directly to statistical quality and process control, Mazda knew their costs would be less by building to higher standards because the costs of poor quality: re-work, customer dissatisfaction, and returns, only drives costs up, not down.


It was not Ford employee's poor craftsmanship, nor was it Mazda employee's superior work that caused the wide variation-for they both were doing what management told them to do. Ford's management team believed building within the specified parameters meant outcomes would be acceptable to customers. Mazda leaders believed in Taguchi’s theory that always building at the optimum target was best for the customer, and also the least expensive approach for the manufacturer. Less variation means higher quality, a better fit, fewer customer returns, less costs to build, and happier workers who are able to continually refine and improve their own their skills.


The resulting impact to Ford’s production line workers and the culture on the other hand was demoralizing. Besides the collateral damage from layoffs, no employee appreciates the constant scorn in the press about their company’s own poor workmanship. The resulting secondary impact of the merit rating system: Man’s self esteem and dignity goes down. An employee’s right to remain a highly skilled craftsman is taken away from him when production-not quality, is the company’s primary aim. As we learn however from Taguchi, the cost of poor quality is actually far greater than the cost of superior quality since variation is less when we operate closer to the ideal target conditions. The merit rating system does nothing to help employees achieve this.


Rather than use statistics to determine where causes of variation actually comes from, most executives in America instead still rely on income and balance sheets as short term indicators to see whether the business's profitability has materially changed from one quarter to the next. When stock price or income statement improvement doesn't occur rapidly enough, it results in rapid fire change, aka employee terminations. 


As these terminations carry forward throughout the business, productivity then falls farther away from the ideal target. This results from ongoing production demand, but decreased production capacity. Cash flows then plummet as on time delivery declines. This continues to create chaos as more variation creeps in. Once this materializes, the business goes into free fall. The merit rating system does nothing to address these problems, rather it assigns the blame and cause of ordinary variation to employees, teams, and even Chief Executives- further demoralizing the individuals, and the overall organization's culture while constantly driving up variation.


If you look at the data, you'll see Deming was correct. The merit rating system is leaving many talented people hanging their heads in disbelief after they leave the bosses office following an ‘average’ performance review. The system contributes very little to increasing employee happiness, and because of variation, merit rating systems do nothing to increase productivity. According to Towers Watson, only 1 in 3 employees feel truly engaged. This leaves people wondering why they can’t enjoy their job. It also leaves people looking for the exit sign when they come to work.  According to the Bureau of Labor and Statistics, Americans ages 18-44 between 1978 and 2008, averaged holding 11 different jobs.


Compensation expert Mercer Consulting just released their 2013-2014 annual compensation survey. The survey-covering a wide swath of employers employing 15 million employees- demonstrates the merit rating system is working on average quite well. For middle meddlers, average Joe’s will see compensation adjustments of 2.8%. For those aspiring actors above the company mean it is 4.8%, and for those non comporting with the commander, it's next to nothing.  What is it like to be a talented graduate with a masters degree from America’s best colleges only to be told your average?


The plain fact is none of us consider ourselves average. While we are all left scratching our heads, and really wondering how this silliness improves people and the business itself, we continue to use merit rating systems as our primary motivators of people. No one wants to be ranked- whether it's employee against employee, department against department, or Chief Executive against Chief Executive.  People prefer working in environments where their contributions are routinely part of innovation and improvement, and where they can truly help one another improve each day.


The biggest cry in America is for more productivity to enable better ROI on stakeholder equity. Nothing changes without improvement, not even the law of averages; it's insanity repeating itself all over again. Overhauling our processes, and improving our people, is leadership's direct responsibility. The merit rating system has failed to achieve either objective and it’s time to throw it out.


Toyota-widely held as the best manufacturer in the world-uses both Deming and Taguchi statistical modeling and continuous process improvement activities to reduce variation and increase profitability. Toyota does not rely on a wide-scale merit rating system, nor does it reward its CEO with a compensation package that even comes close to the pay of American CEOs. On 18B in profits for 2013, Akio Toyoda, CEO of Toyota, earned compensation of only 2.3m. It’s estimated Mary Barra will receive approximately 14.4 million in 2014 to manage the mess at General Motors.


With more governmental oversight of executive compensation likely, and pay disparities continuing between the Chief Executive and his subordinates, the issue of how to reward our employees isn't going away, but we can rethink its impact. Improving the system by reducing variation will achieve better job growth, faster inventory turns, happier employees, and greater ROI's. Perhaps continued process improvement will get government out of the business of regulating executive pay, but only American ingenuity in leading can make it a reality.