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The Value of Labor and Compensation Systems
How Truck Equipment Distributors Can Improve Business Performance
with Advanced Compensation Systems
For many in the truck equipment industry this last decade was
one of tremendous growth for their businesses. Given a list of
challenges they faced during this period I would say that many
would identify production capacity as the major challenge.
Space was sometimes the constraint but for most of my contacts
the issue was attracting and retaining qualified installation
and production personnel. This was the case especially during
the latter part of the decade. With unemployment near 3% for this
period it created many problems for some truck equipment dealers
and quite often the following scenario was played out in their
business:
1. Compensation systems at the truck equipment dealers were
outdated and did not reflect the competitive wages of their
region.
2. With unemployment this low it was an employees' job market.
Many skilled personnel left for other industries that could
use their transferable skills.
3. When trying to backfill the void most companies found that
the pool of unemployed, highly skilled personnel was non-existent.
4. Hiring highly skilled personnel from other industries was
not possible within the current compensation structures of most
truck equipment distributor shops.
5. The employees that were available had limited skills or experience,
or worse yet, had personal baggage that included poor attendance
or shoddy work habits.
6. Because the dealer's compensation system was not current
with the market it was difficult to attract new employees. Therefore,
the companies were almost always short of personnel.
7. In order to attract new employees the companies were forced
to pay new employees more than their current employees exhibiting
the same skillsets.
8. Once this became known among other shop employees, the company
was forced to increase wages for this select group of existing
employees.
Many truck equipment dealers have still not dealt with the underlying
problem in the scenario above and are still caught in the same
vicious circle. They have not kept pace with the local job market
and need to overhaul their compensation system in order to become
competitive. There are many reasons why this is an important issue
for the truck equipment industry, including:
1. Training: Many companies have very broad product lines
and offer everything from ladder racks to large truck-mounted
aerial devices with custom line bodies. In this environment,
it takes many years for an employee to learn all of these products
and become productive. By then the company has a great investment
in training him. For this reason, once fully trained, it is
important to retain that employee.
2. Productivity: In order to remain competitive, distributors
must often resell purchased components at low margins. They
must then make the majority of their profits on the value-added
labor. Therefore, creating and managing a productive work environment
is critical to profitable operations.
3. Quality: Rework costs are often very high for dealers.
Personnel that can perform the job correctly the first time
are critical to retain both from a cost control and a customer
relation's standpoint.
Objectives of a Compensation System
What is the purpose of a structured compensation system? I believe
that there are three main objectives and they are:
1. Employee procurement and retention.
2. Consistency in application of the system.
3. Reinforce positive behaviors.
In order to support the first objective, the compensation system
must be competitive within the local employment area. Regional
manufacturing and business associations will often share wage
and benefit information for the sole purpose of establishing what
changes are occurring in the local market. Armed with this information
a distributor can review how their wages and benefits compare
and make the required changes.
Uniformity is the second important objective. Once a system is
established the supervisors must be trained and held accountable
to manage the process consistently. This training would focus
on effectively carrying out performance evaluations and wage reviews.
In addition, one senior manager must be accountable to insure
company-wide consistency in the administration of these tasks.
One of the major causes of union activity is brought on by disparity
in wages, reviews, and other supervisory actions. A disciplined
approach in creating and managing an effective compensation system
will prevent most union activity.
Let's review the following situation that is prevalent in many
companies and build a case for the last objective. Often the highest
paid production personnel are the most senior, not necessarily
the most productive. In general, the most productive employees
have five to ten years of seniority, know all the products, and
consistently demonstrate the highest levels of productivity. Unfortunately,
they are often paid substantially less than the more senior employees
are because the compensation system has not been responsive to
this group of personnel. In this instance, the compensation system
implies seniority is the most important behavior of an employee,
not work habits and productivity. As I have witnessed many times
this situation is a key driver in turnover in the highly productive
group with less seniority. This is not the message employees should
receive.
Therefore, in my mind, the most important objective of the compensation
system is to encourage and reward positive employee behaviors.
Once a good basic system is established further steps can be taken
to enhance the effectiveness of the system and fulfill the third
objective. Used together or as stand-alone tactics the programs
listed below are strategies that will reinforce desired behaviors.
1. Pay-for-Skill Programs. Compensation systems can
be modified to pay a premium to employees that learn and apply
new skillsets. These premiums are a small percentage of total
wages but are often of more significance to the employee because
of the personal recognition they receive.
2. Work Team Programs. These programs create a rich environment
for assimilating new employees, crosstraining, and reinforcing
improvements in quality and productivity. Pay-for-Skill and
incentive programs are very successful when directed at the
work team level.
3. Lead Programs. The addition of floor leadership can
yield tremendous financial benefits at very little cost. Again,
these individuals are more often motivated by the personal recognition
than by the pay premium. These programs also play a key role
in the success of work teams.
4. Incentive Programs. These can be awarded to individuals,
work teams, or on a plant-wide basis. Incentives can be developed
for quality, productivity, rework, etc. to create desired changes
in behaviors.
A Financial Perspective
Profits are often won or lost on the production floor and skilled
personnel are the means of winning that battle. Business managers
need to broaden their perspective on compensation programs and
consider employee costs in the light of what they produce, instead
of what their hourly wages are.
For example, in the example that follows we will consider the
costs and outputs of three employees with different levels of
experience and compensation. The analysis in the table fairly
represents different businesses I have recently seen in the truck
equipment industry. For example, a $10.00 an hour entry level
wage was quite common for many businesses in recent years. These
entry-level individuals may have had some mechanical or welding
training but lacked the experience to use their skills effectively
within this industry. In many cases, it would take years of in-house
training to bring them up to the same skill levels as the senior
employees. Therefore, the mismatch between the high entry-level
wages and the corresponding lower levels of productivity created
a cost problem for the businesses.
The term productivity may be new to some readers but I will provide
a simple definition. As I am using the term here productivity
is a measurement of the percent of time it takes for a specific
employee to complete a defined task compared to an average, fully
trained and skilled employee. There are many ways to measure productivity
but this simple understanding will suffice for our discussion.
Our analysis will look at the impact of pay rates and productivity
and see how understanding this concept better may provide added
incentives to make improvements to compensation systems. We will
dissect the contents of the table below in detail to highlight
the cost problems facing a business.
True Costs and Marginal Costs
Looking at columns A and B in the table we see three representative
employees with different wages and corresponding differences in
productivity. These differences impact the actual cost required
to complete a quoted hour of labor. Listed below are the main
points we can see in columns A through D:
The high-skilled employee has a productivity rate of 100% and
he is able to complete one hour's equivalent work in one hour.
Therefore, his adjusted labor cost per hour would be the same
as his actual labor cost of $15.00 per hour.
The medium-skilled employee has a productivity of 75% so it requires
33% more time for him to complete one hour of quoted work than
the high-skilled employee. Because it takes him 1.33 hours to
produce one hour of work it will cost his employer $16.67 in labor
cost to complete the quoted hour of work.
For the same reasons the low-skilled employee with 50% productivity
would require 2.00 hours to complete the work and his actual labor
cost would be $20.00 for the one hour of quoted work.
For the business owner this means that he will lose either $1.67
or $5.00 per quoted hour of labor for every hour he uses these
two lower-skilled employees rather than the skilled employee.
Effective Hourly Revenue and Margins
We will assume the quoted shop rate at this distributor is $50.00
per hour. The revenue and margins generated by each employee each
hour are different because of their productivity differences.
This impact is shown in columns E and F and the following conclusions
are evident:
The lower the productivity of the employee the greater time it
takes.
Lower productivity reduces the effective revenue rate per hour.
As seen in column E the low-skilled employee uses two hours to
produce an hour of quoted work. Therefore, the revenue he generates
is only $25.00 per hour.
Taking the difference between the labor cost per hour of output
and the effective revenue rate an effective hourly margin is generated
for each employee. You can easily see the major differences in
margin for the three employees in column F.
Opportunity Costs for the Business
Of greater concern to the business is that there are many opportunity
costs. These costs include loss of margins and shop capacity.
With respect to shop capacity in our example there is up to a
50% loss because of the additional time that floorspace and shop
equipment is committed to each job when the less-skilled employees
do the work. These opportunity costs can be quantified in several
ways as shown below:
Let's take the numbers in column G and view this difference over
2000 hours a year. Compared with the top employee, the $12.50-per-hour
employee costs the company $20,000.00 in annual margin, while
the cost of the $10.00-per-hour employee is $40,000.00. This opportunity
cost in the hourly rate is significant and it is easy to visualize
the huge impact on financial performance if a business has many
employees in these lower-skilled categories.
On a job bidding basis lower-skilled employees also have a large
impact on gross margins. Columns H through J show a typical ten-hour
job bid at $500.00 that is completed by each of the three employees
and factors in their productivity. This analysis shows the opportunity
cost as a difference in margins generated by the job. There is
a difference of up to 10% in margins from top to bottom. Of course
distributors can compensate for the differences in productivity
and can add more hours on the quote. Unfortunately, this can often
mean not getting the business at all.
Capacity losses will create opportunity costs. If lower-skilled
employees are used and no additional capacity is made available
the business will generate less sales revenue. The corresponding
loss of margin will be an opportunity cost.
Another approach taken is to increase capacity and make up for
the lost production throughput. Additional equipment, personnel
and floorspace will be needed to have the same production throughput
while using the lower-skilled employees. Because it takes longer
and requires more floorspace to produce a product it will also
mean having additional in-process inventory which is an expensive
byproduct of this approach. In total, the increases in capital
assets and inventory will create greater demands for cash and
exclude the use of this cash for other business opportunities.
This simple illustration can be viewed in many different ways
but the point I want to make is that there can be a significant
difference in outputs generated by various employees and this
output per employee hour is what is important. Hourly wages need
to be competitive and applied consistently. In addition, the business
must factor in what kind of employee it is attracting and retaining
with its compensation systems. The financial and opportunity costs
associated with less productive employees far outweigh the costs
of attracting and retaining qualified personnel. Based on the
analysis shown above the more productive employee is a much better
investment for the business.
Bringing it Home
In closing, establishing an effective compensation system can
dramatically reduce turnover, and of more significance, reinforce
desirable behaviors. Having worked with many complementary compensation
systems, such as the four mentioned in the article, my experience
has shown that the productivity improvements far outweighed the
minute costs of these programs. Once basic wages are competitive
these complementary programs add notable reward to employees through
meeting their higher psychological needs, a much greater personal
motivator than money alone. In turn, employees respond with higher
productivity, less rework, less attrition, and generate greater
profits for the business. It makes business sense for dealers
to measure their compensation systems against the three objectives
in the article and then make the appropriate modifications. The
bottom line is that spending a little more on the front end on
a good compensation system can insure higher productivity, reduced
cash needs and greater profits for a business.
