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July 21, 2012
Ross Gittins

Ross Gittins

The Sydney Morning Herald’s Economics Editor

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At last instead of jumping to conclusions and riding hobby horses we’re making good progress in analysing the causes and cures of the slowdown in our economy’s productivity improvement. There’s more to it than you may think.

Following the analysis by Saul Eslake for the Grattan Institute we’ve had a contribution from the Productivity Commission’s great productivity expert, Dean Parham, and a synthesis of the state of our knowledge by Patrick D’Arcy and Linus Gustafsson in the latest Reserve Bank Bulletin. Let me tell you what they find.

Productivity refers to the efficiency with which an economy employs resources (inputs) to produce economic output (goods and services). It matters because improvement in productivity is the key driver of growth in income per person – and hence, our material standard of living – in the long run.

The trend in productivity improvement is determined by the development of new technologies and by how efficiently resources – the ”factors” of production: land, labour and capital – are organised in the production process.

The commonest and easiest way to measure productivity is to measure the productivity of labour. You take the total quantity of goods and services produced in a period and divide it by the total number hours of labour used to produce it, thus giving output per unit of labour input.

Figures for the market economy show labour productivity improved at the annual rate of 1.8 per cent over the 20 years to 1994, then by 3.1 per cent over the 10 years to 2004, then by 1.4 per cent over the seven years to 2011.

You see there how productivity surged during the second half of the 1990s, but has since slowed to a rate of improvement ever lower than during the lacklustre ’70s and ’80s. That’s what the fuss is about.

The main way we improve the productivity of workers is to give them more machines to work with. Economists call this ”capital deepening”. Another way to think of it is that we’ve increased the ratio of (physical) capital to labour.

The part of the improvement in labour productivity that can’t be explained by capital deepening is referred to as ”multi-factor productivity” – the quantity of output produced from a given quantity of both labour and capital.

It turns out that capital deepening accounts for 1.3 percentage points of the annual improvement in labour productivity during both the 20 years to 1994 and the 10 years to 2004, and then an amazing 1.8 percentage points over the seven years to 2011.

The first conclusion from this is that the slowdown in labour productivity can’t be explained by any decline in business investment in more machines. It’s thus fully explained by a deterioration in multi-factor productivity.

Multi-factor productivity improved at an annual rate of 0.6 per cent over the 20 years to 1994, by 1.8 per cent over the 10 years to 2004 and by – get this – minus 0.4 per cent over the seven years to 2011.

Fortunately, the position isn’t as bad as that looks. The decline in multi-factor productivity is more than fully explained by the special circumstances of just two industries: mining and ”utilities” (electricity, gas and water).

Mining has seen huge investment in new production capacity that has yet to come on line. And the sky-high prices for coal and iron ore have justified the exploitation of more inaccessible deposits. Utilities have seen much investment in electricity and water infrastructure to improve the reliability of supply.

When you exclude mining and utilities you find, first, that over the past seven years capital deepening has proceeded at the same 1.3 per cent annual rate as experienced in the previous 30 years. Second, although the annual rate of multi-factor productivity improvement has slowed from 1.9 per cent over the 10 years to 2004 to plus 0.4 per cent over the latest period, that’s only a bit slower than the 0.6 per cent we experienced during the 20 years to 1994.

In other words, the main thing we have to explain is not an abysmal performance at present (after you allow for the special factors in mining and utilities) but why the unprecedented rate of improvement in multi-factor productivity during the 1990s wasn’t sustained.

The authors’ calculations confirm the recent slowdown in multi-factor productivity has occurred across virtually all market industries. So it’s a general phenomenon.

The explanation favoured by many economists is that the surge in productivity was caused by all the microeconomic reform in the 1980s and early ’90s. The subsequent fall-off, they say, is caused by the absence of further reform.

But the authors’ examine other, alternative or complementary explanations. They note that ”at a fundamental level, productivity is determined by the available technology (including the knowledge of production processes help by firms and individuals) and the way production is organised within firms and industries”.

So a possible explanation for the surge and subsequent decline in multi-factor productivity improvement, they say, is the pattern of adoption of information and communications technologies.

Then there’s the contribution to productivity from improved ”human capital” – the education, training and skills of the workforce. One indicator of education and experience is the Bureau of Statistics measure of ”quality-adjusted hours worked”.

This has been growing at a consistently faster pace than the standard measure of hours worked since the 1980s, indicating that education and experience are likely to have made positive contributions to multi-factor productivity over this period.

However, the pace of growth of this measure has slowed, suggesting a smaller contribution from improving labour quality has played some role in the productivity slowdown.

Another, possibly contributory explanation for the slowdown in productivity improvement is that, over the course of the long economic expansion between the early ’90s recession and the mild recession of 2008-09, the incentives for firms, workers and governments to implement productivity-enhancing changes gradually weakened. So broad-based economic prosperity has probably eased the pressures driving productivity improvements.

Most productivity-enhancing changes involve a degree of reorganisation than can be difficult for firms and workers. So without clear incentives for change there is unlikely to be a strong focus on enhancing productivity.

My conclusion from this thorough analysis of the problem is that we don’t have a lot to worry about. That’s because, first, when you dig into the figures you discover they’re not nearly as bad as they look.

Second, the structural change now hitting so many of our industries is just the thing to (painfully) oblige them to lift their productivity.

Twitter: @1RossGittins

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July 14, 2012

We’ve been debating what needs to be done to lift Australia’s flagging productivity performance for a year, but only this week have we stopped using it in the unending political blame game and got down to some solid economic analysis.

The breakthrough came in a much-discussed speech Dr David Gruen, of Treasury, delivered to the annual Australian Conference of Economists in Melbourne.

Gruen made the apparently hugely controversial point that the primary responsibility for the productivity of the private sector – its output per unit of input – rests with the firms making up that sector and only secondarily with the government.

The government’s role is in supporting the productive capability of the economy through investment in education and training, science and research, and infrastructure.

”Government involvement in these sectors is important,” Gruen says. ”Markets left to their own devices will tend to result in too little investment where there are social or spill-over benefits [in the jargon, ‘positive externalities’] to the broader community beyond the returns available to a private investor.

”Governments influence the environment in which firms engage with each other and make investment and production decisions. They set the rules of the game, if you like, and affect the incentives that firms face, and their flexibility to respond.”

But it’s businesses that do the playing. So what do we know about the drivers of productivity improvement in the private sector? Well, a fair bit of empirical research has been done locally and overseas in recent years.

It shows that overall productivity improves in two different ways. One source is greater technical efficiency through innovation within the firm. Technical improvement comes about through research and development within the firm, or in partnership with the formal research sector.

But as a small country, most of the technology put into production in Australia is first developed overseas, Gruen says. A survey by the bureau of statistics shows only a small fraction of our innovative firms do things that are genuinely new to the world, or even new to Australia. Much more innovation is simply new to a particular industry.

”What usually distinguishes leading organisations is not so much their ability to create knowledge, but rather their ability to absorb technology developed elsewhere and apply it to their own circumstances,” he says.

Why do firms innovate? According to the bureau’s survey, three-quarters of innovative firms report undertaking innovation to improve profits. About 40 per cent also wanted to increase or maintain their market share and a quarter needed to develop products that were more competitively priced.

That’s pretty much what you’d expect, but the second source of productivity gain is less obvious and less benign: it improves when production in an industry shifts from low-productivity firms to high-productivity firms.

A study of Australia firms in the 1990s found a remarkably wide range in their efficiency. The labour productivity of the most efficient firms was about four times that of the least efficient. Only about half this difference seems to be explained by differences in size.

So the productivity of an industry is improved when low-productivity firms are taken over or otherwise cease to exist, and also when new businesses with bright ideas start and grow.

Few people realise how much turnover there is of firms, even when the economy is growing strongly. According to figures from the bureau, about 8 per cent of firms close down each year. And about 40 per cent of new firms exit in less than four years.

Get this: overseas estimates suggest the net effect of the entry and exit of firms accounts for between a fifth and a half of the improvement in labour productivity over time. In high-technology industries, in particular, start-ups play an important role in promoting technological adoption and experimentation, Gruen says.

Hint to politicians: ”Policies that act to slow the movement of resources will tend to limit this source of productivity improvement.”

Another way to study productivity at the firm level is to look at management practices. Like productivity, management is about how well resources are used in production. So if you can rate particular management practices and give management teams a score, maybe this will help explain productivity differences across firms and even across countries.

One long-running study is doing this for 9000 medium and large manufacturing firms in 20 countries. It gives good ratings to firms that monitor what’s going on in the firm and use this information for continuous improvement; set targets and track outcomes, and promote employees based on their performance.

The study shows management practices in Australia are mid-range: well below the United States, Germany, Sweden, Japan and Canada, but similar to France, Italy and Britain. And we have a larger tail of companies at the poor management end of the distribution compared with the US.

Looking at the performance of Australian firms, large manufacturers tend to be much better managed than small ones – a worry because our firms tend to be smaller than those in other countries. And it does seem clear better-managed firms are more innovative and have higher productivity.

Gruen argues periods of significant structural change – as at present – are often periods of growth and reform for the economy.

For a firm that’s been doing the same thing for a long time, changes in business models are risky, difficult and may well require staff lay-offs. But when structural change means doing the same old thing is likely to be unprofitable, the opportunity cost of transforming work practices is substantially lowered. Structural change usually involves firms coming under greater competitive pressure. And tough competition and innovative activity seem to go together.

In Australia, firms that report having more competitors, that are in industries with low mark-ups, that export, or that experience downward pressure on profit margins are more likely to be innovators.

Case studies of Australian manufacturers hit by the reduction of import protection in the 1980s and ’90s show the firms that succeeded did so by changing their practices. The number of plants diminished, plants became more specialised, model ranges were cut and world-best technology introduced.

Of course, some firms close down and leave the industry. But that’s the harsh part of the lovely sounding productivity improvement: Competition boosts productivity partly by moving resources to more successful firms.

Get it? When politicians protect firms from closing, they risk stifling productivity improvement. For countries, comfortable and rich don’t go together.

Twitter: @1RossGittins

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By Hans Villarica

Jun 20 2012, 11:39 AM ET 6 

Yes, caffeine helps. But new research shows that the moderate noise level in busy cafés also perks up your creative cognition.

Study of the DayGlobal X/Flickr

PROBLEM: To optimize creativity, how quiet or noisy should your workspace be?

METHODOLOGY: Researchers led by Ravi Mehta conducted five experiments to understand how ambient sounds affect creative cognition. In one key trial, they tested people’s creativity at different levels of background noise by asking participants to brainstorm ideas for a new type of mattress or enumerate uncommon uses for a common object.

RESULTS: Compared to a relatively quiet environment (50 decibels), a moderate level of ambient noise (70 dB) enhanced subjects’ performance on the creativity tasks, while a high level of noise (85 dB) hurt it. Modest background noise, the scientists explain, creates enough of a distraction to encourage people to think more imaginatively. (Here’s a helpful chart on typical noise levels.)

CONCLUSION: The next time you’re stumped on a creative challenge, head to a bustling coffee shop, not the library. As the researchers write in their paper, “[I]nstead of burying oneself in a quiet room trying to figure out a solution, walking out of one’s comfort zone and getting into a relatively noisy environment may trigger the brain to think abstractly, and thus generate creative ideas.”

SOURCE: The full study, “Is Noise Always Bad? Exploring the Effects of Ambient Noise on Creative Cognition,” is published in the Journal of Consumer Research.


Matt Grudnoff

Matt Grudnoff

Like a man who buys a cheap house next to a pub and then complains that the noise late at night is depressing his house price, the Minerals Council has come out and complained that Australia is now an expensive place to do mining.

The Minerals Council of Australia released a report by Port Jackson Partners that pointed out that cost pressures are increasing in the mining industry. It showed that since 2007, the cost of producing new capacity in thermal coal and iron ore has almost doubled. It claimed we have also lost our dominance in mining competitiveness to other nations around the world.

Then in predictable fashion, it called on the Government to fix all their problems. Large global mining companies thinking governments have all the answers – whatever happened to market forces?

They called on government to address infrastructure bottle necks, falling productivity, skills shortages, and even went as far as calling for relief from the high exchange rate. They asked for all of this without ever mentioning that all these economic problems are caused by the mining boom itself.

This is because the mining industry is intent on building too many new mining projects at the same time, as well as exporting as much dirt as they possibly can.

A recent economic impact assessment commissioned and paid for by Arrow Energy for its proposed LNG plant in Gladstone highlights what effect the mining boom is having on Australia.
The report says that because the LNG plant would increase gas exports, it would have the effect of maintaining the strength of the Australian dollar. It is the increase in mineral exports, including gas and oil, that is causing the high exchange rates. But rather than point that out, it is more convenient to complain that the high exchange rate is increasing the cost of doing business.

Also, because the mining industry wants to export their minerals in greater quantities, they are creating infrastructure bottlenecks as they overwhelm their existing infrastructure. Again, the strategy appears to be to call on government to fund more infrastructure.

Arrow’s LNG report goes on to say that the plant would be built at a time when many other similar projects are being constructed. It would therefore be competing for what it describes as “constrained labour resources”. The report then says that because of the high salaries the LNG project can offer, they “will attract labour away from other businesses both locally and further afield”.

Put simply, the mining industry is paying higher wages to poach staff from other businesses. By wanting to construct all their projects at once, they create excess demand for key professions and push up the cost of construction. The next step is then to complain that the cost of doing business has also gone up.

The Minerals Council report also notes the fall in productivity rates in Australia over the past 10 years, and suggests this is something the government should be concerned about. A closer look at the productivity numbers shows that mining productivity has seen the biggest fall over the past 10 years and this is dragging down Australia’s overall productivity rate.

The big drop in mining productivity has been mostly caused by large investments in new mining projects that have not yet started to produce, along with the fact that the mining industry is mining increasingly less productive deposits. They are doing this because these less productive deposits are still profitable due to the historically high commodity prices.

Of course, faced with falling productivity rates caused in no small part by the mining boom, the solution seems to be to call on government to stop slacking and do something about it.

Fortunately there is a solution to all the problems the Mineral Council’s report highlights. The government could always take the pressure off by slowing the mining boom. Just like the Reserve Bank increases interest rates to slow the economy when it’s running too hot, the government can ration out mining projects so that the mining boom doesn’t run too hot.

Of course, the mining industry is not interested in that solution. It is far easier to complain about the rising cost of doing business, demand the government do something about it, and then just hope nobody notices the hypocrisy.

Matt Grudnoff is a senior economist at The Australia Institute.

Matthew Kidman

May 7, 2012 

It will take more than deep rate cuts to produce a prolonged resurgence in the stockmarket, writes Matthew Kidman.

The ice man, a.k.a. the Reserve Bank governor Glenn Stevens, managed to sidestep the markets again last week with a hefty half a percentage point cut in the official interest rate.

The unflappable Stevens repeated his 2008 approach by spending the first third of this year turning a deaf ear to the cacophony to slash rates. Then, last Tuesday, he pulled out Crocodile Dundee-sized knife and cut hard: no messing around, and with maximum impact.

It is never easy to pick Stevens’s next move, but if last week’s aggression is anything to go by rates might be down to 3.25 per cent by December. This would get investors hot under the collar and divert attention from the present slew of earnings downgrades. The focus would zero in on renewed earnings growth in 2013 and beyond.

Sure, we will still have to worry about sluggish growth in the US and, to a lesser extent, a meltdown in Europe, but at least we can think positively about the domestic economy.

This scenario bodes well for a new bull market. Lower interest rates have been a consistent trigger for share price rallies in Australia. However, for the local bourse to have a multi-year bull market (the likes of 1974-87 and 1993-2007) we need a lot more than a cut in rates. Lower rates will make people reconsider buying shares but they will not be enough to fire a prolonged upwards march in equities.

Stevens is taking care of the short term but he and his cohorts at the RBA are acutely aware that the real driver of wealth creation is a rise in productivity. In simple terms, higher productivity occurs when there is a greater output without a commensurate rise in inputs. Higher productivity is the elixir for wealth creation and a boon for sharemarkets.

After tremendous gains in 1980s and 1990s, productivity stalled in the 2000s. A paper written in 2011 by the economist Saul Eslake, Productivity: The Lost Decade, shows that labour productivity fell from a peak of 91.6 per cent of US labour productivity in 1998 to just 84.2 per cent in 2010. That is a dramatic decline and highlights how uncompetitive Australia has become.

However, to blame the decline purely on workers would be short-sighted and naive. In the 2000s, multifactor productivity stalled and registered no growth. In other words, capital spent by governments and private businesses delivered no real benefits.

Given that productivity gains are so crucial to wealth creation, how can it be that Australia has recorded strong gross domestic product growth in the past decade? In the 1990s gross domestic income rose by 3.2 per cent per annum, of which 2.1 per cent came from labour productivity gains. In the 2000s, GDI reached 4 per cent but only 1.4 per cent of that came from labour productivity. The slack was taken up by a big boost in the terms of trade and population growth.

If Stevens is correct, and the terms of trade have peaked and immigration rates are slowing, we need productivity gains or we will face anaemic economic growth.

Possibly, the productivity drought will correct itself. The mining boom requires massive investment before we see a meaningful rise in output. In addition, agricultural output will rise now the big dry is over.

However, productivity reforms implemented by the Hawke government in the 1980s and the first term of the Howard government in the late 1990s have now passed. The last decade of politics, especially under Howard, was a lost decade in terms of productivity. Tax cuts and first home owner grants stimulated debt levels and excessive consumption. Luckily, this is now unwinding.

The next federal government must place productivity at the top of the agenda if it is committed to driving up living standards for the next decade. This would include overhauling infrastructure, including building a second airport in Sydney; addressing skilled labour shortages, and attempting to break up duopolies and monopolies in areas such as telecommunications, banking, airports and grocery retailing.

This must be matched by a similar commitment by private business. With the exception of the mining industry, Australian corporations have been more interested in protecting their market share than investing for the future.

Technology, the other major stimulus for productivity gains, is heavily dependent on what happens in the US, and Australia ranks very low on innovation.

As we move into 2014 and 2015, sharemarket investors must keep an eye on how productivity is growing. If the terms of trade fall and population growth eases, productivity will need to rise.

If this fails to eventuate, Australia’s ranking as the world’s No.1 performing stockmarket since 1900, with gains of 11 per cent per annum, may be under serious threat.

The Herald accepts no responsibility for stock recommendations. Readers should contact a licensed financial adviser.

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Lenore Taylor, April 24, 2012

Frustrated ... Jennifer Westacott questions the lack of coherent policies.Frustrated … Jennifer Westacott questions the lack of coherent policies.

BUSINESS believes the political system is failing the country and is frustrated with the divisive political debate and short-sighted agendas of all parties, the chief executive of the Business Council of Australia, Jennifer Westacott, said yesterday.

”We are having this divisive, issue-by-issue conversation but we are seeing no coherent plan for long-term economic growth … In fact we are seeing many issues that once had fundamental bipartisan agreement now being argued and contested,” Ms Westacott told the Herald.

She said she was worried the Greens ”did not start from the premise that economic growth was a good thing” and the party’s new leader, Christine Milne, was ”seeking to divide the business community” by saying she would talk only to ”progressive” businesses.

Speaking as the claims against the Speaker, Peter Slipper – who has stood down – increased the uncertainty regarding the minority government, Ms Westacott said the political malaise that was endangering Australia’s long record of economic growth extended to the major parties.

She criticised the Labor Party for referring to business as ”big polluters” and its questioning of the right of business personalities to have a say in the national debate.

She also attacked the Gillard government for shutting down any conversation about the detail of carbon pricing or reform of industrial relations, and the Coalition for providing no policy details and at times appearing to question policy issues that had once been bipartisan, such as the desirability of foreign investment.

”The divisive issue-by-issue conversation of minority government leaves us with no coherent economic plan, and certainly no plan that starts from the premise that economic growth is a good thing not a bad thing … It’s a bit-by-bit conversation and it is leaving business frustrated and disappointed,” Ms Westacott said.

”The day-by-day story at the moment is always about division, and the unfolding story on each new issue and each new crisis means we haven’t got any longer-term focus.

”We built our current living standards on a shared understanding between unions, government and business that we need strong competitive industries, but now when we raise threats to those industries people say we have no right to even talk about them … If we question the details of the carbon price then suddenly we are climate deniers … If we say we want to look at the industrial relations system then instantly we are supposed to want to go back to Work Choices.

”As for the Coalition, it has given us no detail, and when [shadow treasurer] Joe Hockey makes a speech about welfare and ending the age of entitlement, which was spot on from our point of view, he is criticised for it and the discussion is shut down,” she said.

The Opposition Leader, Tony Abbott, told ABC television last night he was ”not planning to cut benefits … but government has to live within its means”.

He said Mr Hockey was referring to the need to avoid higher social benefits available in Europe. ”We certainly don’t support means tests the government is putting on in breach of pre-election commitments,” he said.

Ms Westacott said the government’s plans for skills and training and the reforms to environmental approvals agreed at last week’s Council of Australian Governments meeting had been positive, and she praised the Coalition for proposing a commission of audit into government expenditure should it win the next election.

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by Dr. Wendell Williams
Jan 27, 2009, 5:04 am ET

Any manager who takes an honest look at individual performance knows all employees are not created equally. About 20% of employees rise to the top of the heap; 20% drop to the bottom; and the rest hang around in the middle doing only enough to attract attention.

Employee-productivity differences have attracted their share of researchers. Most agree that folks in the top half of workers out-produce the bottom half by about 2:1 (i.e., it makes no difference if people are shuffling papers or making widgets). And, when managers and knowledge workers are examined separately, the productivity ratio rises to 3:1, 4:1, or higher (i.e., responsible jobs have bigger ratios).

Productivity is more than a mental exercise. It shows up as absenteeism, errors, reduced throughput, turnover, low morale, rework, an excess number of employees, and so forth. Productivity losses are also sneaky because they are not easily seen; yet, they translate into hard cash: between 20% of base annual payroll leaked for unskilled workers to 50% for skilled and managerial employees — enough to separate a successful organization from a flop.

Converting payroll leakage into gross sales can be an even bigger eye-opener. Twenty percent leakage, for an organization that pays out 1/5 of its gross sales in salaries and benefits, would require a 500% sales increase to balance the books. Want to do more scary math? Calculate the incremental sales necessary to offset a 50% leak in managers and professional salaries!

Enter Financial Chaos and Uncertainty
We are in serious financial times. Opinions vary, but experts estimate our financial stress will last throughout 2009 and perhaps into 2010. The prosperity party is over. Like the dot-com bust, the world changed virtually overnight.

We cannot do much about external economic factors except dig in and wait. But, we can do something about employee productivity, especially when it comes to intelligent downsizing.

Ah’ll be Baack!
There are two ways to downsize. Most managers are accustomed to the Rambo model: plunge into the organization armed with rocket launchers, machine guns, and grenades terminating anyone in the line of fire. At the end of the rampage, the gross payroll body count is reduced; but, since both high- and low-producers are terminated without regard to skills, the organization continues to live with its 20% to 50% cash hemorrhage. Rambo-sizing is the norm.

What about examining employee performance before making termination decisions? Everyone knows performance recommendations are part fact and part fiction. Promotions and performance ratings are almost always based on personality and popularity — not specific skills. Just examine organizations that Rambo-sized their workforce in the past. What effect did it have other than forcing fewer people to spend more time at work? Termination decisions done without future planning are like bloodletting to rid the body of bad humours … they are more likely to kill than cure.

Planning Ahead
If management takes the time and HR is able to competently manage the solution, downsizing can actually help the organization get healthy and stay that way. It’s more like Mr. Spock than Rambo. It is rationally based. It begins by clearly defining the skills the company wants to leave in the past and acquire in the future. Here is an example.

We’reAllThatMatters is a legend unto itself. Employees generally want to work there because they can brag about the big-name. Unfortunately, people (read customers) outside the organization have a different opinion. Employees often treat customers rudely and without respect. For example, even if We’reAllThatMatters’ buggy bookkeeping system overcharges a customer 400%, employees treat anyone who complains as if it was his or her fault.

Now the organization must cut back its workforce due to economic conditions. Should it Rambo-size its employees? Should it ask managers for their subjective opinions about who stays and who goes? Should it amputate whole divisions? Since We’reAllThatMatters’ has been around some time, a majority of terminated employees may be over 40, raising the possibility of a nasty class-action suit. What to do?

Rambo-sizing would be a serious long-term mistake. The payroll would shrink, but both skilled and unskilled employees would suffer the same fate. Customer-sensitive as well as customer-insensitive employees would be terminated equally. We’reAllThatMatters’ payroll would shrink, but payroll hemorrhage would continue unabated. Logical-sizing would be different.

We’reAllThatMatters would a take hard look at itself and honestly calculate the financial impact of poor customer service on future business. It would then develop some key job profiles containing both technical competencies to do the job as well as customer service competencies it wants to build and retain. When this is complete, it would move on to the next step.

Employee-Level Evaluation
Individual employees would have his or her performance objectively evaluated using the list of necessary competencies as a target. For example, customer-centric skills might be evaluated by gathering past examples of service (e.g., similar to behavioral event interviewing), reviewing performance appraisals (to the extent they might include relevant information), giving tests, administering surveys, and so forth.

The secret to success would be to evaluate the skill set of every employee using an objective standard based on the organization’s tactical plan. Results for each employee would be anonymized and independently reviewed by a few highly competent managers. Employees who matched the profile would be retained, and those who did not would be reassigned or laid off.

Smart-sizing could be done with competencies such as analytical skills to develop better problem-solvers, initiative to encourage operational improvements, teamwork to develop better internal working relationships, creativity to foster new ideas and designs … the list goes on.

Final Question
However, there is a price to pay. HR has to develop the skills to help managers analyze and clarify the skills needed. It has to become proficient in accurately measuring competencies (real ones, not garden variety stuff), and it has to professionally manage the process. Managers have a price to pay too. They must have the patience to work through the details of smart-sizing, dedicate the energy and commitment to making sure the process is followed, and be able to clearly define the future at the employee level.

The outcome of this initiative is a smart-sized operation; in other words, the skills of the employees are intelligently aligned with the objectives of the organization. Overall, this should result in fewer employees doing more work (because each employee will be more skilled), less turnover (because employees will be more satisfied), fewer mistakes, better quality, and so forth.

The final question faced by everyone in the operation is whether saving 20% to 50% of base payroll is worth abandoning Rambo-sizing for smart-sizing.