I don’t know about you, but after this crazy week of ignition issues, peanut butter perp walk, and emissions omissions, I’m about up to here with schadenfreude. It is time to move past the glitz and glamor and try to glean something meaningful from this hot mess.

So what exactly can we learn from GM, VW and PB? (In the interest of full disclosure, I haven’t been directly involved with the above three issues. I’m using these news stories as a starting point for discussion and not suggesting any connection between the ideas I raise below and the issues faced by GM, VW and PB).

My take is that a company’s “value proposition” is even more important than I’ve always thought.  A value proposition is nothing less than a company’s reason for being. The value proposition cascades through the board of directors into the CEO’s job description and compensation scheme. Everything else stems from that.

Let’s consider two diametrically opposed value propositions and how they impact product safety and regulatory compliance: (1) the Quality Value Proposition; and (2) the Shareholder Value Proposition.

1. THE QUALITY VALUE PROPOSITION

The “Quality Value Proposition” (QVP) is how I refer to the teachings of statistician Edward Deming (and management guru Peter Drucker to some extent). Although not received as well in America, Deming may as well have been deified in Japan. In 1950, at a dinner with 21 of Japan’s leading industrialists, Deming found an audience enthusiastically receptive to his approach.

The “Deming Prize,” awarded annually by the Union of Japanese Scientists and Engineers and considered the most prestigious business and management award in the world is an indication of the reverence Japan has for Deming.

Post-war Japan was the perfect petri dish for a large-scale test of Deming’s approach. From 1950 to 1980, American GNP grew a respectable 8 fold. During the same period, Japanese GNP grew a staggering 73 fold.  Other factors also contributed to the post-war resurgence of Japan’s economy, but Deming’s management philosophy and the tools (e.g., PDCA) he introduced clearly played a significant role.

Behind the Quality Value Proposition is the concept that quality is not a product of profitability. Instead, profitability is a product of long-term quality improvement. For a company subscribing to the Quality Value Proposition, the first obligation is not to increase short term profits, but instead to drive long-term quality of products and customer service thru innovation and continuous improvement. A company organizing around the Quality Value Proposition views profit as essential to sustainability, but the result of, not the cause of, long-term improvements in quality.

Quality Value Propositions are not new. In fact, one of the pithiest I’ve ever seen comes from 1890. Collis Potter Huntington, head of the Newport News Shipyard set the right tone-from-the-top when he said:

We shall build good ships here; at a profit if we can, at a loss if we must, but always good ships.

129 uninterrupted years later, Newport News Shipyard is still in business.

Quality Value Propositions aren’t socialist, anti-capitalist, or really even Keynesian. In fact, they represent the best and most effective forms of capitalism.

Another 19th-century uber-capitalist, Andrew Carnegie says it well in his 1920  autobiography:

There lies still at the root of great business success the very much more important factor of quality.  The effect of attention to quality, upon every man in the service, from the president of the concern down to the humblest laborer, cannot be overestimated.

Quality Value Propositions are agnostic to regulations because when quality is your organizing principle, you’re not chasing regulatory schemes.  You’re leading them.

Quality Value Propositions eschew a focus on short-term earnings. Not because they’re abhorrent. In fact, short-term earnings are just as desirable as long-term earnings, but the problem is that focusing on them excessively gets in the way of long-term quality improvements or sustainable increases in value.

2. THE SHAREHOLDER VALUE PROPOSITION

In stark contrast to the nuances of the quality value proposition, the shareholder value proposition (SVP) has an appealing simplicity. Having once subscribed to the SVP, the board of directors has a simple, and simply measured, mandate: provide the CEO incentives to increase (quarterly) earnings per share by whatever means necessary.

Urged most effectively in the real world by laissez-faire economist Milton Friedman (and popularized most effectively in film by Michael Douglas as corporate raider Gordon Gekko), the Shareholder Value Proposition became widely known with the publication of Friedman’s September 13, 1970 New York Times Magazine article, titled “The Social Responsibility of Business is to Increase its Profits.”

Just as the Deming quality movement is associated with Japan’s postwar economic miracle, the Friedman doctrine is known for its influence on finance and management from the 1970s thru recent times. Among other things (“poison pill,” “golden parachute,” etc.), corporate boards influenced by Friedman’s philosophy (and intimidated by corporate raiders) made a number of changes to link executive compensation to share price.

The unsurprising result was that CEO focus shifted away from long-term quality, customer service, employee welfare, community involvement, organic growth, and innovation.  CEOs were instead rewarded for focusing, sometimes to the exclusion of all else, on quarterly earnings and short-term share price. This predictably led CEOs to focus resources and creative energy on developing manipulations solely to inflate earnings, even at the expense of long-term value. See, Profits Without Prosperity – Harvard Business Review 2014.

3. HOW THE SVP ENCOURAGES DENIAL, DEFLECTION, AND DELAY OF PSRC CONCERNS

The shareholder value proposition cascades through all levels of businesses that adopt it, discouraging discovery and resolution of potential PSRC concerns because the short-term cost of addressing PSRC concerns (e.g., investigation, root cause analysis, redesign, production shutdowns, testing costs, contractual penalties for delay, renegotiation of statements of work, and so on) are not typically balanced with rewards for addressing PSRC concerns.

Compensation is typically linked to Key Performance Indicators (KPIs) in a way that encourages the denial, deflection, and delay of potential PSRC concerns. In response to this reality, some product safety programs include “Golden Glove” policies, or other workarounds, intended to reward “good catches” and counteract the pressure to deny, deflect or delay. But no system can be sustainable when it depends on line-level workers demonstrating extraordinary integrity against their self-interest.

We don’t expect CEOs to act against their self-interest. We shouldn’t expect the average worker, who makes < 0.1% of the CEO’s pay, to take greater risks and exercise more integrity than the CEO.

It is human nature to select the path of least resistance, which often means denying the existence or seriousness of the issue and doing nothing. In evaluating risk, it is human nature to weight risks to support the outcome we’re predisposed to from the start. Presented with a report of a potential product risk, managers, and other stakeholders must decide whether to take action. Design changes involve known and certain costs (drawings, tooling, testing, etc.). Managers must weigh these known and certain costs against unknown and uncertain product safety risks. Engineering changes may also involve soft costs such as internal reporting requirements, missed KPIs and so on. Doing nothing, on the other hand, saves the known costs and substitutes unknown and uncertain risks (recalls, insurance, litigation, penalties, loss of reputation and trust and so on). “Prospect theory” predicts this behavior because we’re asymmetrical risk-seekers. We consistently select a small chance of gaining a large sum over a large chance of gaining a small sum. Conversely, given the choice between (A) a small (but certain) loss, and (B) a much larger (but uncertain) loss, we overwhelmingly pick (B), and opt to do nothing about the potential product safety compliance issue.

Companies with a shareholder value propositions tend towards frequent promotions and lateral transfers as encouragement to those employees that consistently hit KPIs and earnings targets. This further erodes accountability because employees are often gone by the time the issue comes to a head.

These forces tend to reward the postponement of problem-solving and remediation, even when it is clear that it will be more costly later if kicked down the road. A real world lament from a product safety client is telling:

Pareto analysis at a facility with reports of unusually high quality and safety issues confirmed the problems were all welding issues and all came from just one of seven production lines at the facility. The remaining six lines all utilized welding robots. Root cause analysis confirmed that adding welding robots to the seventh line would eliminate the problem. Adding welding robots, however, would impact the plant manager’s KPIs, and cost him a bonus. Guess what he did?

Doing nothing, kicking the problem down the road, carries no such cost. What would we expect a CEO to do in the face of an issue that jeopardizes their compensation? Would we expect anything different from a plant manager?

Next time: 8 steps to better product safety compliance results.

Rich Young © 2015 LegalKaizen LLC.  All rights reserved.