Open-Book Management Goes Green
by Olen Greer, Ph.D., CMA, and George Schmelzle, Ph.D
From Strategic Finance Magazine
A huge waste company truck pulled into the manufacturing complex of SRC Holdings Corporation in Springfield, Mo. Two men got off the truck and loaded four 55-gallon drums of used SRC diesel fuel onto the back of the truck, their work overseen by two SRC employees.
Because SRC uses an “open-book” management style, the two employees were well aware that the cost to the company for each 55-gallon drum hauled away was $200, which also cut into the employees’ bonus plan. Yet one of the employees knew that there were recycling companies willing to pay SRC for each drum, and the liquid would be recycled into something usable without damaging the environment. After the employee brought this to the attention of top management, SRC located a company that would pay $38 per drum to SRC.
SRC’s unique approach to sustainability is driven by its revolutionary open-book management philosophy that, in effect, transforms every employee into a management accountant and an innovative business partner. The company, which is employee-owned, has discovered that this approach leads to more effective corporate responsibility, ethical practices, and a commitment to sustainability. This in turn can result in better cost control, higher profits, and stronger cash flows.
A Unique Philosophy
SRC Holdings Corporation—SRC originally stood for Springfield Remanufacturing Corporation—has been broadly recognized as the company that first pioneered open-book management principles, which were developed by company president and CEO Jack Stack and documented in his 1992 book, The Great Game of Business. Tons of press followed from mainstream media outlets, and numerous scholarly articles touting the success of SRC were published in academic journals.
SRC originated as a factory owned by International Harvester (IH), which is now known as Navistar. SRC’s original core business was, and remains, remanufacturing vehicle engines and transmissions to specifications approved by the original equipment manufacturers (OEMs), with whom SRC has contracts. This core business places the company solidly in the middle of the sustainability movement, as SRC is in the business of transforming used engines, starters, alternators, turbochargers, and engine components into like-new components.
SRC was officially born in 1983 when IH sold the assets of one of its factories, called “The IH Renew Center,” to an employee group led by Stack, who was the former plant manager. From there, it took him only a few years to implement his open-book management style and transform SRC into a profitable and growing company.
How did Stack do it? Let’s take a closer look.
Opening the Books
Achieving success in business isn’t significantly different from achieving success in a team sport. Every player (employee) needs to (1) know the rules of the game, (2) know how to keep score, and (3) have a stake in the outcome. Knowing these things doesn’t guarantee success, of course, but is a threshold requirement for being successful. Stated another way, if most players/employees don’t know the rules of the game or how to keep score, the likelihood of failure is much greater.
Stack’s observation about the way business is conducted in the United States is that very few employees actually understand the rules of business (the game) and even fewer (the “bean counters”) know how to keep score. At SRC, as part of their required orientation, all employees (janitors, back-office staff, line workers, etc.) are given training on how to understand financial statements, including the income statement (the score), balance sheet, cash flow statement, cost variances, and financial ratios. Stack realized that if employees could grasp the components of profitability and their own role in producing profits, they would develop into successful “players.”
Stack believed every employee needs to have a stake in the outcome if he or she is going to perform at the highest level possible. He also believed that most businesses compensate employees in a manner that incentivizes them toward mediocre performance. Hourly wages and flat salaries encourage workers to do the bare minimum necessary to keep their jobs. Workers who work harder than “the norm” are pressured by other workers: “Slow down! You’re making us look bad!” Meanwhile, management is often compensated with a bonus structure linked to profitability. At SRC, every employee has the opportunity to participate in the bonus structure and become an owner of the company through an employee stock option plan (ESOP).
Giving Power to the People
According to Stack, when given sufficient training and information, employees will make decisions that are congruent with the goals of the organization—especially when increased profits translate to higher compensation.
Typically, when problems such as cost overruns or reduced profitability occur within a company, high-paid consultants are brought in to address these problems. Stack, on the other hand, believes that the existing workforce—not outside experts—should be the first source to be tapped when addressing problems of this nature. In most cases, someone within the company understands the problem and is aware of a viable solution.
Consequently, at SRC, all employees are involved in the management process. They regularly receive financial data to provide them with the information necessary to make informed decisions. During weekly meetings referred to as “huddles,” each employee group is asked to account for its “critical number” (perhaps a cost variance or other relevant metric) and is given the opportunity to provide meaningful feedback and input related to issues or problems that may have arisen. In many cases, if not most, problems are resolved without going beyond a first-line supervisor.
The validity of any philosophy or theory is determined by results: Does it really work? Here are some of the results of the open-book management philosophy at SRC:
The company has grown from $13 million in assets in 1983 to $276 million at year-end 2019 (a 2,023% increase).
Sales have increased from $16 million in 1983 to more than $650 million in 2019 (a 3,963% increase).
Following a loss in its first year of operation (1983), SRC has earned a profit in every subsequent year. This accomplishment is especially noteworthy since the North American auto industry (to which SRC has a strong connection) has experienced numerous periods of widespread losses.
Owners’ equity has increased from $100,000 in 1983 to more than $176 million at year-end 2019—a 175,900% increase, or an average of 4,886% per year!
SRC is marketing its philosophy to other businesses through a subsidiary named The Great Game of Business (GGOB). Clients include Southwest Airlines, H-E-B, and New Belgium Brewing, all of which credit GGOB with helping them turn their companies around.
Analyzing the Impact
The open-book management philosophy has not only worked, it’s been wildly successful. Today, a network of practitioner coaches provides support and training for approximately 4,000 organizations—from banks to retailers to power and energy companies—that are currently using open-book management.
In 2014, Kyle Hutzler, then a researcher with Yale University, prepared an analysis to determine the demographics of these open-book organizations. Using case studies prepared by GGOB consultants, Hutzler found that most open-book companies are engaged in either business services or industrial manufacturing; the vast majority (81%) have less than $100 million in sales; and most are either privately held or employee owned. Furthermore, Hutzler also reported that about half the companies surveyed were distressed—there was a large decline in sales or bankruptcy was imminent—and the most common metric used was sales or profits.
Open-book management practices implemented to “stop the bleeding” included targeted short-term bonuses, extensive business education for rank-and-file employees, scorecards, and weekly feedback huddles. Hutzler concluded in his report that there was a preponderance of evidence to suggest that open-book management meaningfully contributes to improvements in corporate performance with strong, lasting impacts on culture, profitability, and improved internal forecasting.
Encouraging Sustainability
Sustainability has long since moved beyond the “fad” stage into mainstream business philosophy and acceptance. It’s now an integral part of corporate responsibility. In fact, a study published in Harvard Business Reviewmore than a decade ago asserts that sustainability has forced companies that want to remain successful to reevaluate their products, processes, technologies, and business models. (See Ram Nidumolu, C.K. Prahalad, and M.R. Rangaswami, “Why Sustainability Is Now the Key Driver of Innovation,” Harvard Business Review, September 2009.)
At SRC, employees initiate change by examining the company’s weaknesses, risks, and vulnerabilities and then developing innovative solutions to mitigate these issues and turn weaknesses and vulnerabilities into strengths. For instance, employee suggestions resulted in 85% of the energy expended in the manufacture of the original product being preserved in the remanufactured product and 100% of the fluids being recycled. So, instead of disposing of oil, coolants, and other fluids, these liquids are captured and recycled, essentially turning a cost (negative) into a revenue stream (positive). Specific innovative changes include:
Used oil and diesel fuel. As mentioned earlier, SRC was paying $200 per 55-gallon drum to dispose of used oil and diesel fuel. Based on an employee’s suggestion, however, a company was identified that would recycle the fuel instead of incinerating it and would pay SRC $38 per drum. This represents a $238 per-drum increase in operating income. The projected annual impact of this suggestion totals $21,436, not taking into account the positive environmental impact.
Used plastics and cardboard. Plastic and cardboard that had been discarded are now being recycled, courtesy of changes that resulted from open-book management. SRC is now receiving refunds ranging from $35 to $85 per ton for what was formerly waste. The projected annual impact of this suggestion is $8,195 (again, not taking into account the fact that it’s also eco-friendly).
Recovery of removed materials. To fix a specific type of defective turbocharger, a process called laser cladding was implemented to rebuild and reclaim the removed material and restore the turbo to its required specifications. This process enabled SRC to significantly reduce the cost of rebuilding the turbos—and pass some of those savings on to its customers.
Global Recovery Corp.
Perhaps the biggest thing to come from employee suggestions at SRC was the creation of Global Recovery Corp. (GRC) in 2012 to more efficiently handle the activities that had been performed previously by the asset recovery department of SRC Logistics, a subsidiary of SRC. GRC has three main “cylinders” of business:
Surplus. GRC purchases excess and obsolete inventories from large OEMs and sells these materials to both international buyers and non-OEM customers.
Core procurement. The used engines and transmissions that are remanufactured into new engines and transmissions are referred to as “cores.” GRC is charged with the mission of “core procurement” on behalf of SRC’s other divisions. This activity involves searching throughout North America for acceptable cores.
Scrap. Components and materials that SRC can’t remanufacture are purchased by GRC, which in turn adds value to these materials and resells them at a higher price. These value-added services include disassembling scrap engines, transmissions, and other components. For example, a complete engine can be scrapped for 10 cents a pound, or roughly $100 in total. But by disassembling the engine into its component metal parts, the yield may be as much as $150. And by consolidating all the amounts of aluminum, copper, and so on from the various divisions within SRC, GRC is able to demand premium pricing on nonferrous or higher-valued metals. Additionally, GRC is able to skip the yards and sell directly to the foundries.
Pulling Together
Sustainability has transformed the competitive environment, particularly for manufacturers like SRC. And the key to sustainability is innovation. SRC is an excellent example of a company that uses innovation in becoming a world-class competitor in not only the area of sustainability but in developing improved processes and new technologies.
Empowered by the open-book management system, an appreciation for the significance of profitability, and an understanding of their role in creating profits, employees at SRC have an entrepreneurial approach. They provide suggestions and inputs that greatly enhance the bottom line andpositively impact the environment. SRC’s journey provides powerful evidence that corporate responsibility, ethics, and a commitment to sustainability can lead to higher profits and stronger cash flows.
Benefits of Open-Book Management
Superior management control. Under this system, employees will be less likely to waste materials, show up late for work, take long breaks, etc.
Entrepreneurial attitude. In an open-book environment, great ideas will spring from employees and managers, leading to innovative processes, purchase agreements, contracts, and hiring decisions.
Financial literacy. Employees will be well-versed in finance, financial accounting, and management accounting, which will help improve decision making.
Accountability in budgeting. Since employees are well aware of how much their department should spend, budgetary slack rarely exists in open-book organizations.
Improved company culture. Increased transparency and decentralized decision making lead to more people wanting to work at organizations with open-book management.
10 Tips for Implementing Open-Book Management
The following guidelines can help your organization successfully execute an open-book management program.
Obtain commitment. Buy-in from the CEO and her or his staff is an essential component of any successful change effort.
Find the right leaders. Selecting the right leadership team to spearhead an open-book management system is also critical to success. “Right leadership” involves being willing to communicate in a manner that nonaccountants can understand and also involves sharing the “why” before the “how.” For employees to make a meaningful contribution to the success of the organization, they must understand why they’re doing what they’re doing.
Establish a culture of openness and creativity. Encouraging creativity and input from employees is vital to the success of open-book management. They must be comfortable making suggestions to improve the numbers and be properly rewarded when they make a meaningful proposal. This approach helps employees become entrepreneurs within the organization.
Open the books. Teach employees how difficult it is to make money, show them how their work impacts the business, and ask them to help. Identify and focus on a critical number—a measure that could “take you out” if not addressed this year. Examples might include the debt ratio or cost of goods sold as a percentage of sales. Open-book management, in effect, transforms employees into management accountants by providing them with financial literacy, informing them of their role with respect to achieving desired financial outcomes, and involving them in the financial goal-setting process.
Identify the critical number drivers. By identifying and managing the factors that “drive” the critical number up or down, it’s much easier to impact it in a positive way.
Create winning experiences. These breed excitement, enthusiasm, and more buy-in to the open-book process. Mini-games that focus on a specific driver as a target can be used to drive the numbers and provide employees with a winning experience. These successes should then be celebrated and rewarded.
Provide a stake in the outcome. Identify short-, mid-, and long-term rewards, bonuses, and recognition. If possible, include equity ownership as one of the long-term rewards. By doing so, employees quickly transition from the mind-set of “I’m just an employee” to “I’m an owner!” They are thereby incentivized to make changes that contribute to the company’s success.
Keep score. Create scoreboards to track and record progress on the various critical numbers. Update the scoreboards weekly, obtaining new information from the responsible parties. This helps to keep employees focused on improving operations.
Follow the action. All employees should “huddle” weekly to review the past week’s performance and forecast the next week’s outcome(s). This promotes “line-item ownership” and is critical to the ongoing success of the open-book management system. It also has the added benefit of removing budgetary slack.
Ensure sustainability. Long-term sustainability requires continual evaluation and renewal of the process. This should take place annually, at a minimum, and all employees should be involved in this process. People support what they help create!
