Sunday, March 17, 2013

The Barefoot Philosophy Cornerstone #1: Financial Transparency

[This is part 2 of an 8 part series: The Barefoot Philosphy.  It is based on my experiences as the founder of a business—Barefoot Software—which I ran for 12 years.  Please start with the intro.]

My business preceded a lot of those that have made a splash in the business world for doing things in an unconventional fashion.  One that I didn’t precede was SRC, which was founded in 1983, while I was still in high school.  But that company is still around today, and, according to Wikipedia, its revenue is $400 million.  Its founder, Jack Stack, championed a new business philosophy which has since come to be called “open book management.”  What it means is very simple: you open your financials to your employees.

There are no closed-door meetings among the senior team.  There are no secrets.  Everyone knows everything.  Everyone knows exactly how much the company is earning off of their labor at any given moment, and maximizing that is everyone’s business.

Article after article reaffirms that this works.  And yet very few businesses are run this way.  I actually suggested this methodology to my current employer once.  It wasn’t a pretty conversation.

I’ve yet to understand exactly why, though.  Does upper management imagine that they are the only ones smart enough to understand the financial intricacies of the business?  Do they perhaps not trust the employees to be responsible with the company’s money?  Well, I hate to be the one to break it to them, but this lack of trust is one of the major reasons for low employee productivity.  To quote one of those many articles:

High performers don’t thrive in an atmosphere of secrecy and uncertainty.  They want to work for a company that treats them with respect and values their problem-solving skills.1

Perhaps some people are worried that employees will be unhappy once they realize how much money the company is making off them.  First of all, if you have to worry about this, you probably are making too much money off your employees (and you should fix that).  But we’re also going to discuss how to fix that perception in later cornerstones.

While I was running Barefoot, my attitude was always, “I need to understand how everything works financially.”  I broke things down all the time.  I was very influenced by an article I read in a doctor’s waiting room somewhere2 that talked about calculating profit, and all the things most people forget to consider.  I started creating all these Excel spreadsheets with profit calculations and models on them.  Everything went into them: even the money I paid our office manager to generate biweekly payroll was spread out amongst all our billable employees and turned into a line item.  Without those numbers, how could I know whether we were making money or not?  And, once I had the numbers all laid out, why should I be scared to show them to everyone?  Hell, some of my employees were smarter than I was; they might help me find mistakes.

So all those profit spreadsheets were on a network drive where everyone in the company had access to them.  But we didn’t stop there.  Our accounting info was in QuickBooks.  It was, of course, password protected.  But everyone in the company knew the password.  Or at least could know the password, if they were so inclined (some were, some weren’t).

The first objection that some of you are going to have is:  Doesn’t that mean that everyone knew how much everyone else made?  Yes, it does.  This isn’t as bad as you think it is.  Mainly that’s because of the cornerstone we’ll cover next week.  But the bigger issue is, what problem do you think you’re solving by keeping everyone’s salaries a secret?  Perhaps you think that, if no one knows what anyone else makes, there will never be any jealousy over compensation.  Unfortunately for you, keeping salaries secret and no one knowing what anyone else makes are two entirely different things.  You see, each employee knows what he or she makes, and employees talk.  Managers usually know how much the employees that work for them make, and managers are employees too, and employees talk.  There really is no way to keep these things secret, no matter how few people you tell.  Worse, when people don’t know how much their coworkers make, they speculate.  And they’re often wildly wrong.  Now all of a sudden you can have people being jealous of coworkers who actually make less than they do.

Quite simply, this is one of those cases where honesty really is the best policy.  Honesty with all your employees means that they understand things.  When things are bad, you just tell them things are bad.  Not only do they have the financial background to be understanding about it, they often have the knowledge to actually do something about it.  And, when senior management treats their employees like mushrooms,3 the employees aren’t going to assume that everything is fine since no one is telling them anything.  They will often imagine things are much worse than they are and start panicking.

Most importantly, employees (human beings in general, really) need to understand why.  Why does the company do this?  Why does the company set the margins here?  Why won’t the company spend money there?  Why does this project need to be done so badly?  “Because I said so,” is an answer for children (and not a very good one even for them).  Tell them the real reason, and they’ll respect you more, and they’ll do better work, and they’ll do it more efficiently, and they may even fix the problem for you when you aren’t looking.

Maybe your fear is that employees just won’t understand all that financial mumbo-jumbo.  But this is just conceit, plain and simple.  None of us understood the financial mumbo-jumbo, at first.  We had to learn it.  Your employees won’t understand it either, at first.  Teach it to them.  This is an investment which will repay itself tenfold and more.  And while some of them will be annoyed at having to learn something they don’t particularly have any interest in, not a damn one will ever curse you in later years for forcing them to learn it.  It will always serve them well, in every job they ever have, for the rest of their lives.

I’ll tell you one last thing about Barefoot’s financials that I’ve found superior to every other corporation I’ve had the opportunity to work for or with—how we did bonuses.

We had sales commissions, and we had referral commissions.  Those worked pretty similarly to how they work in other companies.  We also had another type of commission: employee commission.4  Employee commission was based on what we called the “direct profit,” or sometimes just “the diff.”  It was basically just the difference between how much we charged the customer and how much we paid the employee doing the work, with just a few other direct costs subtracted (specifically, sales and referral commissions, if applicable).  The commission wasn’t a straight percentage though; it was a more complex formula, and one of the factors in it was squared, resulting in a quadratic progression.  So if the diff was very low (say, $5 per hour), the employee commission might be miniscule (say, 10¢ an hour).  But if the diff was very large (say, $50 per hour), the employee commission would be substantial (perhaps $10/hour).

We would take the employee commission and put it in a pool, and that pool was what went to pay your quarterly bonus.  You got rated on a scale of 1 to 5.  I don’t remember the exact percentages, but it was something like, 1 was 80%, 2 was 90%, 3 was 95%, 4 was 100%, and 5 was 110%—something along those lines.  Whatever percentage you got, you got that much of your employee commission.

Now, there’s a number of things going on here.  First of all, the more the company makes off you, the more you get back on your bonus, and the quadratic progression means that your “cut” is going up faster than the company’s.  So that makes employees happy, first off.  But probably what’s more important is that we’ve guaranteed that the bonus pool is paid for out of the profits.  This avoids things such as “calibration.”

“Calibration” is what it was called at eBay, at any rate.  Under this plan, there is a certain amount of money available to give out to employees.  The performance is also 1 to 5, but the percentages are different: 3 is 100%, while 5 goes up to 150% and 1 gets nothing at all.  The “calibration” part is what you have to do when everyone on your team is really good at what they do.  Instead of a performance rating reflecting an employee’s actual skills and utility to the company, the ratings are forced to fit a curve: only so many 5s allowed, only so many 4s, and so on down to the 1s, which you are required to have some of.  This is moronic.  This actually encourages managers to keep underperformers around so they have somewhere to dump their 1s.  And how discouraging is it to tell some of your top performers that you can’t actually rate them as top performers because too many of their coworkers are top performers too?  It’s like being penalized for building a superior team.  Netflix addresses this in their culture document (emphasis added):

We avoid “top 30%” and “bottom 10%” rankings amongst employees  ...  We want all of our employees to be “top 10%” relative to the pool of global candidates5

In the end, financial transparency avoids creating an artificial gulf between “senior executives” and “low-level employees,” keeps employees in the loop and engaged, and demonstrates respect and trust, which in turn keeps your best and brightest from looking elsewhere for those things.  It’s the first step, but not the last.

Part: << 1 2 3 4 5 6 7 8 >>

1 “How much should you tell employees about the financials?”, ReliablePlant, Quint Studernot.

2 After doing a bit of research, I’m pretty sure it was this one.

3 I.e., keeps them in the dark and feeds them bullshit.

4 Employee commission was for our billable employees.  Non-billable employees had a separate sort of commission—admin commission—based on the gross profit of the entire company.

5 Netflix Culture: Freedom & Responsibility, slide 113.

No comments:

Post a Comment