The Problem of Excessive Executive Compensation for Lean Manufacturing

A Wall Street Journal article today titled Snow Defends Presidents’ Handling of the Economy got me thinking again about the problem of excessive executive compensation for Lean manufacturing. The problem of excessive executive compensation for lean Manufacturing is that it is a kaizen killer.
What’s a “kaizen killer?” I will explain but first let’s see what U.S. Treasury Secretary John Snow has to say on the topic of executive compensation in America. We can imagine Mr. Snow shrugging as he claims that we are seeing the United States’ “labor market efficiently rewarding more-productive people” even as the income gap widens.
What’s been happening in the United States for about 20 years is [a] long-term trend to differentiate compensation,” Mr. Snow said in an interview with The Wall Street Journal last week. “Look at the Harvard economics faculty, look at doctors over here at George Washington University…look at baseball players, look at football players. We’ve moved into a star system for some reason which is not fully understood. Across virtually all professions, there have been growing gaps.
The article cites a study that CEO pay has increased from 40 times the average worker’s pay in 1970 to 400 times the average worker’s pay today. Why are CEOs’ compensations so high? The invisible hand of the market, says Snow:
In an aggregate sense, it reflects the marginal productivity of CEOs. Do I trust the market for CEOs to work efficiently? Yes. Until we can find a better way to compensate CEOs, I’m going to trust the marketplace.
Mr. Snow, a former CEO himself and a trained economist, now has a job which in part requires him to use statistics to spin economic information in a way that is favorable to the people he works for. It is a pity that to Treasury Secretary Snow the problem of the widening gap of income and excessive executive compensation in the United States is one at a “philosophical level” and not a problem at a practical level that affects dozens of millions of Americans and actually needs to be addressed by policy under Mr. Snow’s watch. Ignorance is easier to plead than incompetence.
But CEOs are leaders of organizations who have been hired to run businesses profitably. They do not have the option, unlike Mr. Snow, of raising taxes in order to stay in business. Executives who want to stay competitive need to engage everyone in their organization in kaizen and Lean thinking. To executives, the widening gap in compensation is not an issue at the “philosophical level”.
What’s the problem with executives who are paid 400 times the average worker? It makes people who are asking “What’s in it for me?” no longer believe you when you reply “job security” or “improved competitiveness” or “a better work environment”. Executives who are compensated in ways that are excessive are not credible as leaders in a kaizen culture.
For our purposes Lean manufacturing (or Lean healthcare or Lean transaction or Lean government) is when there is a kaizen culture in the organization that is as close as possible and profitable to TPS and the associated business philosophy. For our purposes kaizen is persistent improvement across all aspects of a business, based on eliminating waste, variability and unreasonable conditions, towards real profitability.
This type of kaizen culture requires the development of people who understand TPS and will continuously do kaizen and solve problems for themselves and their customers to reduce cost and improve quality. This requires significant ongoing education and training within an organization.
In our experience, the companies that are most successful in the world with kaizen do kaizen as OJT – On the Job Training. I’ve been taught that there are three parts to successful OJT. They are knowledge, ability and motivation. If any one of these three is lacking, the results will be poor. In summary:
Results = Knowledge x Ability x Motivation
I would argue that one of the key roles of a leader is to develop the people in their organization. This is true from the Chief Executive making sure that she has a reliable team of individuals who can take her place, all the way down to the front line supervisor making sure that new workers are trained to follow standards that are in place.
When people are treated unfairly, this rapidly erodes motivation. Based on conversations I have had as part of my effort to teach people about kaizen, very few who are paid a salary in the range of “average” think today’s executive compensation is fair. This badly erodes the ability of these leaders to lead people to a kaizen culture like that of Toyota. Whether or not executives today understand this is another important question, one that is beyond the scope of this article.
I suppose at this point I should make a strong case for why executive compensation that is as much as 400 times that of the average worker is “excessive”, but I’ll leave that up to smart people who have argued more eloquently and passionately than I can here. Author and management thought leader, the late Dr. Peter Drucker raised the early alarm over excessive executive compensation. Author, consultant and fellow blogger Bill Waddell wrote a delightful rebuff of Bob Lutz’s justification of his excessive compensation. Economist, lawyer, writer and actor Ben Stein wrote brilliantly on Sunday February 12 in his New York Times column titled New Front: Protecting America’s Investors. Ben Stein’s article is such an impressive display of fairness and clear thought that I hope it is widely read by his peers.
According to a Watson Wyatt Worldwide survey of 55 institutional investors, cited in the February 13, 2006 issue of BusinessWeek, 90% of institutional investors think that corporate executives are overpaid and 85% think the compensation system hurts the image of corporate America. Institutional investors are typically not shareholder activists or labor representatives in their spare time. For the most part they are hard-core capitalists, so this particular statistic is saying something.
But let’s suppose Mr. Snow is completely right and that a CEO making 400 times is only the best example of capitalism at work rewarding the most productive performers in the job market. Excessive (or should I say questionable?) compensation for executives of the type described in the March 18, 2006 Wall Street Journal article The Perfect Payday represents a similar problem for Lean manufacturing.
The article describes how CEOs and executives at companies such as Affiliated Computer Services, United Health Group, Mercury Interactive, Analog Devices, Brooks Automation, Comverse Technology and Vitesse Semiconductor all appeared to reap significant financial benefit from bending the rules.
The CEOs all had agreements that allowed them to perfectly time their right to buy company stock. The dates they were granted happened to be when the stock traded at the lowest value that year. These CEOs did this not once, but many times
The odds to something like this happening by chance alone in one example were one in 300 billion, according to the article. Maybe extraordinary luck is part of what makes these CEOs 400 times more productive than the average worker. But he SEC doesn’t think so and they are investigating these cases as examples of backdating.
It’s not that I don’t believe in business leaders being very well compensated. People who have great ideas, take significant personal risks, or help organizations execute good ideas in a positive and transformative manner may deserve to be compensated more generously than the person who doesn’t offer ideas or take significant personal risks.
Peter Drucker said “Strategy is a commodity, execution is an art”. In this day and age where strategy (ideas such as restructuring an organization’s business lines, putting an emphasis on innovation, or relocating to lower cost countries) seem to be a commodity available for purchase from any number of experts, the CEO of today who executes these strategies hardly seems to qualify for such generous compensation.
I would take it a step further. To borrow a saying from the military, “Amateurs worry about strategy. Dilettantes worry about tactics. Professionals worry about logistics.”
In the military, strategy happens at the level of Generals. Other officers then execute these orders through by giving orders to carry out tactics. The logistics required to build or blow up bridges, take or save lives happens at the level of what is known as the rank and file. We’re back to relying on those 400 people who are less productive than the CEO / General with the winning strategy and artful execution.
Brad Schmidt of Gemba tells the 2,000 year old Chinese story of the warlord who was undefeatable on the field of battle. This warlord believed in the “four sames” philosophy. Unlike other armies in those warring times, his army all had the same food, same clothes, same lodgings, and the same enemy. In China 2,000 years ago these soldiers, like Treasury Secretary’s workers who are 1/400th as productive as the CEO of today, were expendable. The Chinese warlord most probably received much greater rewards for victory in battle than the average foot soldier. Yet he understood that creating distance between himself and his troops by flaunting this gap in compensation was not the way to win.
Bringing it back to Lean manufacturing, it’s true that consultants are sometimes criticized for receiving excessive compensation. When consultants work at a company only to do “kaizen events” to make improvements in quality, cost, delivery or safety, I would agree with this. These things are a commodity, like the strategies and decisions of most excessively paid CEOs. Consultants see an opportunity to apply a known solution to a problem their client company is facing. Like the best executives they study the current situation, identify the gap with the target condition and apply their knowledge and skills to close the gap. While this benefits both sides, too often the consultant or executive does not leave a culture of kaizen at their client company. The result is short-term cost reduction but sustainability in the long-term is lacking. The same is true for excessively paid executives.
Based on anecdotal evidence, kaizen consultants are paid anywhere from 2 to 10 times what the average worker at their client is paid. As long as kaizen consultants are credible in delivering the results they promise (and they are promising sustained improvement), they are practicing what they preach and doing their work in a way that is respectful to people, I believe this is fair. But ultimately the market decides and sets the price based on supply and demand. Hopefully the same will be true for executive compensation very soon, for the sake of making better companies and better societies through kaizen.
Now that I’ve gotten this one out of my system, dear reader, please enjoy many months of rant-free blogging.