Open Book Management: By the Numbers

Jan. 1, 2006
Opening the financial books to all employees pays dividends for several material handling companies.

In 2004 net income tripled for Federal Warehouse Company (East Peoria, Ill.). Patrick Roesler, vice president of finance and administration for the privately held company, says profitability will climb another 30% this year. What happened?

Roesler attributes much of these gains to a decision that executives made a little more than two years ago. They decided to share detailed financial information with employees, explain what the data meant, show people how their actions could impact the numbers, and give them a role in making them better.

Federal has five primary lines of business. The warehousing and logistics division operates 500,000 sq.-ft. of food grade commercial warehouse space in East Peoria, Ill.; it also manages a transportation fleet and performs some freight brokerage. As an Allied Van Line agent, the company has nine locations out of which it moves and stores household goods. One business unit does home deliveries for Sears and other furniture retailers. Another offers secure record storage services, and the Fun Transport division ships over 12,000 uncrated motorcycles every year. In total, the company recently posted about $35 million in annual sales and employs around 300 people.

Practicing a strategy known as "open-book management," every month the manager of each Federal business sits down with employees and reviews the financial statements for that unit. They review areas where the business succeeded and where it did not, and run through the key areas where employee behavior has a direct impact on performance. The objective, says Roesler, is to open a line of communication that encourages everyone to participate in the problem-solving process.

"Who best knows where the issues are other than the people who are doing the job every day?" He asks. Today, everyone in the company has a much better understanding of what the key issues are.

"It's amazing the level of questions that are going on now compared to what they were. Now, employees are asking questions based on knowledge. They know where the company is. They know what the impact items are," says Roesler.

For example, in such labor-intensive businesses, workers' compensation costs can be a big issue. To minimize these costs it's in the best interest of the company and employees for everyone to work safely. Sharing the exact cost of workers' compensation claims with employees has helped to underscore this mutual goal. As a result, annual workers' compensation costs have fallen from between $625,000 to around $350,000. As a self-insured company, these savings go right to Federal's bottom line.

They've also focused on damage claims. Managers have shown employees how claims impact profits, and how they have a direct control over these costs. Over the past couple of years they've reduced the total cost of damage claims from 1.2% of sales down to 0.75% of sales.

"It's creating a sense of ownership in all of the employees, getting employees to think and act like owners." says Roesler. "Before we started we were very operationally focused, which you have to be. But we weren't really focused on doing that to create profit. Profits were a thing that happened, but we weren't focused on the profit side of the business."

In the early stages, when Roesler introduced the concepts of openbook management, he would ask people how they thought the company had done in the previous year. In almost every instance they thought that the company had made great money.

"The assumption was that just because they were busy, they were making money," he recalls. "They had no clue that in a couple of our locations we had actually lost a significant amount of money in the year prior."

The idea of open-book management is that by presenting employees with detailed financial data on company performance, teaching them how to understand it, and rewarding them based on performance, they will act more like owners. According to the most recent Census of Distribution, an annual study of warehousing and distribution practices and performance conducted by Material Handling Management [See page 36], managers at one out of five distribution operations today share financial data in some form with employees.

Because such information is the source of power in a traditional top-down management structure, the open-book approach requires a different type of culture. Managers have to become comfortable with sharing information, and relinquishing control. And employees have to become comfortable with assuming some of the responsibility for making the numbers.

It can be a difficult transition, but the benefits are more than just anecdotal. The National Center for Employee Ownership conducted a study in the late 1990s, when the strategy was gaining popularity. The study examined 50 companies over a three-year period before and after they began practicing openbook management, and compared their performance with competitors. On average, revenues for the open-book companies grew 1.7% faster each year. As it compounds over time, such an advantage can really add up.

When Federal Companies embarked on its open-book journey, new leadership was looking for a strategy to improve performance and engage employees. Knowing that it would not be an overnight fix, and not wanting it to seem like another management flavor of the day, the program was introduced with a three-year timeframe in mind. They've just wrapped up the second year.

"We're very focused on maintaining this, even after we get through this year," says Roesler. "We've enjoyed the results. We like what we see running this way. We have no intention of ever changing the process."

The company hasn't done it alone. It has been supported by The Great Game of Business, a consulting subsidiary of Springfield Re-Manufacturing Corp. (SRC). Jack Stack, the president and CEO of SRC, is a well-known champion of open-book management and employee ownership. He credits the approach with saving SRC from going out of business after management bought out the company in the early 1980s, and slowly but surely turning the Springfield, Mo.-based firm into a powerhouse of related companies specializing in remanufactured components for truck, automotive and related markets.

The program laid out by the people at The Great Game has three main facets: know and teach the rules, follow the action and keep score, and reward good performance. At Federal Companies all new employees attend a week-long training program that reviews the open-book concepts and guides new production workers, office staff and managers through the company's financial statements. Over time they pick up a deeper understanding on the job, in the monthly reviews, and through the financial reports posted in the facilities.

Of course financial knowledge alone is not enough for people to start thinking and acting like owners. Federal has an incentive pay system that pays out to employees twice a year. Two-thirds of each employee's incentive pay is based on how well their business unit performed against budgeted profits, and one-third depends on the performance of the corporation. It's split this way to encourage sharing of ideas between business units that could improve overall performance.

In 2004, Roesler reports, the company paid out $358,000 in incentives to employees. In 2005 they expect to pay out around $443,000. This pool of money grows according to a formula: first the company has to generate a fair rate of return to shareholders based on how much they've invested in the company. After that mark is achieved, 40% of profit dollars above the required rate go into the incentive pool. If they hit or exceed budget, 50% of profit dollars go into the incentive pool.

"Any company that wants to move forward with this, one of the things you have to really be focused on is reasonable, accurate, attainable budgets," says Roesler. "That way employees can get there and feel good about getting there. That will drive them more than anything else."

Same Game, Different Company
NewStream Enterprises ( Springfield, Mo.) is a contract packaging company. A subsidiary of SRC, it has been practicing open-book management since it was established. The company buys parts and assembles service kits for OEM customers such as International Truck and Engine Corp. ( Warrenville, Ill.), which sell the kits through their distribution networks. NewStream has also branched out into distribution and inventory management. It employs around 110 people and posted $70 million in revenues in 2005.

The bonus program at New-Stream allows employees to earn up to an additional 13% of their base pay. At the beginning of the fiscal year, which starts in February, employees receive a book that shows the company's 2006 budget month by month, and how the bonus program will be calculated and what the payout will be if they achieve the plan. Bonuses in 2005 were based upon profits. Next year, according to Gary Goetz, general manager of NewStream, they will be based on cash. That will be New-Stream's "critical number," the financial metric that people will need to focus on over the next 12 months to make the company stronger and better.

"In 2005, with some of the changes in the marketplace— inventories and customer requirements—we saw a higher demand on our assets. As we made our profit plan this year, our assets rose and we didn't get the cash out as quick," says Goetz. "As we roll into '06, we've gotten people focused on profits, now we have to change those assets into cash."

What that will mean is a renewed emphasis on increasing inventory turns, and reducing receivables. Goetz says they will develop " minigames" around things that will impact cash with smaller rewards, such as free lunches and prizes.

"We almost try to fool people by making it fun and a game, where you don't realize you're making these great business decisions," says Goetz.

Over the years NewStream has changed things around on a regular basis to keep everyone focused on the numbers and on making good decisions. The weekly " huddles" when they share the financial data (usually on Wednesday) follow a standard agenda. They review the income and cash-flow statements, including total shipments, cost of goods sold, overhead and other expenses, and profits.

"We show them where everything gets taken out of the shipping number as far as costs go," says Goetz. "Then we roll that over to a modified cash-flow statement because we also want to show that just because you're making profits, might not mean that you're having a positive cash flow."

This consistency means that anyone can run the huddle, Goetz, the CFO or the sales manager. New-Stream hourly people have even led the huddles, adding their own voices and insights to the numbers.

One time they put together a Family Feud-style gameshow. Goetz played the role of Richard Dawson, passing out roses to employees. The teams were made up of people who had been at the company for different periods of time. It was time-consuming to set up every week, Goetz recalls, but at the end of the day people really understood how such items as rent, utilities, and trash removal, all roll up into overhead.

"It's not all about good news. We also have to share the bad news. We have to share when healthcare costs go up, and other changes that have a negative impact. It's very tough to sit there in front of employees and say that this bad thing just happened and it could have an effect on bonuses. But then again, you're being very open and people don't find out about it too late," says Goetz.

If he stopped sharing such information, Goetz thinks he would have a lot of upset employees on his hands. People who have left NewStream and come back often do so because they want to feel like they're really part of an organization, like they can have a positive impact on the success of the business, that they're not just showing up and doing a job.

"The challenge is getting people engaged and understanding why you're sharing the financials and what the rewards are," says Goetz. "It takes some hard work up front, but I think that at the end of the day, when you see people who have done it, and you see that employees are engaged and they're really focused on business, it usually has a positive impact. Then it becomes such a strong tool in your everyday business that you wonder how you could have done it without it."

Open Book Management: Software Support

Warehouse software firm builds open-book management principles into its product

To share or not to share financial data (and responsibility) with employees? If they even ask the question, managers at most public and private companies usually come up short.

"Most public companies share the numbers with their employees, but they don't share any control over the numbers. It's a post mortem. Very little decision making trickles down to the workforce in terms of the ability to impact those numbers," says Ann Price, CEO and president of Motek (Beverly Hills, Calif.). "Most private companies share lots of responsibility and authority, but don't share the numbers. Therein lies the interesting paradox."

"Successful businesses rely on execution based on numbers, and yet we don't really create an environment within our organizations that allows you to see the numbers or execute based on the numbers. It's absolutely crazy," she adds.

Motek develops and sells a voice-and radio frequencydriven warehouse management system (Priya) targeted at mid-to large-sized retail, wholesale and third-party logistics companies. Price founded the company in 1989. From the beginning she shared financial information with her employees. But she didn't really explain what it meant.

At an entrepreneur leadership program she attended at MIT, Price met and had a chance to speak with Jack Stack of Springfield ReManufacturing Corp. (Springfield, Mo.). Stack is a long-time promoter of open-book management and employee ownership. When Price returned home to California, she began to teach her employees what it actually meant when she said "margins are down," and she had everyone read Stack's book, The Great Game of Business (Currency, 1992). Then they worked together to figure out how to apply the open-book principles at a software company.

One of several innovative approaches taken at the company, Motek operates under one "to-do" list. A web-based relational database keeps track of all tasks that need to be completed. Tasks can be entered by employees, customers or even outside technology partners. Each to-do is assigned to a department. Each department reviews its to-do list every Monday. Individual employees commit to completing various to-do's by the end of the week or the manage month, which is where open-book principles come in.

"Every item on the to-do list has a dollar sign associated with it, positive or negative," Price explains. "Part of crossing it off your list is communicating the financial impact of the activity."

If employees complete their assignments as promised they earn $100 in travel dollars per week. Even when someone doesn't complete a task, if he or she reports that they are coming up short by Thursday, they still receive the money. What they're rewarding is the communication, says Price, not necessarily the accomplishment. If they know about the problem on Thursday, managers can assign more people to a job to get it done on schedule, a high priority for any software company.

One of Motek's fundamental principles is that everyone takes vacation. Each employee has five weeks of vacation per year. It rewards $4,700 in travel dollars on average to every employee every year. By placing a high value on employees' lives outside of work, the company has built a fiercely competitive group of people who have implemented the company's warehouse management software for customers 100% on time and on budget with zero overtime for 15 years. About eight years ago they started to build the company's core principles into their product.

"We started to consult with our clients about how to use our system to eliminate overtime, reduce overhead and provide employees with enough data about what they are doing in the warehouse so that they could leave early and have more time off," Price recalls.

The result was real-time, engineered labor standards. This capability allows order pickers to see on their handheld devices, as they complete one cycle through the warehouse, how they are doing against the standard. It's a classic application of the open-book strategy of giving employees performance data, and the ability to impact performance.

"It has to do with believing that if you show people the numbers and how they work, that they will change their behavior based on it. I've seen it in my workforce, which is only 25 people. And I've seen it in warehouses where there are 1,000 people," says Price. "Overnight they go from a group of people who had overtime and didn't get the orders out, ... to people who deliver more work in less time and go home early."