China’s GDP Dilemma
With the announcement that China GDP growth has slowed to 8.1%, the unbridled demand for labor will also cool off. It’s a tricky time for China as its previous strategy of pushing hard on the gas pedal to grow GDP at any cost won’t work any longer. Now China faces the challenge of growing its economy at moderate pace.
It is already starting to drive differently to effect this change. Currently China is now driving with two feet. One foot is tapping the brakes (by curtailing construction) and one foot is gently pressing the gas pedal (through the loosening of credit by banks).
What other avenues can China pursue to grow this now large country at a controllable pace?
There are many levers that governments have used over the years. But in China’s case, it has already pulled many of them as far as they can go. Let’s take a look at a couple of those options and why they won’t work in China right now:
Devalue its currency. As China never let the Yuan rise in value in order to fuel its growth, it is under tremendous pressure to increase the value of the yuan from other governments and even its own citizens who desire more global purchasing power. It is politically untenable to increase the valuation of the Yuan without expecting economic retaliation from other countries. This option is not available to China right now.
Transfer GDP creation to a different sector of the economy. China turbocharged construction over the last decade to fuel its fast GDP growth and is now slowing that sector down due to excess capacity in the industrial sector and an overheated residential market. Comparatively, as the US exited manufacturing, its transition was buffered by significant consumer demand for services, government subsidized healthcare and a strong housing market. This allowed much of the employee population previously employed by manufacturers to find new, albeit lower wage, work. The U.S. had a more balanced economy which allowed it more choices. China’s low wage strategy has not enriched the bulk of its population meaning that consumers cannot afford to carry the economy right away.
China can’t wholesale offshore its jobs to lower its manufacturing costs and spur demand. Its economic success is based on a promise to its citizens that it will increase their standard of living over time. Without a place for those displaced manufacturing jobs to go, the promise would be broken and instability would result. Secondly, the difference in wages in neighboring countries isn’t enough to overcome the increase in logistics costs in all but the most labor intensive industries. This was not the case in the U.S. where Chinese wages were a tiny fraction of U.S. wages and the transfer of some jobs resulted in lower cost goods for the majority of Americans.
China can’t reduce wages of its employees to spur export demand by quietly letting inflation reduce wages relative to the cost of other goods. Intentionally or not this is what occurred in the U.S. over the last several decades. Reducing wages in China overtly or passively would only reduce China’s already paltry consumer demand. This is one of the areas of GDP that China is trying to grow in order to reduce its dependence on exports. Look at the Foxconn to understand what direction wages in China are going. The U.S. transitioned to lower wages because the transfer of manufacturing jobs also lowered the cost of consumer goods. The pain while noticeable, was manageable as people reduced savings to fund current lifestyle with the expectation that the government and pensions would provide a comfortable retirement as it had for their parents. Americans are now realizing what we did to ourselves with this domestic consumption GDP strategy.
China can’t automate its way into high productivity. While there will certainly be automation projects at individual companies and it will occur over time, don’t look for a government strategy that would rapidly automate the plant floor to increase competitiveness. This is simple. While the U.S. rapidly increased productivity through automation, it was able to absorb the workforce in other industries. China can’t do the same on such a large scale.
So what options are left?
There are only three that I can see and from my observations China is pushing hard on all those levers.
Rather than export production China can export labor. This is the “government spend” component of GDP growth China is investing its treasure in building political allies and securing natural resources around the world. For example, it is investing heavily in the Bahamas by building out its infrastructure. And guess who is providing the labor for 8,000 jobs there? This is a technique used frequently by the U.S to invest in other countries for political reasons but ensures that the U.S. receives a share of the economic benefits by requiring U.S. contractors participate in the projects.
China can increase the value of what it produces to generate greater GDP. Exiting out of low value goods such as apparel production and into technology is a goal of the Chinese. This is a slow but traditional path as countries move from agriculture to industrialization. Alternative energy and automobile production are two good examples. Unfortunately this has generated some accusations from global manufacturers and technology providers that rather than develop or license technology themselves, Chinese manufacturers are counterfeiting brands and stealing intellectual property to speed up this transition. How this will play out is unknown.
Chinese production operators commute home in company supplied buses after a day's work. None have cars and many supervisors and managers carpool.
China can increase its labor productivity in its existing industry to lower its costs while increasing standard of living. I can personally vouch for this change in attitude by Chinese manufacturers. During a recent visit to China, I visited factories where young supervisors had implemented sophisticated techniques including active use of kan bans, 5S and changes in process to effect line leveling. They also exhibited a thorough understanding of how to manage constraints within production. Even the accuracy of payroll is now becoming a hot topic as labor laws are being enforced and wages rise. Increasing productivity was the secret to the U.S.’s success. The challenge is productivity gains are a slow path relative to most other methods of growth because it comes from the bottom up. The upside is productivity gains are a sustainable competitive advantage because it is extremely hard to duplicate. Whether the government will make this a formal strategy is yet to be determined.
This is an interesting inflection point for China’s economy and I look forward to seeing if China can exhibit the same tenacity and success in the next phase of its economy as it did in the last one.
Why Lean Fails
Lean desperately needs a political advisor.
Political campaigns are difficult because the candidate must become the person that provides a vision for a wide range of issues to a broad base of constituents. When candidates get into the details, people get lost, bored or they begin hearing things they don’t like.
As a result, successful campaigns limit themselves to one message that is used over and over again. “Hope and Change” and “I like Ike” are two that come to mind.
If I were to shrink Lean’s message into a few words today, I think most would agree it is:
Eliminate Waste
It has all the trappings of success: It is short. It is easy to act on. Everyone wants to remove waste from their process. Unfortunately for Lean, removing waste from a process doesn’t necessarily add up to business success.
Lean has a classic campaign problem. Lean has a broad range of concepts, tools and metrics required to be successful. But it only has a short window to communicate to a wide variety of people and an even shorter amount of time to demonstrate success.
So what sound-bite is most frequently absorbed from an introduction to Lean? “Eliminate waste.” In fact, to make sure they don’t forget this goal, management will post the Seven Wastes of Lean on the wall. Kaizens are held and 5S efforts are not far behind.
No surprise at the outcome of this effort. Waste is identified and removed.
“Let the sales team know! We can produce more with no additional labor, equipment or overhead required. Costs are dropping. Finally, we can price aggressively and still make a profit. We’ll finally wipe out those pesky low-cost competitors.”
All is good.
Good, that is, until the competition reacts. They drop their prices to meet yours.
At that point, volume begins dropping. With all this extra capacity, idle people and machines stick out like sore thumbs. I don’t have to tell you what happens next.
Is it any wonder many people consider Lean a failed methodology? It results in lay-offs and shrinks the revenue opportunity. It is now harder to survive than before Lean was introduced.
While reducing waste is a great objective and simple message, there is a fundamental problem with it. It doesn’t tell people what to do with that extra capacity. As a result, some companies will inadvertently have it work against them.
Now for those of you itching to let me know all the other things that should have been done in conjunction with the reduction of waste, I’ll refer you back to the first couple of paragraphs in this blog. Requiring a re-engineering of your entire business practice in order to implement continuous improvement is not realistic.
If I were Lean’s campaign advisor, this would be the new campaign message:
Reduce Lead Time
I can still use the basic tools such as kaizen, 5S and even hang a poster. The difference is I am only going to focus on those things that will reduce lead time. More importantly, I know what to do with any gains that I earn: Reduce lead time.
This is important for three reasons: It works with existing metrics, shorter lead times are a sustainable competitive advantage. Finally, companies can cash that buffer, time, in for a wide variety of benefits. Let’s look at this in more detail.
First, reducing lead times will work with the current metrics in place at any company. Have a Lean related success? Change the lead time on the master data screen in your ERP system. Every other metric will continue to work. If you are not willing to change the lead time then it doesn’t count as a success.
Second, Start quoting shorter lead times rather than reducing prices. Give your customer that time as an additional value. They will hungrily chew it up with their own inefficiency or use it to make themselves more competitive. And you will still get the satisfaction of nailing the competition. When they have to meet your lead time or lose an order, the competition will use overtime and premium freight to overcome their inefficiencies. Fists will start thumping on tables because both are immediate red flags. Management knows profits or volume will soon fall but no answer is in sight.
Third, a shorter lead time gives you more options to manage your business. Removing waste scatters benefits throughout the plant making it difficult to cash in. A shorter lead time puts all the efficiencies in one place: time at the tail end of the process. If increased volume isn’t your goal, you can cash that time in for a wide variety of benefits. For example, move overseas operations closer to your customers. This will allow you create jobs at higher wages because you can eliminate logistics costs. Enter new markets with no capital investment. Get rid of that last bit of Overtime and Premium freight. Or invest the time back into more improvements.
Lean for President!
Hitting the Continuous Improvement wall
Ask a manufacturing engineer or production supervisor how long they have been under pressure to reduce costs and improving productivity and they’ll most likely say since they started working.
Improvement methodologies such as Total Quality Management and Design for Manufacturability come on strong and manufacturers rally around them as a new approach to wringing incremental performance out of operations. And yet decades later on the production floor, some weeks everything performs flawlessly and other weeks it seems that Murphy’s extended family has come to visit.
Fatigue with the improvement projects can set in over the years because the big issues of a production line have been managed. The machines are rarely down for more than an hour. Kan bans to manage and reduce WIP have been implemented. As the teams move down the Pareto chart, the big gains have been achieved and each new effort seems to return less gain. Eventually people move on to other issues and performance of the production line flattens out.
Chasing down the biggest issues first is so ingrained in our minds that it seems almost like a law of nature. Invoking a justification of Pareto analysis, commonly known as the 80/20 rule brings nods of agreement in justifying the order of how issues should be addressed.
But there is a follow up question that should be asked that almost never is: “Even though we’ll solve our biggest issue, how much variability will be left in our system based on the remaining issues.”
This is an important question because the process will suffer from the cumulative effects of the remaining variability. The workforce can be a significant cause of variability. So as the number of employees that participate in the process increase there is going to be a cumulative effect of variability from each employee within the overall process.
This is supported by statistical analysis which will be described shortly, but for those not familiar with statistics, a more familiar way of explaining this would be as follows:
Let’s say we wanted to meet a co-worker after work at a restaurant to celebrate an event. If we invite one person, we can be fairly certain they will be there on time. But as we increase the number of co-workers invited, it becomes increasingly likely that some will be late. A few will have last minute calls from customers; others will be stuck in meetings that run over. And others will have emergencies at home that require their immediate attention.
The same happens in production; as the number of people increase within a process, the inevitable delays that occur increases as the number of people increase. Without directly managing all the little issues that cause this delay for each individual, there’s a limit to the amount of improvement that can be achieved in production.
But compared to a celebratory night out after work where only 2 people need arrive to begin the party, in manufacturing, everyone has to show to begin working.
Statistical analysis can be used to describe this scenario and even predict the variability and delay. The cumulative effect of the delays can be expressed as what is commonly referred to as the Sum of Independent Variables. Statistics show that the means (average) and variances of multiple independent variables are cumulative.
As each employee is an independent variable, their effect in terms of delay on production is cumulative. In order to bring a process into control requires the management of all the independent variables affecting the process including the workforce.
This can be described through a manufacturing example as well. Disruptions are considered when an operation is completed sooner or later than expected.
In this example, the process has been in place for years and the big issues causing disruptions have been resolved. For the most part the equipment is never down for more than a couple of hours and material quality and dimensional issues have been ironed out. The labor standard that is used to measure, cost and schedule the process is now a reflection of the actual average time it takes to complete this process.
To begin with, the example starts out very simply. There is one person on the line. This defines N (N equals the number of independent variables or people in this case) as equal to 1.
Experience would tell us that most days the process goes as planned. Almost nothing happens out of the ordinary and production runs as expected. Here are some examples of the disruptions that do occasionally occur in this process.
- While typically punctual, a couple of times a month an operator is late getting into work and production starts behind schedule.
- Skill levels vary between operators and they complete an operation in slightly different amounts of time.
- The operator is delayed by others such as a maintenance person or material handler
The curve below describes an example of the frequency and impact of those events; it’s a familiar shape and known in statistics as a Gaussian distribution or normal curve. For the purpose of this example the average time (or labor standard) to complete this operation is 2 hours for N=1. The variance in production time this example has been measured at 30 minutes, but the curve could apply to any cycle time and variance.
Distribution of variance in time in a single operation where there is one operator.
Average (Mean) = μ = 2 hour
Variance = б2 = 30 minutes
To make the example more typical of an actual production scenario, 14 more operators and operations are added to the process. Each one of these people is considered an independent variable. As stated above in the discussion of the Sum of Independent Variables, the mean and variance of the delays that each person causes are cumulative. Now N (Number of independent variables) = 15.
The average production cycle time is:
Mean = N * μ = 15 * 2 = 30 hours
Variance = N * б2 = 15 * 30 = 450 minutes = 7.5 hours
When the independent variable ( a production operator in this case) has a Gaussian distribution, the distribution of the sum is also Gaussian. The graph below shows how the distribution broadens as N is increased. For convenience of graphing, the mean is set to zero. Obviously with a non-zero mean, the distributions would also shift to the right of the graph. In other words, the mean for one person is two hours, the mean for 15 people is 30 hours, in this case all distributions are set at 0.
Distribution of variance in time as the number of people and operations in a process changes (N=5,10,15 or 20 people)
With N=1 person, the variation in work time is relatively small, centered around the standard work interval of 2 hours. With N=10 or 15 people, it seems like almost every day there is some event occurring. Between machine jams, operators calling in sick, temporary help on the line due to turnover and maintenance mechanics who are busy working on other equipment, the variations in performance add up over the course of a month. Every once in a great while, it seems like nothing goes right and hours of production are lost. This cumulative effect is reflected in the Gaussian distribution with N=15 in the figure above. The variations in the total production time are significantly greater than one might expect by intuitively extrapolating from one operator to 15.
Because these individual delays are typically small, it feels like they are unmanageable or that investing in solving all the different causes would not justify the returns. However there is a difference between managing production equipment and individuals. Controlling each piece of capital equipment, while similar, requires a different approach due to their unique design of tooling, dies and capacity. Individuals, while also unique, all respond well to equitable and fair management. This means the investment required to decrease labor related delays on production can be spread across all operators and support staff on the line. Additionally, it affects the operators and support staff on all production lines. The result is instead of working down the workforce related variables one person at a time, the workforce as a whole improves providing significant improvement. In this example, the improvements reduce delays.
To understand the return on investment possible, if the disruptions to the operation due to labor is reduced by 10% the variance of the operation is reduced by 45 minutes.
The result is production schedule adherence improves, and the need for overtime decreases, idle time in downstream operation is reduced and costs such as premium freight and inventory buffers are reduced as well.
As one of the three pillars of Lean, the workforce has long been recognized as critical to the success of operation. But in practice, because an individual’s impact on an entire operation in terms of delay can be small, managing the individual is often moved down in priority. Experienced Lean practitioners may suggest these small variances are why self empowerment is important. But viewing the cumulative impact of small variances across an entire production team and supporting staff is something an individual can’t see. The value of the effort is found in identifying and systematically managing common, small variance across the entire workforce.
Variance reports apply to Timekeeping and Payroll too
As I introduced in my book Lean Labor, the Perfect Paycheck is a concept borrowed from the manufacturing term “Perfect Order”. A Perfect Paycheck one that is accurate, delivered on time, and at the right price.
Delivering a Perfect Paycheck is a good first step in achieving Lean Labor. That’s because not only does it deliver quick reductions in waste, but more importantly it sets up an accurate baseline of data to make better labor related decisions during the day.
But let’s face it, when it comes to spending more time building jet engines or making sure an employee’s time card is accurate, the jet engine gets the attention. This is the challenge that people in IT and Payroll present to me when their Perfect Paycheck efforts aren’t broadly adopted.
While there can be a variety of reasons for Lean or any type of project to stall, one common theme is that the participants don’t understand the issues and the benefits. Effort and reward may be experienced by different people or departments. Or when it comes to timekeeping and payroll, often it seems that the administrative pain isn’t worth the gain. A couple of minutes here and there are much less important than ensuring an order is delivered on time.
When it is Operations that doesn’t seem to be adopting the changes required to achieve the Perfect Paycheck I ask “What are they being asked to do and what are the consequences if they don’t?”. While the responses are varied ranging from the Payroll department will fix the mistakes to people aren’t paid accurately all the time, it typically boils down to one situation. The Operations group doesn’t understand the cost of not making change and feels that they have other tasks to do that have more impact on the company.
One of the simplest techniques to remedy this is what I call the “Paycheck Variance Report.” Operations is very familiar with tracking and controlling variances. A variance is an unexpected change in cost or time needed to complete an operation. Variances can originate from a wide variety of places. It might be that the price of the materials shot up recently or someone was on overtime when they worked that week and it cost more than expected. It could also be a positive variance where someone was able to accomplish something faster than expected and it cost less. Operations and Finance reviews these variances closely and while they know they can never get every variance under control, they do make a continuous effort to do so. One area I have never seen tracked in a variance report is the timekeeping and payroll process. As you might imagine, since these processes are not tracked, they are not improved unless the variance is too large to miss. In order to make your Paycheck Variance Report simple to understand within your company, get a sample of a variance report that is written today and copy the format.
I suggested to one payroll project manager who was suffering from project crawl that they start tracking all the issues and recording how much time and money it was costing Operations and the company as a whole. He could then deliver this Paycheck Variance Report to the Operations Manager on a monthly basis. He would then be able to look at this report like he would his other variance reports. He may not act on every one, but you can be sure that if any of the issues ranked higher in terms of cost or time than a more traditional variance, he would be on it in a flash. One thing about Operations, when it comes to saving time or money, I have never seen them biased about what they need to do to execute on the project. But they must be convinced that what they change is going to be worth the effort.
Do you measure labor in hours or dollars?
If you collect labor hours and multiply by average wages and benefits to calculate product cost, you will want to read the rest of this blog.
The Bureau of Labor Statistics recently released data on average wage and benefit costs for U.S. Manufacturing.
For production employees , average wage is $16.92 with benefit costs reaching $9.50. 33.5% of a production employee’s cost is in benefits. This includes paid leave, supplemental pay (overtime, bonuses, and shift differentials), retirement pay, insurance and legally required benefits.
While this in itself is not newsworthy, but it got me to thinking, how variable is each of these components?
In almost every company wages, paid time-off and supplemental pay is changes from employee to employee based on tenure, skills, past performance and all the other factors that go into compensation.
But as I did a little research, I realized yet an additional component is becoming even more variable And at 11% of total compensation, this is a big one.
Companies are looking at the 2010 Patient Protection and Affordable Care Act and realizing that to avoid fines, benefit costs may have to become variable based on the total wages an employee earns. Here is a good article explaining how this works.
Insurance was already variable. Medical Compensation is based on the prior history of claims in the plant which is the financial side of the reasoning behind the importance of safety programs.
This healthcare legislation is just another step to increase the variability of compensation. Even for employees who earn a “static” hourly wage.
For manufacturers who are interested in accurate product costing and track labor in hours, this news makes it just that much harder to understand what their true product cost is. To get a sense of the problem they are facing, consider how compensation might vary between employees on a production line and even from one hour to the next with the same employee.
Average wage = $16.92 Variations of plus or minus $2 an hour doesn’t seem unlikely
Paid time off = $1.72 Variations from $1.50 to 2.00 seems possible
Supplemental Pay = $1.14 Variations from $0 to 2.25 seem very reasonable
Insurance = $3.13 While this is a large percentage of compensation, it’s probably not going to vary much in the next couple of years so we’ll say it can range from $2.75 to 3.50.
With these ranges one can look to see what how this variability might impact a company’s cost from day-to-day.
So when the costs all stack in one direction or another there is a swing of 33% in hourly costs. My guess is that this rarely happens, but let’s use engineering math and say that half the swing does occur on a more regular basis. That means there can be an occasional 16% swing in costs from one employee to the next on the production line and probably a frequent swing of 8%.
The question becomes, if we’re talking about random swings in labor cost, what does it matter? No one can control “random” so everything will wash out. The problem with this argument is that much of this is not random. People earn pay through pay policies, supervisors schedule people with specific intentions in mind, so wages are not random. Their variability is a result of work and pay practices which are controllable.
O.K. so pay variability is not random, is this variability worth understanding and managing?
This is a question for each individual company to answer. If it were my company, the first thing I would look at is my profit margin. If my wage & benefit variability is significant compared to my profits, it would be really important for me to understand and control it. In other words, if I earn $7 on every labor hour I invest and my wage and benefit variability ranges from plus or minus $3-4 (similar to the example above) that means my profits could swing 50% just based on who is working on the line even if their output is identical.
Companies that have realized this is a problem are now tracking not just labor hours but using their Timekeeping and HR systems to allocate exact wages and benefits to every hour worked to ensure exact labor costs are known for every hour spent. They re-use much of the information that generates their employees’ paychecks to generate their product costs.
Aker Philadelphia Shipyard recently spoke on an Industry Week webinar and claims that 95% of their wage and benefit costs (including salaried workers) are allocated to specific projects to ensure they know exactly how profitable an effort is. Understanding cost is important, but Aker really takes advantage of this information and identifies where the cost spikes are occurring so they can change their work and pay policies to manage them more effectively.
Measuring labor performance by hours is easy, but is it profitable?
Human Resources: We need your help to optimize the labor supply chain.
As the topic of finding skilled workers to work at manufacturers continues around the world, leave it to China to push a solution forward. China’s Ministry of Education has announced the cancellation of majors at its colleges that have not found employment for more that 60% of its graduates for 2 consecutive years. I read this announcement recently in a Wall Street Journal Blog.
This will probably have the desired effect of pushing those on the edge of a decision between majors to the one with more job opportunities. I wonder though, how motivated will a student with a desire to study history be as they move through a civil engineering curriculum.
What the Ministry of Education has done is to put a “push” system in place. They are trying to forecast the demand for new hires and supply the correct student mix.
China is not alone in struggling with this problem. The U.S. is dealing with slack demand for investment bankers and consultants while skilled trade openings go unfilled. All the while students are taking on too much debt to obtain a degree that can’t produce enough value to pay the loan back once the degree or certificate is earned.
If I were to apply a couple of supply chain concepts to the education system, I would think about the following.
How can we change the system from a push to a pull? We are constantly making the wrong mix of students, ensuring too little employment for some and shortages (petroleum engineers and welders for example) of others.
Is it possible to shorten the lead time of education to improve the ability to respond to changes in demand for a specific degree? Four year degrees have been around for a long time. Is it really necessary to have that much time invested before a student can start delivering value to a company?
Are the risks and rewards in the labor supply chain in the right place?
Students must invest heavily with high uncertainty about their ability to earn a return on their investment. But their risk is mitigated heavily as they are able to take loans that do not look at career choice as an indicator of their ability to pay in the future.
Educational institution risk comes in sourcing students rather than ensuring employment. They also have the shortest ROI as they are paid before they even deliver their services.
Hiring companies have little control over the labor supply chain until a degree or certification is earned. So they are at the mercy of supply and demand for a resource that is critical to their success. But they contribute to this problem as well by releasing unneeded employees back into the market when production demand slackens.
I wish I had an answer in a neat package, but I don’t. What I do believe is this is a prime opportunity for HR departments to become supply chain experts just as their counterparts in Operations did as they improved inventory management over the last two decades.
The company needs HR expertise. If I were in an HR department today, I would immediately take the following actions:
- What are the specific skills required to do the job? Is a certification or degree needed or can a person begin work today as they finish their coursework?
- Reach out to local schools and invite them to talk to the hiring managers to collaborate on curriculums can be redefined to put students to work sooner.
- Begin holding open houses to the parents of high school children. Bring them into the company and show them that manufacturing has changed and jobs are available.
- Think about a more flexible work strategy that will allow your company to flex up and down with changing demand while limiting the swings of hiring and layoffs that disrupt the entire labor supply chain.
Accomplishing these tasks would resolve student debt issues, improve flexibility of the workforce and allow companies to hire the employees they need today without impacting the revenues of the educational system.
Can productivity and innovation be compatible co-workers?
“Improve productivity” is one of the oldest goals in manufacturing. We’re told with higher levels of productivity come lower unit costs and all will be good. Market share improves, jobs are secured and even the standard of living can increase.
It’s such an important metric that it is measured by government agencies around the world such as the Bureau of Labor Statistics and the United Nation’s International Labor Organization.
And yet while the U.S has continued to relentlessly improve productivity, its manufacturing industry has only shrunk over the past 20 years. When I visited China recently many companies spoke of offshoring their labor intensive operations to even lower labor cost countries, repeating what occurred in the U.S.
Many employees today look at productivity efforts as just another program to reduce headcount. It’s no wonder when I speak to people about continuous improvement efforts, only the ones who are in crisis want to act immediately. They are going to lose their jobs anyway.
Productivity is simply the output divided by the input. In this case, the input is labor. For some reason even though companies have four choices in how they can improve levels of productivity, they will often favor the three that eliminate employees or reduce their standard of living. They are focused on the denominator – labor.
- Outsource or Offshore the work to someone who earns lower wages
- Automate the process and eliminate the labor
- Directly reduce wages
But companies have a fourth way they can improve productivity:
- Increase throughput using the same labor
The one method that actually maintains jobs and standard of living. Unfortunately the fourth option is the one that is least used (I base that statement on the employment levels in manufacturing over the past decade).
What’s confounding about this choice of action when it comes to productivity is that it results in undermining of what CEO’s say is the largest factor in their ability to compete: Workforce talent and innovation.
In a survey conducted by the U.S. Council on Competitiveness (click here to download the paper) 406 CEO’s around the world say that innovation is the number one most important driver of competitiveness, followed by their company’s ability to access and control labor and material costs. Below is a stack ranked list of the driver of competitiveness taken from the paper.
This is the part that I have trouble understanding. Out of the four options that companies have to increase productivity, why would they focus their efforts on the three that inhibit innovation? If a company is looking for new and better ideas, does outsourcing and automating the generators of those ideas out of the company improve or detract from competitiveness?
I’m not suggesting no one automates or outsources anything. Certainly the automation of highly repetitive or inherently unsafe processes is a good thing. What I’m suggesting is that management take a look at their mix of productivity projects and increase their efforts to increase throughput using the same labor by an extra 10 percent.
I’ve documented companies in my book and on this site who have done so and the results are incredible. When employees see that management is working to achieve corporate goals while still keeping the workforce intact, the ideas begin to flow from everyone. That flow of ideas means companies can achieve what is most important to their CEO’s: A talented workforce that has the ability to think and execute on innovation.
The next time you are challenged with increasing productivity or lowering labor costs. Take a minute to focus on the numerator of productivity: throughput. Throughput can be increased by making more product to sell or it can be from bringing back in materials and services that have been previously outsourced. The good news is when you begin thinking like that, you are not alone. Your entire company wants to help you be successful.
Why rising commodity prices increase pressure on labor costs
Over the past year I’ve noticed a significant increase in calls from manufacturers and distributors whose products are primarily composed of primary metals. They are telling me that they really need to focus on their operational labor costs.
This was a bit of a change as normally these types of manufacturers have very low levels of labor compared to the cost of materials in their products. They are typically interested in talking to me about administrative efficiencies and compliance with company policy and government regulation. I’m talking about manufacturers who forge, stamp, extrude and cast their products.
At first blush it would seem that rising commodity prices would be a good thing, manufacturers and distributors can pass them down the supply chain and if they are fortunate they might even increase their profits. When you read about gas prices going up, the message of increased profits at oil companies always rises to the top of the media headlines.
As I listened to these manufacturer’s stories however, it became clear why the increased interest in actively managing their workforce was rising as fast as their raw material costs.
When gas prices rise we have choices, we can drive less, carpool or take public transportation. As food prices rise we trade down on brands or substitute hotdogs for steak. We have choices when our wallets can’t absorb the price increase.
Unfortunately for the consumers of metal products there aren’t many economical substitute products. They have spent many hours and dollars engineering these products into their own products and services and are fairly locked in. In many cases both the manufacturers and their customers have contracts that fix the price of their products down through the supply chain. So when prices rise, the entire supply chain feels the pinch. Unlike food or gas, there are very few substitute products or services that can lower a particular company’s costs. Aside from pushing back on the manufacturer, customers are left with two choices. They can absorb the higher prices and reduce their profits or they can look to see if they can source a similar product through another company.
One might question the viability of finding a similar product at a lower cost when the entire industry’s costs are rising. But the reality is that different manufacturers of the same products, even using the same equipment with the same debt levels do have different costs and resulting prices.
Savvy manufacturers know this is good news. It opens up an opportunity for them to attract new customers. Loyalties fade fast when profits start drying up. These manufacturers also know that everyone is scraping for every penny so it’s important to not only price aggressively but to also have the underlying cost structure to maintain their own profitability.
Getting the pricing right is challenging. Should they value their products based on the current market value of the raw materials or at the price they purchased those raw materials (probably lower)? It may seem tempting to delay re-valuing the inventory, but this sword is double-edged and cuts hard the other way when prices start falling. Secondly, exactly what part of the product cost is comprised of material? There are still labor and overhead costs. During this new customer feeding frenzy, inaccurate costs might increase revenues, but also eliminate profits.
The second challenge is ensuring the company’s cost structure is competitive in the market. Customers are doing some heavy price comparison and products are viewed through a commodity lens like never before. If a company isn’t as efficient as their competitors, everyone soon knows it with a result being reduced revenue or lower profits.
So what can a company do? Some will try to hedge the price of their raw materials so price change is less of a factor in their business. But for all the Southwest stories (the airline that effectively hedged fuels prices and won increased business and profits) there are many more untold stories of hedge strategies that left more money in someone else’s pockets than their own.
The second strategy is the one I’m discussing with companies, and it goes as follows:
- Labor is the most controllable cost in the product. Identify waste in your workforce and eliminate it. This doesn’t mean lost jobs because in this environment the opportunity to increase revenues with a lower cost product through new customers will keep those people at work.
- Understand your labor costs very accurately. It’s relatively easy to know the material cost in a product. But do you know exactly how many hours were spent on this product in both direct and indirect labor? How about the hourly rate or if they were overtime hours? How about total delivered costs from engineering through distribution? Knowing this will allow a company to cost and price products accurately, ensuring it wins profitable business and walks away from unprofitable deals.
- Shrink inventories. Don’t stuff the supply chain with inventory exposing the company to price swings. Management will spend too much time trying to deal with the impact of rising and falling commodity prices rather than focusing on adding value to their customers. Shortened lead times and increased employee agility will decrease the need for raw materials, WIP and finished goods. This strategy will help win business no matter what raw material prices are doing.
It’s always exciting when a market heats up and companies get to compete for new customers. It becomes fun when you have competitive cost advantage.
Unions, Companies and the Government achieve a common goal: More jobs in the UAW contract
I was pleased to see that the UAW has agreed to a new contract with GM. It’s been a painful decade for unions as enrollment has dropped to a low of 11.9% of the wage and salaried workers in the U.S.
One of the reasons that participation has dropped is that there are just plain fewer workers that can join a union. This has occurred because companies in search of higher productivity to survive global competition have four options:
Offshore production to lower wage countries
Automate production jobs and eliminate the labor
Reduce wages
Increase throughput using the same labor through changes in process
Three of these strategies have a negative effect on employees, innovation and jobs. Only the last option can improve competitiveness and maintain and grow jobs. Unfortunately the first three are easy and quick…and don’t require participation or agreement from employees to execute.
This lack of job security can make it difficult to motivate employees to find small improvement in their work…the type of success seen in many continuous improvement projects.
I’m hoping that this new contract heralds an era of renewed collaboration between management and unions. When unions and management are both focused on the same goals and have similar expectations, continuous programs like Lean stand a chance. And so do jobs in America
The headline agreements of this UAW contract indicate shared goals and common understanding. I would guess that economic conditions were a large driver at the negotiating table in this case.
But when the economy gets better, how can companies and unions continue to stay aligned to ensure that the real objective, continued global competitiveness, doesn’t get lost in the battle over labor security, wages and benefits and productivity gains.
In Lean thinking, meeting system objectives must outweigh the benefits that local efficiencies deliver. This approach to thinking would serve both unions and management well in ensuring that when negotiating individual terms, that the overall outcome meets both sides’ expectations.
This can be difficult, because it is challenging to negotiate line items when the interdependencies between pay, labor and production aren’t completely understood by everyone at the table.
There are proven techniques to resolve this challenge. One of the most interesting techniques I have heard of involves using a timekeeping system to model the effects in changes in work rules. What this particular company did was to enter in the proposed work rules into their timekeeping system. They re-ran the previous year’s payroll with the new change incorporated. With this information they had a very accurate understanding of how the changes would affect their cost of labor. Now a hard dollar value can be placed on each proposed change. This is much more effective than estimating the impact during negotiation and then overrunning a labor budget 9 months into the year.
Modeling proposed changes in workforce management systems can include more than just work rules. Benefit changes, skill and certification planning, impact of absenteeism, safety incidences by job and tenure, turnover due to retirement, mix of tenure on a line, temporary employees and fatigue are all negotiating points that can be easily modeled and valued using the previous year’s time, labor and production data.
By understanding how the changes will impact costs and output before the change is agreed to, the actual benefit and cost of a proposal can be understood by both groups. Better alignment and fewer surprises occur.
At the end of the contract a scorecard measuring the effectiveness of those changes can also be developed linking the changes in rules with a factual audit of changes in behaviors, costs and productivity. This can highlight unintended consequences in behaviors, costs and output in unbiased terms that both groups can see.
Inventory and contract management with suppliers has long benefited from these types of measurements and data used in negotiations. Isn’t it about time we started applying supply chain science to union negotiations as well?
Rising wages in China are a positive sign of an economy in transition
It’s not until you see the growth in retail, marvel at the rate and scope of infrastructure investment, tour the factories and meet with the people that you begin to understand the momentum and excitement that is going on in China.
The first time I visited China (1995) bicycles clogged the streets of Shanghai. I visited small appliance manufacturers where the most basic manufacturing processes were taking place.
I’ve been back several times since then and the progress is astounding. Shanghai holds its own with any modern city in the world and the streets are now full of cars.
The phenomenal growth is the result of China’s ability to execute on a number of factors well. Its fundamental basis of success through has been through the ability of the government to focus its efforts on specific areas of the economy (infrastructure and exports) combined with a willingness for its people to support shared sacrifice for a better tomorrow.
This is demonstrated by China’s low levels of consumption (estimated at 36% today by the World Bank) and high level of investment (46%).
One of the mis-perceptions I think people have of China is that the average manufacturing production worker’s wages are low but so are their living costs so they have a good quality of life.
This couldn’t be farther from the truth. China’s manufacturing boom is coming from high levels of government investment in specific segment of industry, a weak Yuan, and a prolonged sacrifice in the standard of living from millions of hard-working people.
But painful changes in several macro-economic conditions and a populace that recognizes not everyone is sharing in the sacrifice equally is forcing the government to re-calibrate its strategy:
The prolonged global slowdown has exposed a gap in China’s strategy: It can’t fix weak demand with low labor rates and a controlled currency.
A real estate bubble is making housing very expensive, especially in the larger cities.
Unrelenting inflation in food prices.
Increasing political pressure from the U.S. to increase valuation of the Yuan.
More manufacturing jobs than people in coastal regions. It’s a rough estimate, but a common number is that there are 1.2 jobs for every person. This is driving up wages as people jump from job to job.
Rather than footnote every point. I’ll share one of my sources for Chinese economic statistics. The rest is fairly well-known.
The government recognizes decisive action must take place. In its most recent 5 year plan, it is trying to combat these issues. China wants to increase wages and benefits to level out income disparity between its wealthiest and poorest groups.
It is also trying to reduce the cost of consumption by slowly increasing the valuation of the Yuan. This will provide increased purchasing power to its people, reducing basic food costs as well as making it more attractive to purchase goods.
It hopes to not only begin to improve the quality of life for lower-income groups, but to also shed its dependency on exports and internal investments by growing the consumption component of its GDP.
The plan is good but expect the ride to be bumpy.
First, for those companies that make a living based on the advantage of having the lowest labor costs in the world. This is a challenge. FoxConn who employs 1 million people recently announced that it would begin replacing people with robots. This was reported in an aptly titled piece by The Economist: “Robots don’t complain or demand higher wages or kill themselves”
During my recent trip, I spoke to several labor intensive manufacturers who were moving out of China to the next lowest cost country such as Vietnam and Bangladesh. Others are looking to find ways to increase productivity.
That kind of response from business is a problem for China because the only thing worse than underpaying people is creating an economic situation that forces them out of a job. China is trying to transition its economy to industries that have higher economic value-add so that it can increase the standard of living without relying on low-cost labor.
The second issue for China is that people save too much. Yes, it’s great discipline. But I assure you, the Chinese have an affinity for the finer things in life just like the rest of us. The high savings rate is because there is no social safety net in terms of healthcare or retirement. The government has recognized this as well and is mulling over how to provide benefits for 1.3 Billion people so that they spend a little more now.
This all provides a little relief to the American worker. A weakening dollar, domestic wages that have stagnated and its main manufacturing rival experiencing large wage increases result in more U.S jobs. To read about the experience of one American manufacturer that moved to China, read this:
High wages causing job drain. A government forced to consider large sums of Treasure spent on healthcare and retirement benefits. Corporations making profit based decisions that cause pain among the populace. That all sounds so familiar.
