Tale of Two Factories

While I'm of the view that incentives ought to reinforce goals rather than drive them, either way it doesn't take a genius to realize that incentives can have a significant impact on results. So it is with our manufacturing partners.

The nature of aluminum extrusions is that it's a capital intensive business. Machines require cash, inventory uses a lot of cash (and you won't find any aluminum smelters offering credit), and you tend to need a lot of space if you want to offer finishing services. Companies that are able to manage rapid growth against these capital constraints are as much fascinating as they are unusual. Progressive incentive structures are difficult to come by anywhere in the world but surprisingly I've come across a number of companies in China that reward based on profitability instead of some arbitrary figure (or the traditional 13th month of salary).

As an example, one rapidly growing factory distributes 8% of profits to managers and directors. While the company probably pays below average for its managers, the profit share means that many of them can make as much if not even more than their annual salaries paid just before Chinese New Year's. Of the remaining 92%, 70% gets distributed amongst the partners and the residual is reinvested.

Interestingly, they also have a borrowing mechanism that allows managers, directors and also shareholders to lend funds back to the company where the company pays interest on those "deposits" at a similar cost to what they would get from the bank. I suspect that like microfinance, where voluntary savings are often an indicator of the trust that borrowers have in their institution/borrowing group, "deposits" here can be used as an indicator for senior managers as an indication of the level of trust and optimism that employees feel for the success of the organization over at least the term. Of course this can also be dangerous depending on the liquidity of the company should one day the level of optimism/appearance of security be less so.

Let's call this Factory A. Now let's compare it to Factory B - with a much more of a command and control type structure, Factory B was purchased from the state by a technocrat at rumoured wholesale prices. About 5-6 years ago both companies were the same size with 8-10 extrusion presses. Now Factory A has over 50 presses while Factory B has 14. While there is undoubtedly more to it, there's little doubt in my mind that culture reinforced by incentives have played a large part.

There is one caveat that may be masked by the rapid growth of the company. The number of people employed per machine is nearly double in Company A versus Company B - which is a little counter intuitive. Within the Chinese context, and this is an area I think culture has played a role - managers are given hiring power and often want to hire more people from their own villages which to my mind somewhat ego driven in that I suspect that the profit that they are awarded is disconnected enough that the trade off in lower profitability for them specifically is offset by the increased stature of having more employees.

As a result, Company A is a little more expensive than Company B in pricing but my confidence in Company A being able to produce consistently to our requirements especially when aesthetic finishes are a concern is significantly higher. I am also told that the books are still rather opaque at both institutions. I've yet to hear of any Chinese companies that practice open book management (I suspect in part because of, er, "tax management") - thus Company A requires that its employees and culture has a great deal of trust in order for the incentive structure to work.

I think smart managers/entrepreneurs realize that while incentives are a cost, managed properly they can also become investments in culture that pay for themselves many times over.