Should Companies Expand Human Capital Disclosure?
The cover story for the November 2011 edition of CFO magazine, "Power from the People," introduced a topic that had been discussed among human capital experts for some time but had been the subject of little media coverage. The discussion was about whether investors and other stakeholders would benefit if publicly held companies reported more information about their work forces. Human capital "disclosure" had been mostly limited to executive compensation data, executive succession plans, ..
The scenario is simple, says Tom Landa, chief financial officer of AmeriSteel. A worker fails to do proper maintenance in one of the company’s steel mills; the machine fails; production stops; output slows; prices go up; customers drift away; profits sag; and everyone receives a smaller bonus at the end of the year.
The cause-and-effect chain is so simple, in fact, that Landa teaches it to all employees at the Tampa-based $670 million company. He reasons that if they understand that every thing they do affects the company financials, and that their bonuses are linked to those numbers, they will take more responsibility for their actions. “What happens if a manager doesn’t perform preventive maintenance on machinery? Someone gets hurt. And now they know what happens every time someone gets hurt,” Landa says.
A recent convert to the idea of open-book management, Landa joined AmeriSteel in 1995, following some rough years for the company. In 1988, it went public. Then, after several years of recession, it was purchased by its majority shareholder, Kyoei Steel, but not before severe culture shock had set in. “Employees had lost their drive. We had good people with no motivation. Still, the asset we wanted to keep was our 1,800 employees, so we had to change something,” Landa says.
What AmeriSteel changed was the notion of showing company financials solely to top executives. Chief executive officer Phillip Casey believed that by introducing open-book management, he could bring a sense of ownership to the workforce. Open-book management, however, just starts with opening the books. For the concept to work, companies need to educate employees about the meaning of the numbers and, most important, make them responsible for profits by tying performance to their individual compensation.
At the outset, Landa had his doubts. The prospect of spending hundreds of thousands of dollars on training when the company was already having problems didn’t seem wise. Nor could he imagine finding the time and energy necessary to teach finance to the entire company. “I thought it sounded a little hokey,” he admits. Besides, “something that simple couldn’t possibly be effective,” says Landa, who worked for Exxon Corp. for 20 years before joining AmeriSteel.
At Casey’s urging, however, Landa first trained other executives to read and understand financials, as well as how to manage under the new system. Then, in the first year, he put employees through 18 hours of similar training, emphasizing how they individually affected the financial statements. Landa met resistance from both camps. AmeriSteel managers didn’t want to give up their workers for training; employees didn’t understand why the training mattered. “Overcoming the initial inertia was the hardest part,” says Landa.
Results were more than impressive. In 1995, before open-book management was initiated, AmeriSteel operated five steel mills with 2,300 employees and produced 1.6 million tons of finished steel at a cost of $146 per ton. Two years later, the company had four mills, produced 1.7 million tons of finished steel at a cost of $127 per ton–and had only 1,800 employees. To Landa, there’s no doubt that open-book management was a significant catalyst. Employees, he says, reduced overhead and worked more effectively once they understood how doing so affected them personally.
Champions and Naysayers
Landa is not alone in his enthusiasm. Popularized by Springfield, Missouri-based Springfield Remanufacturing Corp. beginning in 1983, open-book management has been instituted at hundreds of companies, including such industry giants as Monsanto Co. and R.R. Donnelley & Sons. Another 5,000 to 10,000 share limited financials with employees, claims Corey Rosen, director of the Oakland, California-based National Center for Employee Ownership. Advocates call the philosophy enlightened capitalism, a business revolution, and an idea whose time has come. And despite difficulty in measuring results, they swear that a companywide understanding of and responsibility for the numbers leads to increased sales, increased profits, and a more satisfied workforce.
Still, more than 15 years after its debut, pure open-book management remains more talked about than practiced. Estimates are that only one percent of U.S. companies fully embrace the idea. And even its biggest champions warn that to make a program successful, companies must clear high hurdles–skeptical managers, apathetic employees, and costly training–with no guarantees of success. “Companies don’t always realize the extent of the changes needed,” says John Case, executive editor of Harvard Management Update and author of The Open-Book Experience: Lessons from over 100 Companies Who Successfully Transformed Themselves. In addition, he says, there is a tendency to oversell the benefits. “The idea of open-book management generates high expectations. People think that all [employees] will be treated as equals, that they will be in charge of their own work. There is an initial level of enthusiasm, then a feeling of let down if things don’t improve immediately,” Case says.
For CFOs, the introduction of open-book management is a test of endurance and a leap of faith. It means turning all employees into finance employees, a task Landa terms “monumental.” It also means overcoming their own doubts about sharing information many consider confidential. And if the company plans to go public, CFOs must figure out how to distribute financial information to employees before it is released to the general public.
For companies that manage to surmount these obstacles, however, the benefits are clear. Not only does the concept lead to better performance, says Landa, but it also provides an education for the CFO. “It forces the CFO to become more knowledgeable about other areas of the business,” he says. “If you don’t know the business, you don’t know what motivates people.” And if you don’t know what motivates people, he infers, you won’t know what incentives will be meaningful.
Employee Resistance, Management Fears
According to the experts, AmeriSteel had the right formula for a successful open-book program. First, executives shared the information, then they followed up with education, and finally they tied employee compensation to measurable goals. Equally important, Landa and his team had the wherewithal to deal with employee resistance and management fears.
Those fears, experts say, are almost inevitable. Executives worry that sharing financials will have unintended and unpleasant consequences. They believe that telling employees how profitable the company is will lead to demands for higher pay. There is concern that employees will use sensitive financial information against the company in union contracts, or share the information with competitors, customers, or over the Internet. “Managers don’t always want to open up [the books], because then they open themselves up to more criticism,” says Edward Fritz, executive vice president and CFO of CommonHealth, a Parsippany, New Jersey-based health care communications company, which has practiced open-book management since 1997.
For their part, employees often resist the whole idea of learning finance, says Fritz, who remembers seeing “glazed looks” when he tried to teach the details of the balance sheet. “Just getting them to the training meetings was hard,” he says, admitting, “I used to get impatient when something seemed so obvious and they didn’t get it.”
And many managers and employees do not want bottom-line responsibility. Austin, Texas-based Whole Foods Market Inc. has practiced open-book management since the company’s founding 19 years ago, but because of acquisitions, it has often had to orient new employees. “It totally freaks some people out,” says Jody Hatch, vice president of human resources, noting that often new managers of acquired companies don’t even know how profitable their stores are. “Some people don’t like the responsibility. They like going to work, clocking in, doing what someone else tells them to do, and leaving.”
Troy Beatty, CFO of Norfolk, Nebraska-based Supertel Hospitality Inc., which owns 63 hotels in 63 markets, says 15 percent of his managers left as a result of the open-book strategy he initiated in 1997. “Some people were in an environment in which they were too comfortable. They showed up to work, knew what was expected of them, and left,” he says. But by making each hotel manager responsible for revenues per available room, the open-book initiative made many managers uncomfortable, and ultimately led to defections. In the long-run, Beatty says, the turnover was good because it weeded out the managers who were not committed to the company. “Now when we advertise for employees, we say, ‘We are an open-book company.’ If people don’t like it, they shouldn’t apply.”
The Training’s the Thing
Securing buy-in from executives and employees alike, says Bill Fotsch, president of Great Game Coaching (a consulting division of Springfield Remanufacturing that focuses on helping other firms convert to open-book management), requires information, and lots of it. Every company must identify its critical metrics–financial and nonfinancial–to measure success. A hotel chain might emphasize occupancy rates. AmeriSteel looks at the cost of converting raw steel into finished steel. CommonHealth looks at billable hours per employee. The numbers may change as employees begin to understand financials, Fotsch says, but the key is persistently and clearly presenting the information.
Nowhere is that more true than at the beginning of the process, says CommonHealth’s Fritz. Unlike Landa, Fritz was sold on the approach before he got started. He just needed the right strategy to reach CommonHealth’s employees, who he terms “creative types”–writers, artists, and consultants. So instead of handing out income statements, Fritz designed a colorful series of visuals to explain open-book concepts. “I used big charts and graphs, but not a lot of numbers. I’m not trying to turn them all into accountants.”
To engage AmeriSteel’s employees in the finance dialogue, Landa chose a customized board game that explained the basic concepts and followed it up with straightforward data. Now information is shared with employees via electronic bulletin boards that are located throughout the company’s facilities and updated every two weeks. In addition, each of the 21 divisions of AmeriSteel creates its own newsletter, whose front page typically presents company financial information.
Training employees to understand the numbers and executives to manage in an open-book environment can be expensive. Fotsch estimates that a large public company will spend an average of $75,000 on external consulting and training to launch a pilot program, in addition to lost work time or overtime. After the initial launch, the company will pay about $20,000 to $30,000 per year for several years to consultants to reinforce the program. For the same services, a 50-person private company can expect to spend about $10,000 on external consulting and about $4,000 a year in subsequent years. “The costs are pretty significant,” says Landa, who spent up to $250,000 to roll out his program.
Most companies hire outside firms–Great Game is one, Kansas City, Missouri-based Connections Inc. and Boulder, Colorado-based Educational Discoveries Inc. are others–that specialize in training employees to understand financials. At St. Louis-based Monsanto, director of Y2K planning Greg Griffin, who initiated open-book management in 1995, turned to a board game called Zodiak to educate employees. Created by Tampa-based Paradigm Learning Inc., the program averages $50 to $100 per person. But Griffin, who spent under $1 million to educate some of Monsanto’s employees, has no regrets about the cost. “I can see the success,” he says. “People started treating the company the way they would their own home or property.”
More problematic is the impact of open-book management on the conduct of the finance department itself. Fritz, for example, says open-book management changed the makeup of his office. “We reorganized to become a financial services office, not just an accounting office. I had to add staff just to support open-book management,” he says, adding that “it’s definitely worth the investment.” But even with the extra help, Fritz says he carries some of the extra burden, since many executives feel more comfortable dealing with the CFO than with the dedicated staff.
Incentives are Key
Open-book management works only if it is accompanied by adequate incentives. “People start to back away if they don’t have some sort of reward. In effect, you are asking people to take on ownership behaviors, but not treating them like owners. That’s like getting to smell lunch, but not being allowed to taste it,” says Rosen, of the National Center for Employee Ownership. “If people don’t have a stake in the company, why should they care?”
Some companies offer performance-based bonuses and others lean toward employee stock ownership plans (ESOPs). For short-term bonuses, at AmeriSteel, for example, employees can earn up to one-fifth of their total compensation based on performance measures specific to their operation. Mill-employee incentives are tied to tons of finished steel produced, while marketing-personnel incentives are tied to sales volume. In addition, employees are awarded six options for every share of AmeriSteel they purchase.
Sharing equity is key, says Hatch of Whole Foods, which offers an ESOP in addition to performance-based bonuses. “The more team members own stock, the harder they try to meet their goals. It’s a “wildfire incentive”; it feeds on itself.”
There is some evidence to back up Hatch’s point. In 1997, the National Center for Employee Ownership completed a study comparing the sales increases of open-book-management companies with ESOPs and those without. Companies with an ESOP reported an average sales increase of 2.2 percent better than would have been expected given the industry’s performance over a three-year period, while those without reported a 1.7 percent increase. “It’s hard to find companies that sustain open-book management more than three years without sharing equity,” Rosen says. “Ownership is really the glue that makes open-book management work.”
Knowing it Works
Nearly every company that wholeheartedly embarks on a conversion to open-book management claims the program has been successful. Measuring success, however, is tricky. How can a CFO directly link bottom-line improvements to opening the books? Sometimes, the only evidence is anecdotal. Beatty, of Supertel, points to the $1.2 million in additional gross profits last year, and although he cannot prove open-book management is responsible, he makes a strong argument. He recently sat in on a meeting of the housekeeping team at one hotel. “One woman ordered six months’ worth of supplies instead of two months’, and people were all over her because of how much money she spent. That’s how I know it works,” he says.
AmeriSteel’s Landa says his program helped reduce the cost of converting a ton of scrap steel into a ton of finished steel from $145 to $127. Fritz, of CommonHealth, claims the open-book program significantly reduced employee turnover compared with that of its major competitors.
However, Alfred L. LaTendresse, the former CFO of RTW Inc., a provider of comprehensive-care products and services, based in Bloomington, Minnesota, believes it’s impossible to try to quantify success. “On these types of soft issues, you can never measure; that’s a fool’s game. I knew it was working by the types of questions employees were asking, and by the fact that two years into the program, 75 percent of employees had bought into the employee stock purchasing plan,” says LaTendresse, who introduced open-book management at the company in 1990.
No Magic Bullet
When open-book efforts fail, it’s usually for one of two reasons: loss of leadership or an underestimation of the amount of work involved. For example, Sprint Government Services, a division of Sprint, attempted to convert to an open-book system in 1993. But the executive spearheading the program was transferred, and it died out. Similarly, a plant at Chesapeake Packaging Co., a division of Chesapeake Corp., began instituting open-book practices, but the idea never caught on, because the plant was sold before the practice was fully implemented.
At Knights Electrical Contracting Inc., the reasons were more complicated. Terry Herr, president of the Lebanon, Pennsylvania-based controls contractor, wasn’t afraid of buy-in at the company that he helped found in 1990, because Knights Electrical was completely employee-owned from the start. “But that broad-brush motivator doesn’t always work,” he says. “People didn’t care the way I thought they would.” A few years ago, he restructured with only a few employee-owners and began reintroducing open-book ideas. As incentive, he returns 50 percent of net profit to employees as bonuses. “Now employees are interested in overhead costs because it affects their bonuses.”
Lisa Gladstone, president and CEO of St. Petersburg-based Priority One Financial Services Inc., thought introducing open-book management would be easy because many of her employees were already finance oriented. But when she rolled out the program, it just created confusion. “I went about it poorly. And doing it poorly seems to muddy the waters more than not doing it at all,” she says, admitting that her biggest mistake was not fully explaining what the numbers meant. “People read things into the numbers that weren’t there,” says Gladstone, who relaunched open-book management last year complete with a campaign to educate employees.
Such failures don’t fully explain why open-book management isn’t more widely embraced. “There’s a lot precluding people from doing this,” Fotsch of Great Game admits. “We’ve spent years telling people they should keep finances confidential, and now we’re telling them to share everything. The concept is easy to understand, but doing it can be hard.”
The main reasons, however, are both internal and external to the finance department. For example, the CEO of a company must believe in open-book management for the concept to be adopted–a difficult proposition at private companies, where owners often view company financials as their personal finances. But even with top-level buy-in, there are no guarantees that everyone will be committed. At Monsanto, for example, Griffin introduced the concept layer by layer at the organization. But even now, he can’t say if everyone has bought into the idea. “You can’t just take a poll and ask, ‘Who buys it?’ I can only look at the fact that waste is down and the bottom line looks good. For us, it is an on-going process.”
And let’s not forget how much extra work is entailed. “Many finance executives fear that opening the books will consume a large amount of their time,” says LaTendresse. There is also speculation about whether all employees can learn finance. William Norris, the CFO of DP Applications, a Beaverton, Oregon-based data-warehousing start-up that doesn’t yet practice open-book management, believes they can, “as long as you keep it simple.” But, he warns, one of the dangers in opening the books is that employees will become too focused on profits at the expense of growth. “People are naturally going to view their own compensation as their first priority.” The challenge, he says, “is to explain to them how to balance that view with the company’s needs.”
Still, Fotsch insists that despite the skepticism, open-book management is becoming more mainstream. In 1998 alone, he says, Great Game worked with more firms–between 60 and 70–than it had in its first three years combined. “Business is growing exponentially, but we’re still slightly off the beaten path, and that makes some people nervous,” Fotsch says. “But that, too, is changing.”
Julie Carrick Dalton is a freelance writer based in Woburn, Massachusetts. ———————————————————————— Salaries Still a Sacred Cow
Why open-book management typically stops at compensation.
Open-book management implies that the books are open. But most companies still draw the line at the chapter on salaries. “People would rather let co-workers know about their sex lives than their salaries,” says Corey Rosen, director of the Oakland, California-based National Center for Employee Ownership.
Most financial executives agree that disclosing salaries violates privacy and could create jealousy or resentment among employees. “We think some things should still be confidential,” says Troy Beatty, CFO of Norfolk, Nebraska-based hotel chain Supertel Hospitality Inc.
Many companies get around the taboo by publishing only the salaries of top executives, or at least of the CEO. Others, such as Supertel, lump salaries together by employee group, team, or department, rather than by individual. And some publish averages for each position, so employees can see if they are above or below the median without finding out what co-workers earn.
There are some real purists, however. Whole Foods Market Inc., a $1.1 billion food retailer in Austin, Texas, has practiced open-book management since the company was founded in 1980, and shares everything from the salary of the CEO to the hourly wage of the newest checkout clerk. “It’s true there is some envy and resentment when you share [information on] salaries, but we don’t keep any secrets here,” says Jody Hatch, vice president of human resources. “They know if they work hard, they can move up and make more. Either that or they leave.”
PSS/World Medical Inc., a $1.3 billion, Jacksonville, Florida-based medical-supplies distributor, is another company that doesn’t keep salaries secret. Patrick Kelly, chairman and CEO, believes that sharing salary figures–the most sacred of cows–builds trust. “Open-book can work against you if you share some numbers but not others,” he says. PSS openly discusses the salaries of its 5,000 employees at companywide meetings. “We don’t see it as creating jealousy. We see it as a reason to try harder.”
Some executives may like the idea of employees gauging their performance by comparing salaries with peers. But most don’t think their company or its employees are currently ready to let go of paycheck confidentiality.– J.C.D.
———————————————————————— Public Disclosure
Going public can mean closing books.
Open-book companies, even those with successful programs, face another stumbling block if and when they go public. The Securities and Exchange Commission restricts companies from sharing certain financial information with employees before sharing it with the general public. Open-book companies have a choice: either scale back how much information they share with employees, or decide to make all employees “insiders,” thereby restricting how they can trade stock.
Patrick Kelly, chairman and CEO of PSS/World Medical Inc., a $1.3 billion, Jacksonville, Florida-based medical-supplies distributor, began sharing information with his employees when the company was founded in 1983. In 1994, however, PSS went public, and executives chose not to share consolidated financial statements with employees before the general public.
The backtracking proved difficult. “As a public company, [not sharing information] became an issue for us. Employees felt bad that we weren’t communicating with them as openly as we had,” Kelly says. Now PSS communicates performance information with each of its 109 locations, but does not provide a consolidated report of how the company is doing as a whole. “It was a trust issue. They wanted us to trust them with the numbers, but we couldn’t. I’d say, ‘I’d tell you, but then I’d have to kill you,'” he jokes.
Going public has put a different spin on his open-book strategy, but Kelly says it has had advantages as well. The company’s stock has been on a roller-coaster ride during the past year, dropping from $24 to $12 per share, then climbing back to $22. Because so many employees participate in the ESOP, they had an incentive to work harder to bring the stock price back up, he says, adding that several hundred are millionaires as a result.
Arlington, Virginia-based AES Corp., a $2.4 billion independent power producer, chose a different strategy when holding its IPO. Instead of scaling back the information they shared with employees, executives decided to make every employee an insider. “They knew they couldn’t release the consolidated financial statements to employees otherwise. They thought the restrictions on employees’ ability to handle stock was a reasonable price to pay,” says John Case, author of The Open Book Experience: Lessons from over 100 Companies Who Successfully Transformed Themselves, who has studied AES’s open-book strategy. Whether a company decides to withhold information, as PSS did, or make all employees insiders, as AES did, depends greatly on the culture of the company, Case says. “What works for one may not work for another.”–J.C.D.
———————————————————————— Open-Book Nightmares
What Executives Are Really Afraid Of
* Once they know the financials, employees will want more money * The numbers will be misinterpreted * Employees will tie up the finance department with endless questions * The data will be used against the company in union contracts * Employees will share the financials with competitors, customers, or over the Internet * Executives will be exposed to greater criticism