Open Book Management (#322)

The topic of this episode is open book management. The general concept is to formally share your financial information with employees on a regular basis. Ideally, you’d provide training to employees about what all the numbers mean, and then do a presentation each month to talk about the company’s results, so they can ask questions.

Advantages of Open Book Management

The main reason for doing so is to get employees more directly involved in running the business. The thinking goes that if everyone understands the situation, they’ll be more likely to pitch in. This means contributing more ideas about how to improve operations.

 It might work especially well in start-up companies or in businesses that are in trouble, since everyone would know how dire the situation is, and be more likely to help. And it could be useful when employee pay is linked to the performance of the business, as would be the case with profit sharing.

Disadvantages of Open Book Management

 Based on that logic, you’d think everyone would use open book management. But it’s not used much at all. In fact, I’ve proposed it to every CEO I ever worked for, and got laughed out of the room every time. Their viewpoint is a bit different.

 There are a couple of arguments against it. First, if the company is losing money or its sales are going down and employees know this, then they might be more likely to leave. Whereas, if you didn’t tell them about the financial situation, they’d be more likely to stay.

 Another reason is that employees would be more likely to demand pay increases if the company was wildly profitable. I suppose there might be some validity to this, though I’ve run through the financials of hundreds of companies, and I can’t think of any that were doing that well. Most organizations are just scraping by or making modest profits.

 A continuation of that logic is that, if management doesn’t increase employee pay, then their reaction will be to work less, since they’ll feel they’re being undervalued by management.

 And another argument against open book management is that, once you start providing financial information to employees, it’s pretty hard to turn off the information flow. If you do, then employees will think that you’re hiding something.

 In essence, if you’re an optimist who believes in the better side of human nature, then you might be more inclined to try open book management. If you’re the reverse, then only threat of certain death will convince you to do this. In my experience, most senior managers are in the second camp. No amount of arguing will convince them that this is a good idea.

 And we’re not done yet, because you also need to consider the reaction of investors to this approach. Their main concern is how it will impact their return on investment. Again, it depends on their mindset about its impact. Having dealt with a lot of investors over the years, I think they’d only approve of the idea if you could prove a positive outcome in advance, which is pretty hard to do.

How to Implement Open Book Management

 So, a few suggestions. If you’re going to try open book management, start off at an extremely high level. That means just the sales numbers for the quarterly financial statements. You could get into all aspects of sales, so that employees understand things like the seasonality of the business, and which regions generate the most sales, and which products sell the best. At this level of information, employees are not being told about profits, so they can’t draw any conclusions about how their compensation fits into the financial situation of the company.

 Run the project at this level for quite a while – maybe a year – and see if it results in any additional employee engagement, such as more improvement ideas. If there’s a way to quantify it, then do so. If the results are good, then move down the income statement a little more, to include the cost of goods sold and the gross margin.

 At this level of information sharing, employees learn about what products cost and how much the company makes from each individual product sale. You could even get into details like the impact of volume purchasing discounts on raw material costs, and how much product returns cost the company.

 Again, if the results are positive, then consider moving down the income statement again, and talking about operating expenses and profits. This is a more incremental approach, which makes it easier to stop at any point.

 Also, by discussing information just once a quarter, you’re not getting employees overly accustomed to these discussions. That means you could pull out of the whole arrangement if there’s not enough support from senior management, and the employees may not notice.

Responsibility Accounting

 Another option is to use responsibility accounting instead. This involves only reporting financial information to employees for their areas of responsibility. For example, you’d send maintenance expense information to the maintenance manager, and sales data for the western sales region to the sales manager for that region. The presentation format is usually accompanied by their budget information, so they can see budget versus actual information.

 I’ve done this in every company I’ve worked for, and it always had total senior management support. The difference here is that information is specifically being provided so that you can hold people accountable for their areas of responsibility. People are expected to take action to fix whatever problems appear in those reports. Senior managers understand this.

 Compare it to the reasoning behind open book management, which is that employees might be more supportive if they know more about the company’s financial situation. The argument supporting it is inherently weaker. In short, I certainly recommend responsibility accounting, and suggest that you roll out open book management with just sales information to start with, to see how it goes. Then proceed based on what happens.