The Great Game of Business – Chapter 8 section 2 (part 15 of 17)


KEY POINT: If you don’t’ stabilize a sales forecast, you can’t control your company. If you control a forecast, you control the world.

 Month Six: Hold an Early Sales Meeting

Toward the end of July, we reserve several rooms at a beautiful resort in the Ozarks and bring all the sales and marketing people together for a two-day meeting. (Remember, this is supposed to be fun.) Each of the salespeople makes a presentation about his or her expectations for the next eighteen months. … People discuss how they are coming along with their individual goals, what they are planning to do in the rest of the current year, and how they see the following year shaping up.

Managers listen to the sales presentations, and we play a game of what-if. We do everything we can to poke holes in the salespeople’s strategies. … So it’s in everybody’s interest that we identify any problems, false assumptions, unrealistic expectations, or hidden risks. Like these:

What is it going to cost to deliver on these sales commitments?

Do we have the capacity? The skills? The equipment? The money?

Can we get the parts we need?

How fast does this customer pay its bills?

How vulnerable are we to competition in that market?

What if interest rates rise?

What if this deal doesn’t pan out?

How likely is it that the customer will increase the order?

How likely is it that the customer will cancel?

Can we handle that?

What’s our fall-back position?

Ask the toughest ones you can think of, and ask early enough in the process so that there is time to come up with new answers or devise new contingency plans.

Your company may not have a sales force per se. … If that happens to be you, get together a group of friends and colleagues and have them grill you about your expectations for the coming year. One way or another, you want to wind up with the best sales forecast possible, and that means doing whatever you can to tear it apart before you embrace it.

Month Five: Put together the Sales Plan; Work on the Standard Costs

After you’ve discussed the preliminary sales forecast, you need some time to come up with a better, stronger, smarter version. We generally allow ourselves two or three months. … During that period, the sales and marketing people digest everything they’ve heard at the July meeting and figure out how they should modify the sales plan. They do research, revise strategies, riase or lower estimates, go over schedules with customers, rethink contingencies, whatever. … Toward the end of September, they pull all the information together in a new, improved sales plan.

By then, we’ve also pinned down a lot of our costs – almost all of them, in fact, except the ones that depend on the final sales plan. … Goals, on the other hand, have only been discussed informally at this point, although we do know what issues people are concerned about, and what things they’d like to see happen. … We can use the responses to guide us in developing a game plan that people will feel enthusiastic about.

Month Four: Present and Debate the Sales Plan

In October, the process moves into higher gear, as the sales department comes out with its revised forecast. … Everybody gets a five-page document detailing what we think our sales will be in the next fifteen months – the last quarter of the current year and the entire following year. … A vague forecast is useless. People can’t respond to it, and you can’t base plans on it. Spell out precisely what you expect to sell, how much, and when. It’s better to be wrong than to be vague.

Once the sales plan has been presented, we encourage every to go at it, to rip it apart, to expose any weaknesses or inconsistencies. The debate happens in two stages. First, the middle managers take the plan back to the frontline supervisors, who go over it carefully, paying close attention to the implications for their specific areas. … At the same time, we are converting the dollar figures into pieces – for example, the actual number of fuel-injection pump nozzles we’ll have to produce month by month to meet the plan. The supervisors can then take those numbers to the people on the shop floor and get them involved in the debate.

This step – converting dollars into things – is important. You can only get people to contribute by putting the forecast into a form they readily understand and react to, a form that corresponds to what they do every day. … At the end of October, the middle managers get back together with the salespeople to report what they’ve heard from the front lines and to come to consensus on the forecast.

Month Three: Agree on the Costs of Executing the Sales Plan; Start to Target Wants and Worries

November is when we settled on the standards for the coming year. The accounting department distributes an in-depth, month-by-month analysis of what it will cost to produce and deliver the goods in the sales forecast. … Most standards do not have to be changed very much (if at all) form year to year.

Whatever the reason for change, it has usually been analyzed and discussed by the time November rolls around. In any event, the person in charge of standards goes over each one with the individuals affected. The supervisors and middle managers literally have to sign off on the changes before the budget can be approved. I personally review every change greater than 10 percent. We want to make sure that the standards are fair – that they are attainable and that they keep us competitive in the market.

There’s another reason to get approval of the standards. In giving it, people are making specific commitments to one another for the next twelve months. They are agreeing to carry their weight by meeting the standards. Those commitments are the basis for the Game. Without them, there is no Game, just a different form of manipulation and coercion. Commitments are vital. You have to achieve consensus on the plan.

This is also a good point to launch the general discussion of goals, since you will soon be deciding how to spend the cash generated under the plan. Ask people about their worries and their wants.

Are there things that need fixing?

Should equipment be replaced?

Do they want new offices or factory spaces?

What do they see as the greatest threats to their jobs?

It doesn’t matter where the dangers may lie – in the economy, the marketplace, or the company itself. You want people to look over the entire landscape and talk about their most pressing concerns and urgent desires. After all, you will have a limited amount of cash with which to address those concerns and fulfill those desires, so it’s important to find out which ones are most important to people.

We do that by having a company-wide discussion that begins in November and continues intermittently for several weeks. We raise the issue in staff meetings, and the people there take it back to the rest of the organization. If there seems to be a pretty broad consensus, we can begin to draw up lists. If more discussion is needed, we hold additional meetings either at the company or off-site.


The Great Game of Business – Chapter 8 section 1 (part 14 of 17)

Chapter 8 – Coming Up With a Game Plan

The heart of the Great Game of Business is the annual game plan. By that, I mean a set of financial statements spelling out what you expect to do month by month for the entire year. Without a plan, people have nothing to which they can compare their performance, no means of recognizing problems, no targets they can use to organize, motivate, and challenge themselves. They won’t know what they have to do to support one another, or whether they are doing a good job, or how to evaluate the numbers they’re generating on a daily, weekly, and monthly basis.

Emotions will cloud the picture. Barriers will go up. As the leader, you won’t know whether to celebrate or sound the alarm. No matter what you do, people will second-guess you. As for that bonus program, don’t waste your time on it. Without an annual plan, how could you ever come up with objective, quantifiable goals to shoot for? For that matter, how would you ever know if you’d reached them?

The annual game plan will tell you that, and keep you posted on other important matters:

Is the company ahead of schedule?

Is the company behind schedule?

Is the company right on the money?

Who is carrying the load?

Who is falling behind?

You need more than a plan that is firmly rooted in reality. You also need one that people not only accept but agree to – without reservation. All the players must be ready to make the plan work. They have to wantit to work.

You can only get that sort of consensus by opening up the planning process and bringing the entire workforce in. … Otherwise, the plan will become a club, not a tool they can use in their work, and they’ll regard the goals as yours, not theirs – which defeats the purpose of having them.


So how can this happen? … that encourages everybody to participate, that makes sure each person is consulted about the decisions affecting his or her job, and that produces consensus on the final results? How do you do all that without bring the company to a total standstill? … Most important, how do you make it fun?

Show people their stake in the process. … This is everybody’s big chance to say exactly how he or she thinks it ought to be set up. … First, decide what winning means. Ask people:

What do they think they can accomplish in the coming year?

How much can they increase sales and production?

Do they want to?

What concerns do they have about the company?

Are there problems that should be fixed?

Do they want more space?

Do they need new tools?

Do they want additional perks or benefits?

The planning process is a time to think about the future, to dream a little. It’s also a time to think about what dangers may lie ahead, so that you can figure out how to minimize them. … At the end of the process, you want to be able to tell people, “Here’s what we say we want, and here’s how we can get it, provided we all just do what we say we can do.”

There should be nothing boring about coming up with the annual game plan. Don’t make the mistake of approaching it as an arduous but necessary ordeal. … That doesn’t mean you have to invent a whole new way of planning. We use a process you can find in any textbook on budgeting. There are four phases based more on logic than anything else:

  1. Determine what your sales are likely to be in the coming year.
  2. Figure out what it’s going to cost to produce these sales and how much cash you can expect to generate as a result.
  3. Decide what you want to do with the cash.
  4. Choose your bonus goals for the year.

Simple stuff. What makes it all interesting, even exciting, is the drama that comes from having everybody involved.

Countdown to the New Year 

Step one in planning: put together a schedule. Without a schedule, there’s a natural tendency to underestimate the time required, and you will probably let things slide. … So how do you develop a planning schedule? Work backward from new year. Figure out what you want to have when you finish, and how long it will take to produce it. Our annual game plan has eight documents:

  1. Income Statement
  2. Balance Sheet
  3. Cash-Flow Analysis
  4. Sales and marketing plan
  5. Capital plan
  6. Inventory plan
  7. Organization charts
  8. Compensation plan

You can undoubtedly get by with fewer – we did for years. Th essential documents are the Income Statement, the Balance Sheet, the sales and marketing plan, and the compensation plan (which includes the specifics of our Stop-Gooter bonus program for the year). … We give ourselves more than six months to produce the plan. … The first two months are relatively low-key, a period of preparation. May, we are thinking about the sales forecast. … The real excitement begins in October, when we present the sales plan to the entire company, and from then on the pace does not let up until the end of our fiscal year, January 31 – New Year’s Eve at SRC.


The Great Game of Business – Chapter 7 section 3 (part 13 of 17)

  1. Start with a small bonus pool an let it grow as the year goes on, so that people have the opportunity and incentive to meet all the goals – and earn the entire bonus – right up to the end.

By “bonus pool” I mean the total amount of money available to be paid out in bonuses during any given period. I’m saying the pool should start small and grow form month to month or quarter to quarter.

This is a very important point. If you are not careful, inadvertently build some subtle demotivators into your plan. Suppose you decide to give people the chance to earn 25 percent of the annual bonus in each quarter of the year, and they come up short in the first two quarters. That would take a lot of the steam out of the program. People might well get demoralized and stop trying. Suppose, on the other hand, they simply had to the achieve the goals at any point in order to earn the bonus for the entire year – and they got everything done by the middle of third quarter. Chances are that the company would be headed for big trouble before the year was through.

We avoid these pitfalls by increasing the stakes as the year goes on and by rolling any unearthed bonus form one quarter into the pot for the next quarter. Here’s how it works: the bonus pool for the first quarter is 10 percent of the total for the year. For the second quarter, it’s 20 percent; for the third quarter, it’s 30 percent; for the fourth quarter, it’s 40 percent. Let’s say we hit half of our targets in the first quarter and thus earn half of the available bonus. That amounts to 5 percent (half of 10 percent) of the total bonus we are eligible to earn during the year. We get paid the 5 percent we’ve earned right away; the unearned 5 percent is rolled over into the second quarter pool. So now, in the second quarter, we are going after 25 percent of the annual bonus pool (the 20 percent share for the second quarter, plus the 5 percent share left over from the first quarter). Suppose we don’t hit any of our targets in the second quarter. In that case, the entire 25 percent gets rolled into the third quarter, which means we are now shooting for 55 percent of the annual bonus (the 30 percent share from the third quarter, plus the 20 percent from the second, plus the 5 percent from the first). Even if we hit all of our highest targets in the third quarter, there is 40 percent of the bonus pool available to go after in the fourth quarter. If we don’t hit any of our targets, we still have a chance to earn the rest of the annual bonus (95 percent) before the end of the year.

As a result, people stay in the game right up to the last whistle. We can win one quarter at a time, or we can pull it out on a Hail Mary pass in the final seconds. Like the man said, “it ain’t over till the fat lady sings” – and, by then, we have another game ready to go.

  1. Communicate, Communicate, Communicate

Above all, make sure people understand how the bonus program works and are kept up-to-date on how they’re doing. Bad communication is the main reason most bonus systems fail. … Of course, if the bonus program makes sense, explaining it shouldn’t be that difficult. … Go ahead and launch the program. Most people are going to learn about the bonus game the way people always learn about games: by playing it.

What’s crucial is to have an effective system for keeping track of the results and communicating them throughout the company. Set a day and a time when the latest score will be announced each week .. and then make sure you hit it. People will start looking forward to these updates. Do no disappoint them. If you are late with the scores, you will feed people’s doubts and suspicions, dampen their enthusiasm, and undermine your chance of success.

Obviously, we are talking about fundamental questions of management here. That’s perhaps the most important benefit of a good bonus program. It provides a powerful incentive to make sure people throughout the organization have a clear understanding of their roles and the information required to perform them as well as possible. A company’s ability to manage the flow of information will go a long way toward determining not only the effectiveness of its bonus program but its ultimate success in the marketplace.

  1. Don’t Pay the Bonus Unless It Is Earned (But Do Everything You Can to Help People Win).

This is a simple point, but it is fundamental. The bonus program should be a tool for putting people in touch with the realities of the marketplace. A bonus should not be seen as a gift from management. It should be a reward people earn by doing a better job than their competitors who are out there vying for the same customers. You undermine that message if you pay the bonus when people come up short on their targets.

Bonus Math, or How It All Adds Up

  1. Set the profit targets and the maximum bonus payouts
  2. Decide on a Balance-Sheet goal
  3. Set the targets on the Balance-Sheet goal
  4. Protect your equity

That can be very, very tough for a CEO. If people have tried hard and missed by a tiny amount, there is a big temptation to pay the bonus anyway. Resist it. Once you start changing the rules of the game, you step onto a slippery slope, and it’s hard to go back. … So now, as we near the end of the quarter, our accountants come into the weekly meeting with sheets showing exactly what we must do to get to the next level on each goal. You can always come up with a few thousand dollars extra in some area, if that’s what it takes.

Bonus Power

The real power of the bonus program lies in its ability to educate people about business. Once they understand the math, they see how everything fits together, and how business can be a tool for getting them what they want. And it all doesfit together. The system really works. You can’t criticize it because it is simply a reflection of reality. You can criticize individuals. You can take people to task for the way they do business. You can go after the ones who are greedy, who only want to help themselves, who exploit other people for personal gain. But the fault lies in those individuals, not in the nature of capitalism.

The Great Game of Business – Chapter 7 section 2 (part 12 of 17)

If bonus programs are so great, why do so many of them fail?

 We’ve come up with a checklist of what you should do, and what you should avoid, when you create your own bonus plan.

  • Put everybody in the Same Boat

Every employee should be part of the same bonus program, from the chief executive to the people who sweep the floors and answer the phones. Give everybody the same goals and similar stake in the outcome. At SRC, we calculate bonuses as a percentage of regular compensation. Whenever a bonus is paid under Stop-Gooter, each of us gets a check for an amount representing a preset percentage of our annual pay (salary, or wages plus overtime).

We don’t all get the samepercentage, however. Under Stop-Gooter, most managers and professionals are eligible to earn bonuses totaling up to 18 percent of their annual pay. For everyone else, the maximum bonus is 13 percent of annual pay. The reason is simple: we want people to move ahead, to take more risks, and to shoulder additional responsibilities. If they do, it’s important that they get rewarded. But, that said, we want everyone to go after to same goals and be subject to the same rules.

That’s because we want people to play together as a team, to pull in the same direction. It’s easier to win that way. We don’t want people or departments to compete against one another. We don’t want to set up squads that try to beat one another. We certainly don’t want to pit managers against workers, or vice versa. We want a compensation system that encourages people to understand one another’s problems, that gets them to work things out. We want people to see how much we all depend on each other, regardless of where we stand in the company. At SRC, you win when everybody wins, when the company wins. I don’t want a company-wide bonus program in which some people win and others lose. The only ones who lose should be our competitors.

  • Stick to Two or Three Goals – and Get Them from the Financials

Giving people a long list of goals is like not having any goals at all. Build your bonus program around two or, at most, three goals per year. … I want goals that keep people focused on the fundamentals of business: making money and generating cash. I also want goals that educate people about the different aspects of the business, that teach people exactly what it takes to be successful, and that provide an incentive to do the right things. Finally, I want goals that make the company stronger by eliminating our weaknesses. As it turns out, you can get all that by choosing your goals off the financial statements.

We almost always base one of our annual goals on pre-tax profit margins – ensure people stay focused on making money. The other goal has varied from year to year, depending on what we’ve seen as our biggest vulnerability at the time. As a general rule, however, we make a point of taking the second goal off the Balance Sheet – to make sure people also pay attention to generating cash. (I’ll talk more about the process we use to select goals in the next chapter, “Coming Up with the Game Plan.”)

Now a funny thing happens when you choose goals from the financial statements. For every one you pick, you get about five or six others at the same time. … So the bonus game takes people down the money trail, and they see everything that happens when customers are slow in paying their bills. They get an education in business, numbers, and the accounting system. They learn how it all fits together. And they accomplish several goals in the course of going after one.

  • Give People the Chance to Win Early and Often

A bonus program is first and foremost a tool for motivating people. If it doesn’t motivate, it isn’t working. And what gets people motivated? Winning. … Set up your bonus program so that you put people on a winning track from the outset and then make it possible for them to keep winning right through the end of the year.

That’s the whole logic behind our system of payouts. After we choose a goal, we set the levels at which we will pay bonuses. There may be as many as five payout levels for each goal. With the profit goal, for example, the company’s baseline is usually a pretax margin of 5.0 percent, while our top target is 8.6 percent. If we come in with a pretax profit margin below 5.0 percent, we don’t’ earn any bonuses. If it’s between 5.0 and 5.5 percent, we get into the first payout level, which pays hourly people bonuses equal to 1.3 percent of their regular pay. We hit the second level at ta pretax margin of 5.6 percent, and the bonus rises to 2.6 percent. The third level starts at a pretax margin of 6.6 percent, and pays 3.9 percent of regular pay. So it goes until the company gets to an 8.6 percent margin or better, at which point an hourly employee earns the maximum payout on the profit goal of 6.5 percent.

Coming up with the specific targets and payout levels is largely a matter of arithmetic. (see “Bonus Math” at the end of this chapter) The numbers will, of course, be different for every company. You must do the math. The bonus system won’t work if the math doesn’t work. In making your calculations, however, do not lose sight of the fundamental purpose, namely, to get and keep your people motivated. Here are some general rules to bear in mind.

  1. Set the baseline at the lowest point that still guarantees the company’s security.

Everybody must understand that the basic health of the company is paramount. Nobody should earn a bonus for doing the minimum required to protect jobs. We figure, for example, that a pretax profit margin of 5 percent is the lowest we can have without getting into trouble. (Remember, 40 percent of profits go to taxes, so that leaves us with about a 3 percent after-tax margin, which we need for working capital – replacing worn-out machines, handling swings in inventory, and so on.) On the other hand, you don’t want to push the baseline so high that people get discouraged right off the bat. Keep the first payout level well within their range. … Set the baseline at a level we’ve already achieved in the past.

Notice that people are focusing abovethe survival point. Many companies set their goals too low, as if it’s okay to break even. … We never want to operate that close to the line.

  1. Make sure people have the opportunity to take home a significant portion of the additional profits generated under the bonus plan.

Bonuses won’t motivate people if they think the company is being cheap or greedy, or if the rewards aren’t commensurate with the effort they’re being asked to put out. They must feel that the plan is both a fair deal and a way to earn some big bucks

  1. Make it possible for people to earn bonuses frequently enough to keep them involved in the Game.

One of the most common mistakes companies make is to have just one bonus payout per year. Then they compound the mistake by not announcing how much people have earned until long after year-end, and not actually paying it for several weeks beyond that. What happens is that people ignore the bonus program until the final quarter – if you’re lucky. More likely, they pay no attention to it at all and regard whatever they get under it as a gift. That kind of bonus is not a reward; it’s a bribe.

We set up the Stop-Gooter program so that people have a chance to earn a bonus every three months. … People are going to be skeptical when you lay out the bonus deal for them. They won’t really believe it until they see the money in their hands. But once that happens, their attitude will change so fast it will take your breath away.

The Great Game of Business – Chapter 7 section 1 (part 11 of 17)

Chapter 7 – Skip the Praise Give Us the Raise

There is no more powerful tool a manager can have than a good bonus program. … If a bonus program works, it can be an incredible motivator. It can get people producing at levels that make the cost of the program seem like peanuts, no matter how much you may have spent to set it up.

What a bonus program does is communicate goals in the most effective way possible – by putting a bounty on them. … When you do that, you get people’s attention very fast. … We call it “Skip the Praise – Give Us the Raise,” or STP-GUTR – pronounced Stop-Gooter. Here are some of the things we like about it:

  1. Stop-Gooter is our most effective educational program. We use it to teach people about business.

If the goal is to improve the debt-equity ratio, people learn about debt and equity and how they can affect both. … Whatever the goal, it gives people a big incentive to find out about some aspect of the accounting system, the company, and the competitive environment.

  1. The bonus program serves as a kind of insurance policy on the company and our jobs.

That’s because we use it to target our vulnerabilities. Every year, we figure out what is the greatest threat the company faces, and we get the entire workforce to go after it in the bonus program.

  1. The program brings us together as a team.

It ensures that everyone has the same priorities and that we all stay focused on the same goals. It eliminates mixed messages. … The bonus program forces the problem out into the open. Once it’s there, you can go to work on it. You can solve it.

  1. The program helps us identify a problem fast.

If we don’t achieve a goal, we find out very quickly why we missed it. … The bonus program forces the problem out into the open. Once it’s there, you can go to work on it. You can solve it.

  1. Stop-Gooter is the best tool we have for increasing the value of our stock.

We always set it up to guarantee that the stock value will rise substantially if we hit our targets – and will be protected even if we don’t. … “This Game is all about equity and job security.” Short-term incentives like bonuses are fine, but we want to make sure people never lose sight of the long-term payoffs.

  1. Most important, the bonus program provides the structure of the Game.

It sets the tempo. It keeps the action going week in, week out, all year long. It gives us a language , a way of communicating. It creates excitement, anticipation. … It makes sure that people stay involved, engaged, and on their toes. It is, in short, our most important motivator, which is its primary function.

Bootstrapping: the best reason for paying people with bonuses

I am a strong believer in operating a company, any company, as if its future were always on the line, as if something could happen at any moment to threaten its survival. Most companies do, in fact, follow that principle when they are starting up. … Bootstrapping is a mentality, a set of habits, a way of operating based on self-reliance, ingenuity, intelligence, and hard work. When you don’t bootstrap, you grow fat and sloppy. You get into the habit of buying solutions to your problems. You take the future for granted. … You let your costs rise, and you take your eye off the ball. You get caught up in a lot of issues that have nothing to do with making money and generating cash. The next thing you know, a competitor comes along and knocks you out of the box.

As I’ve said, there is only one sure way to protect jobs, and that is to be ruthless about costs. But least-cost companies face an unpleasant choice. If you want to come in below your competitors, you can (1) pay your people less or (2) make your product faster. That’s about it. No humane person enjoys making such a choice. Who wants to have a business that provides people with the lowest standard of living in the market, or that forces them to work so fast it’s unhealthy? Who wants a company that prevents people from taking care of their families and themselves, from leading a full and happy life? But what’s the alternative if you’re going to be competitive and stay in business?

A bonus system like ours offers a way around this dilemma. It allows the company to hold base salaries at a level that gives people a great deal of job security – that pretty much guarantees they’ll have work so long as they do a decent job. But if people do a better than decent job, if they can figure out ways to improve, the company shares with them whatever additional money they generate by paying them bonuses. The more they generate, the bigger the bonuses. It’s like getting a raise, maybe even a very substantial raise, over and above their regular salary, but in a way that doesn’t jeopardize their future employment. We know we can survive the tough economic periods. We may not pay bonuses in tough times, but we’ll keep going. We won’t lose jobs.

In effect, we’re creating a certain elasticity for the down-times. We don’t ever want to lay people off, and we don’t want to cut wages either. Most of the salary a working person earns goes to cover his or her fixed costs. … I don’t know of anything harder than having to cut basic living expenses.  We want people to be able to count on a certain level of income, but we also want to give them the opportunity to earn more. And they will earn a lot more as long as the company is in good shape and they are performing up to their capabilities.


The Great Game of Business – Chapter 6 section 2 (part 10 of 17)

How We Calculate Our Batting Average

Every business should have its own counterparts to the batting average. We have several. One of the best is the overhead absorption rate. This is the number people on the shop floor use to determine how much overhead they cover, or “absorb,” when they spend their time working “on prime,” that is, working on products. … When I talk to executives from other companies, they find this hard to swallow. They can’t believe that our hourly people know, or care, what they are doing to cover overhead. … If we don’t absorb all the overhead we have budgeted, we have to pay the difference out of profits, and that cuts into our bonuses, not to mention the value of our stock.

Tip #4: Find Sources That Can Help You Develop Standards

No matter what business you’re in, there are benchmarks and standards, and the chances are that someone has already calculated them. You can usually find them out by digging around. Suppose you have to buy workers’ compensation insurance for a new business. You need a way to measure safety. Well, the federal government has developed formulas for measuring safety, and the insurance companies use those formulas to set premiums. You can use the formulas as well to monitor your own safety in order to establish your own benchmarks. The better you do, the lower your insurance costs. Then you can use that to educate your people about their impact on overhead, to show them how they reduce overhead by improving safety.

How We Developed Standards on a New Product

When we decided to start remanufacturing automobile engines in 1985, the first thing we did was to look for the best automotive remanufacturer in the world. We talked to all the machine tool manufacturers, asking them, “Who remanufactures automobile engines faster than anybody else, and how fast do they do it?” Three or four sources told us, “Dealers in Minnesota. Ten hours per engine.” So then we had to find out what the Dealers did to make engines that fast – what equipment they had, what their overhead rates were, how much they paid their people, and so on.

We started by calling up Dealers. They had moved to another state. It turned out they had a strong union in the Minnesota plant. They were paying $14 an hour for assemblers. That told us right away why they had a ten-hour standard: it was the only way to compensate for their high direct labor costs. If they were paying that much for assembly, they had to come up with the most efficient processes for cutting down the number of hours they put into the engine block. That give us a tremendous advantage right off the bat. Our automotive assembly plant was in an area where the going rate was $4.50 an hour. We reason that if we could build an engine in ten hours with workers making $4.50 an hour, we could establish a solid foundation for the business. Over time, we were able to increase the labor rate to as much as $10 an hour and create a standard of living that people could live with.


Moral: You need standards to show people the real world. You can’t just go out there with wishes and goals. You need to give people a strategy to get there. You need to guide them. You have to show them the goal is attainable, and here’s how they can attain it. Unless you run into a situation that defies mathematics, like the fuel-injection pump problem. Then you’re going for a miracle. And sometimes people can produce miracles, but it helps if they’re well educated. I don’t think the people in the pump room could have pulled it off if they hadn’t already been trained on standards.

So that’s basically what we did. We found out who was the best, we set a ten-hour standard, and we went after it. We couldn’t make it, so we settled on twelve hours, and later knocked it down to eleven hours. We paid about $6.50 an hour, plus the bonus. Our salespeople say our prices are among the best in the industry. And we have all the business we can handle.

KEY POINT: Numbers are not a substitute for leadership. What’s important is how you use them.

Never get so far into the numbers that you leave out the human factor. Use the numbers as a tool to get people to contribute more, not less. If we use them to create an environment in which people don’t contribute, or can’t contribute, that’s worse than not using them at all.

Tip #5: Tell the Stories Behind the Numbers

Once you’ve developed some standards, what do you do with them? How do you use them? More important, how do you get other people to use them? How do you demystify the numbers? How do you turn them into tools that people can use – that they wantto use – to contribute more? In short, how do you educate people around the standards?

I have always found that the most effective way to do that is by telling stories. With standards, we can use the numbers to tell stories about what has been happening in the company and what we can do to change. WE can bring problems out into the open where they can be addressed – where they haveto be addressed. Once people understand a standard, they expect us to do something when we aren’t meeting it. They know that if we don’t, we won’t make money or we may run out of cash, which would be a story in its own right.

It’s a way of animating the numbers, bringing them to life. When you use the numbers to tell stories, you can educate people without threatening or intimidating them. You can show where the numbers came from and what they mean. You can illustrate in a way people understand that they do make a difference, they do control their own destinies. It’s their game.

Tip #6: Look for the Profit in Problems

Whenever you turn a loser into a winner, you get a double bang for your buck. Say you have a problem that’s costing you $500,000 a year and you figure out a solution that winds up earning you $500,000. You don’t have a $500,000 winner. You have a $1 million winner. When you can stop the bleeding and turn it into healing, you’re twice as well off as before.

The financial system sho­sws you where you can make more money just by telling you where you’re losing it.

The Seventh Higher Law Is: When You Raise the Bottom, the Top Rises

You really want people to solve their own problems. If the problem gets bad enough, you can always go in and tell people what to do. But all you’ll get is the routine. You won’t get any creativity. So you hope to don’t have to get to that point. It’s much better to have an environment­ in which people can come up with solutions themselves. Standards are tools for finding solutions.

Benchmarks Can Turn an Operation Around 

What turned people on was the challenge, the fun of the game, the fun of winning. Humor and laughter go a heck of a lot further than yelling and screaming and throwing tantrums. But you can’t set up a game like that if you don’t have standards.

KEY POINT: If you can’t get people beyond the day-to-day issues, if you can appeal to something they really want to do, they’ll blow by every obstacle. 


Moral: Don’t accept any number until you understand where it came from and you know it’s real.

KEY POINT: Businesses always have problems. Numbers tell you where the problems are and how worried you should be.

The Great Game of Business – Chapter 6 section 1 (part 9 of 17)

Chapter 6 – Setting Standards

Numbers have gotten a bad reputation in some quarters: no surprise when you look at how they’ve been used. Most companies use them as punishment – as tools to supervise, intimidate, or control. They don’t use numbers as tools to build – to teach people to be more productive.

KEY POINT: The payoff comes from getting the people who create the numbers to understand the numbers. When that happens, the communications between the bottom and the top of the organization is just phenomenal.

You can’t generate that quality of communication just by dumping numbers on people, however. You have to make the numbers both comprehensible and interesting. … The trick is to be able to evaluate those numbers, to make sense out of them, to know what to do with them. For that, you need standards.

A standardis the number to shoot for in any particular category you are measuring. It may be a ratio. It may be a percentage. It may be an absolute number over a period of time. All that depends on the category. … Some standards are obviously more important than others, if only because some categories are going to have a bigger impact on your ability to make money and generate cash.

The number and variety of standards will vary from person to person and from job to job, but everyone in the company needs some way of measuring how he or she is doing on a daily, weekly, and monthly basis. … Anyone who really gets into the Great Game of Business will compile a substantial list over time. But don’t overdo it in the beginning. You can start playing the Game with a couple of standards – say, one related to sales and another to productivity – and build from there. The whole idea is to throw a spotlight on some part of the action. Standards make the Game faster and more fun. They allow you to determine easily and quickly how you are contributing to the process of making money and generating cash.

KEY POINT: Numbers like these are no more complicated, and need be no more intimidating, than the calculations millions of baseball fans do whenever they want to figure out their favorite hitter’s batting average or their favorite pitcher’s ERA.  

In business, however, people don’t do the calculations because they don’t understand the rules. Standards help you teach them. They allow you to show people the equivalent in your business of batting .400.

Numbers Make the Team

Most important, numbers like these help everyone play the samegame. People need to have some way of keeping score. … So how should you go about developing and implementing standards at your company? By choosing a category, picking a target, and going after it. Pretty much any target will do, as long as you can explain why it’s worth aiming for. … Setting standards is a team effort and an ongoing process. Encourage people to debate each one. Let them negotiate. Over time, you’ll get it right. Just start, stick with it, and learn from your mistakes. That said, here are some tips about setting and using standards from someone who has already made just about every mistake there is.

Tip #1: Do You Know Your Critical Number?

Every company has one. It is the number that, at any given time, is going to have the biggest impact on what you’re doing and where you want to go. Exactly what it is will depend on a variety of factors. … Whether you’re aware of it or not, it will make or break your company. It is the number you haveto do well on if you are going to succeed, or maybe even survive. So it’s vital that you identify it and come up with standards people can use to go after it.

The good news is that it’s generally pretty easy to track down your Critical Number, assuming you know your business reasonably well. Pay attention to what keeps you up at night. Better yet, ask your people what keepsthemup at night.

Tip #2: Build a Standard Cost System

Sooner or later, your Critical Number will have to do with costs, and by then you’d better have a standard cost system in place. It’s the only way of making sure that your costs are in line with the marketplace, that they aren’t so high as to undermine your ability to compete. Remember, you can only make money in business by being the least-cost producer or by having something no one else has, and even in the second case you’d be foolish not to keep your costs down. To do that effectively, you must have a standard cost system that tells you what your costs should be in every aspect of your operation. Without it, you’re going to have a hard time getting your people involved in controlling costs, mainly because they won’t know what to do. In fact, they probably won’t believe you if you tell them the company’s costs are too high. And you’ll find it almost impossible to teach them how to follow the basic rules of business: make money and generate cash.

Most companies use what I would call an average cost system. They look at what they paid the year before and set that as the cost. Systems like that seldom are specific enough and never provide targets. … That kind of cost accounting is really an obstacle to improving productivity because it accepts and rewards inefficiency. If you are going to improve, you need to know how much you should be spending, not just how much you’ve spent in the past. That means going over every product, looking at every part, examining every process and operation, breaking each down into its individual components, and then coming up with standard costs for everything you do.


  • Is anything going to happen in the next twelve months to affect these costs?
  • Am I overlooking any outside sources of information, such as industry groups or competitive wage surveys, that could assure me these costs are reasonable?
  • Am I purchasing supplies in the right quantities? Using the right suppliers? Checking other sources?
  • Is this specific operation really necessary? What would happen if I didn’t do it?
  • Have I created ways for people to contribute their ideas about reducing costs? Do people feel they are part of the process?
  • Most important, will people buy into these standards? Have I given them every opportunity to debate the standards? Do people think the standards are theirs? This is where ownership starts. Do people own these standards?

Tip #3: Look for the Reality Behind the Numbers

More than work, it takes creativity and imagination to develop good standards. There is a whole art to quantifying these things, and it’s one that’s worth learning because the more quantifiable something is, the more you can do with it. But before you can be an effective quantifier, you have to develop an eye for the reality behind the numbers. You have to learn how to recognize what the numbers really represent, what sort of behavior produces the numbers, and what people can do differently to change the numbers.


Numbers are not magical, and they aren’t sacred. They are important only as cluse to the reality that produces them. To use numbers effectively, you have to strive constantly to understand that reality – to move from the abstract to the specific. Many a profitable company has gone out of business because people neglected to find out the reality behind the numbers on the bottom line. You can’t pay your creditors with money that’s tied up in stale inventory or uncollected receivables.

To develop useful standards, on the other hand, you almost have to reverse this process. You have to understand what really happens in the workplace, how people go about their jobs, and then come up with tools they can use to measure their individual contributions to the common goals. That involves moving from the specific to the abstract. The trick is to do it in a way that does not confuse people, or disorient them, or send them mixed messages. The best kind of standard is one that makes so much sense to becomes second nature.


The Great Game of Business – Chapter 5 section 2 (part 8 of 17)

Overcoming Your Fear of Disclosure

The Great Fear #1: What if your competitors get hold of your numbers?

The notion of opening up the company’s books strikes terror in the hearts of many CEOs, who shudder to think that the numbers might fall into the wrong hands – like their competitors’. I have to admit that, in the beginning, our numbers were so bad it didn’t matter whether or not our competitors saw them. Then, as we began teaching people the numbers, we could see our company get stronger, and so we worried less about our competitors because they weren’t strengthening themselves in the same way.

The Great Fear #2: Is it your competitors you fear – or your own employees?

Sad to say, a lot of companies hide their financials not because they’re afraid of their competitors, but because they’re afraid of their employees. They don’t think people will understand the numbers, and there’s some truth to that. If you don’t show employees how to use financial information as a tool to help the company, they might well use it as a weapon against the company. I still think you’re better off in the long run being open with financial information. When the numbers are hidden, people make assumptions, and they’re often crazy ones. Nine times out of ten, people think a company has a lot more money to spend on wages and salaries than it does. They’re trained to think big, and they don’t understand business. It’s amazing, for example, how many people confuse profit with sales.

The Great Fear #3: What do you reveal if your numbers are bad?

The CEO of a screen-printing company came up to me after I had given a speech to business group in California. “I love your message,” he said, “and I love the way your run your business, but I could never let my people see all our company’s numbers. They’d leave if they knew how bad we were really doing.” I said, “Does that mean you only show them good numbers?” He said, “Yeah, I show them good numbers to keep them motivated.” I said, “Do they trust you?” He said, “No.” … The truth is that you’ve got to give people the bad as well as the good. It’s the only way to build trust, and you must have trust, if only because you’re bound to make mistakes.

How to Be An Open-Book Manager

Sometimes I think what I’m really doing is conducting an orchestra. … I’m Lawrence Welk, going “ah-one and ah-two.” My job is to keep the rhythm going. I keep things on schedule, on time. That can be tricky because conditions are always changing. You need to be flexible, but you also need structure. What’s essential is to make sure that everybody is playing from the same scorecard. Our scorecard is a set of financial statements, notably the Income Statement and the Balance Sheet

We mix all kinds of metaphors in explaining those documents to people. I usually tell them that the balance sheet is the company’s thermometer. It lets you know whether you’re healthy or not. An Income Statement tells you how you got that way what you can do about it. … Don’t rely on the kind of financial statements provided by CPAs. Those statements are designed to give outsiders – investors, tax collectors, bankers – the information they want to know about a company. Employees need something a little different. The general form is the same, and the standards of accuracy should be just as high, but the detail has to be broken down in a way that sheds more light on what’s happening inside the company.

How you do that depends entirely on your business, but here are some general rules to follow:

  1. Start with the income Statement. It is the best tool you have for drawing people into the action of the game because it is constantly changing. As a result, it lends itself to demonstrating cause and effect. You can use it both to monitor the action as it unfolds and to show people their role in determining whether or not the company makes money.
  2. Highlight the categories where you spend the most money. Those are obviously the ones that are going to have the biggest impact on your company’s profitability, so you want to monitor them very closely.
  3. Break down categories into controllable elements. If labor is a variable expense, you want people to see it vary. If you use trucks in your business, people should know how much you’re spending there. In a sales organization, you’d keep a close eye on travel, entertainment, and other selling expenses; in a professional service firm, you’d probably want to break down billable hours. The whole idea is set up the income statement in a way that lets people observe the effects of what they do.
  4. Use the income statement to educate people about the balance sheet. While the action may center around the Income Statement, it is the Balance Sheet that tells you the real score – how secure jobs are, how much wealth has been created, where the company’s vulnerable. You ignore it at your peril. Once people get the hang of the Income Statement, moreover, it’s a fairly simple matter to show them how the changes there produce changes in the Balance Sheet. Use the same principle of breaking down large Balance Sheet Categories to illuminate cause and effect.

Above all, develop a set of financial statements that works for your particular business. If you have a chain of clothing stores, your internal statements will wind up looking very different from those you would develop if you had a travel agency. … But the process by which you would come up with your statements would not very much at all.

At SRC, we break out the various costs involved in the manufacturing operation. Typically, these costs would be lumped together in the Cost-of-Goods-Sold line on the income statement. That may be adequate for a banker, but it doesn’t tell us very much about what’s really going on in production, where most of our people work. We want them to see exactly what effect they are having on profits, so we break down the Cost-of-Goods-Sold line into its basic elements – material, labor, and overhead. Every week, the various departments forecast whether, and by how much, they are going to be over or under budget for the month. Then, after the month’s close, we produce a hundred-page set of financial statements showing exactly what happened where and how each person contributed.

Visitors sometimes find all this a little overwhelming. I tell them to bear in mind that we didn’t create this system overnight. It took us years to develop all the mechanisms we now have for keeping people up to date on the numbers, and we’re sill coming up with new ones. But we started out very simply. In the first year, your chief financial officer would put together a daily report like chicken scratch for the bank showing where our cash was, where our inventories were, where our receivables were, what we owed, and so on. That would be passed around the company. People got curious. They would come down to the front office in the morning and ask, “What do we owe today?” From there, the reporting system just grew and grew.

Employees wanted to see exactly where they fit into the process; … Their questions told us what information we should be reporting. Management’s role was to instill the desire to know. We did that by a variety of methods – through the bonus system, the weekly meetings, and all the other games we developed along the way.

The Great Game of Business – Chapter 5 section 1 (part 7 of 17)

Chapter 5 – Open-Book Management

The more people know about a company, the better that company will perform. This is an iron-clad rule. You will alwaysbe more successful in business by sharing information with the people you work with than by keeping them in the dark. … Don’t use information to intimidate, control, or manipulate people. Use it to teach people how to work together to achieve common goals and thereby gain control over their lives.

The Language Cure: how open-book management works

When I talk about open-book management, I’m referring to the practice of communicating with people via the numbers. This is a cornerstone of the Great Game of Business as we play it at SRC. I’m not saying … it’s a cure-all … people aren’t going to believethe numbers if you haven’t established some credibility and begun to foster a sense of mutual respect and trust. And people aren’t going to act onthe numbers if they’ve never had the experience of winning, if they think of themselves as losers, if they walk around with sand in their eyes. And people aren’t going to care about the number if you haven’t given them a sense of the Big Picture by educating them about how the company works, where they fit in, and why it all matters.

Start with the basics. Once you’ve laid the right foundation, then it’s essential to teach peope the numbers, because numbers are the language of business, and you can’t understand business, let alone play the Game, if you don’t speak the language.

Take the Emotions Out of the Business

I am second to none in believing that business ought to be people oriented. But no company serves its people well be elevating emotions over numbers. That’s one of the things I like most about open-book management: it takes the emotions out of the business, or at least out of the decision-making process.

Let people evaluate the situation for themselves. Don’t do it for them with rah-rah squads. You can communicate more clearly with numbers. If I tell people one plus one is two, that message gets through without distortion. The challenge is to get people to appreciate what I really mean by one plus one is two.

And when you have bad news to deliver, the numbers are crucial. It’s hard to share bad news. … So the person who is supposed to deliver the news tends to put it in the best possible light, which often undercuts the message. … So somehow you want to send the message clearly without getting people down. You can do that with numbers.

Magic Number: why open-book management works 

There are only two ways to make money in business. One is to be the least-cost producer; the other is to have something nobody else has. … If you have the lowest costs in the market, you can undersell the competition and still earn a profit. By the same token, you don’t have to worry too much about losing business to competitors who charge less. If your costsare lower, a price war is going to hurt them more than you.

On the other hand, it’s always nice to have to come up with an edge that customers can’t get anywhere else. Maybe it’s quality, maybe it’s a particular service, maybe it’s a unique product, maybe it’s a brand name. As long as you’re the only one who has it – and customers want it – you can charge a premium for it.

The best way to control costs is to enlist everyone in the effort. That means providing people with the tools that allow them to make the right decisions. … Those tools are our magic numbers. Every business has them. Specifically, they are the numbers that tell you whether or not your costs are lower than your competitors’. To know what your costs should be, you have to find out what your competitors’ costs are – what their labor rates are, how fast they make their product, what fringe benefits they offer, what other incentives they provide, what they pay for material, what their debt levels are, and so on. Only then can you determine what you must do to be the least-cost producer.

Of course, when you’re striving for lower costs, you can also try to come up with additional services – services that nobody else has. … The idea is to offer something that allows you to charge a little more. In most businesses, however, you’re not going to be able to charge a lot more. So you can never stop trying to be the least-cost producer.

Improvements Come in Fractions; Only Surprises Come in Whole Percentages

The best argument for open-book management is this: the more educated your workforce is about the company, the more capable it is of doing the little things required to get better.

Business is a game of fractions. If you look at the income statements of corporations today, you’ll see that very few of them have pretax margins above 5 percent. So a 1 percent improvement in profitability is very, very significant, but it takes time to achieve it. Surprises, on the other hand, pack a bigger punch. … nobody hates surprises more than the manipulative control freaks who practice old-fashioned, secretive, need-to-know management. That way of operating virtually guarantees a steady stream of surprises, because people don’t have the tools they need to forecast and project, to live up to their commitments.

The Sixth Higher Law Is: You Can Sometimes Fool the Fans, But You Can Never Fool the Players.


The Great Game of Business – Chapter 4 (part 6 of 17)

Chapter 4 – The Big Picture

Nowadays we start teaching people the Game as soon as they come to work at SRC. We plunge right into the financial statements. Once people understand the numbers, oncey they see how the Game works, once they get it, business makes all the sense in the world. It puts everything they do in perspective. It makes them understand why they’re here. It shows them what theyir contribution is and why it matters.

But you may want to start a little more gradually, as we did in the early years. It’s a lot easier to teach people about making money and generating cash if they know what the company does and how they affect its performance. Paint the Big Picture for them. Tell them why you’re in business using terms they already understand. Then the numbers will make sense when you get to them. You’ll be able to demonstrate how they can serve as tools to stay connected to the Big Picture on a daily basis, to keep everybody focused on common goals. And that, after all, is the main reason the numbers are important: they constantly lead you back to the Big Picture.

Most of the problems we have in business today are a direct result of our failure to show people how they fit into the Big Picture. KEY POINT: The Big Picture is all about motivation. It’s giving people the reason for doing the job, the purpose of working. If you’re going to play a game, you have to understand what it means to win. When you show people the Big Picture, you define winning.

 So these are the steps so far:

  1. Create a series of small wins
  2. Give people a sense of the Big Picture
  3. Teach the numbers

That’s the rough sequence, at any rate. The truth is that we are always looking for more wins of any size, and we never stop reminding people about the Big Picture. You shouldn’t either. Here are some ways to go about it.

*Give Everyone a Course in Your Business

Sometimes you have to make a dramatic statement to get people to step back, see how everything fits together, and think about the broader purpose of what they’re doing. … So, one day in October 1980, we shut the plant down and had everybody show up instead at the Hilton Inn across town, where they participated in what we called Employee Awareness Day. It began with workshops run by the different department heads. People divided up into small groups that went from room to room. They learned what each department did, and how it fit in with what the other departmetns were doing. The head of engineering explained how his department made it possible for us to take on new products and keep up with technology. The materials department put on a skit dramatizing what would happen if inventory got out of control.

*Market Your Products to Your Employees

Just because you spend a lot of time, effort, and money telling customers about your products, don’t assume your employees understand those products. The chances are that most of them know about only one small part of the process. They can’t possibly see the Big Picture if they don’t understand what your company does – what products or services it delivers to customers, how it helps customers solve theirproblems and take care of their need. The answer is to spend some of your marketing budget on your own employees.

The company was spending millions of dollars on ads, posters, brochures, and other material designed to get customers to believe in our products, but we weren’t using any of it to generate pride in our own people. So we went to the sales and marketing people and asked them to help us out. … That marketing campaign helped us to turn the entire operation around. It got people thinking like members of a team, which is crucial on an assembly line.

The lesson was: market to the people who are producing the goods. In fact, you should sell your people beforeyou try to sell the customer. It doesn’t do any good to go out there an sell an empty product. You want to sell a product that has life in it – that has people in it.

*Move People Around

People Express Airlines used to have a practice it called “cross-utilization,” whereby employees would get experience in different parts of the business. The flight attendants would spend time handling baggage, for example, and the accountants would work in customer service. It was, in fact, an effective technique for getting people to look beyond their specialties and get a direct, firsthand sense of the Big Picture.

*Draw a Picture

Don’t just tell people about the Big Picture, show it to them. Put it in the form of charts and graphs. Use them to decorate the walls. Anything that can be measured can be turned into a picture – net profits, retail sales, sales per customer, output per week or per day or per minute, energy use, scrap, you name it. And those pictures can be very dramatic. At one point, we had a graph in the cafeteria that went right off the paper, all the way up to the ceiling. It was about overhead costs, and it sure got people’s attention.

But the most effective pictures we have aren’t charts at all. But the most effective pictures we have aren’t charts at all. They are the stock certificates we distribute every year, as a way of giving people physical evidence of their equity in the company and how they have increased their holdings in the past twelve months. The certificates look real enough, although they have no intrinsic value: normally, an Employee Stock Ownership Plan doesn’t issue stock certificates, just an annual statement. We do this strictly because we want people to see the Big Picture. It’s a way of reminding people to see the Big Picture. It’s a way of reminding people how we measure success. We’re saying “In this company, you get equity. When you play the Great Game of Business, that’s the measurement of success.”

*Get Incentives from the Six-Year-Olds

A company is just a means to an end, and the end lies outside the four walls of the business. So the real Big Picture, the one that matters most to people, reaches beyond their paycheck out into the community. We put a lot of emphasis on community programs – Adopt-a-School, the Christmas drive for homeless children the United Way, the Special Olympics, the Red Cross. We have a hard time saying no to anybody. For us, it’s all part of the Big Picture.

Go Beyond Quality

Educating people about the Big Picture runs counter to a lot of ideas that become popular in the 1970s and ‘80s – notably the quality movement. Back then I found that people who were into quality didn’t care about anything else. One of my closest colleagues at SRC thought it was a big waste of time to teach people about the different parts of the business. “Why should a manufacturing guy like me care what the marketing people are doing?” he’d say. “All I care is that they do their job right. If I do my job right, and marking does its job right, and all the other people do their jobs rights, we’ll have a successful business. I don’t have to know how the marketers go about promoting sales. What matters is quality. You get quality by making sure people pay attention to details, not by telling them how the company works.”

The argument sounds logical enough, but it’s wrong. I knew from experience it was wrong. I had seen companies run that way, and they usually had terrible quality, not to mention a host of other problems. When people focus on their narrow specialties, the different departments go to war. They don’t function as the parts of one company. They act more like competing factions. It becomes very hard to make money or do anything else very well. Quality isn’t better. It’s worse.

The Danger of Mixed Messages 

When you don’t teach people the Big Picture, you run a constant risk of sending people mixed messages. I know one Fortune 500 company president who sent out word he wanted to improve customer service, so people began building up inventories at the product distribution centers. What he didn’t tell them was that he was being evaluated according to return on assets – that is, net income as a percentage of total assets. As the inventories grew, so did the company’s total assets, and the further the president was from earning his bonus. In the last quarter of the year, he suddenly ordered his people to stop all deliveries so that he could meet his goal. It was a disaster. Fourteen hundred suppliers were shut off without any warning. Literally hundreds of thousands of jobs were put on the line. The happened because the president sent the wrong message. He said we wanted better customer service when he really wanted a better return on assets. He didn’t tell people the Big Picture and everyone was screwed and demoralized.

Compensation systems are the primary way that companies send mixed messages. But they may also do it with their performance evaluations, particularly if they use Management by Objective. People can get very confused. They develop tunnel vision. They don’t see the effects of their actions. Say you tell a person she’s being evaluated on inventory turnover, and she drives the inventory down to nothing. So what happens? Your inventory carrying costs are very low, but the production people can’t operate their machines efficiently, so manufacturing costs go through the roof. That’s why you need to get everyone to focus on the Big Picture.