Employee Participation Cuts Production Costs

Summary of working paper 6033

...the 'traditional' and the 'voice' approaches... achieve equal amounts of cost reduction: almost 3 percent per year in real terms.

One way for companies to raise profits is to reduce costs. For decades Japanese automakers have required their suppliers to reduce their costs by several percentage points per year. More recently, U.S. automakers have adopted the idea that the prices of the components they buy from suppliers should go down every year, even using the Japanese word "kaizen," or continuous improvement, in describing how suppliers should achieve this goal. Ford, for example, announced in 1996 that suppliers should reduce costs by 5 percent per year through 2000.

In Complementarity and Cost Reduction: Evidence from the Auto Supply Industry(NBER Working Paper No. 6033), Susan Helper uses information from two surveys she conducted in 1993 and from field interviews done over the past 12 years with the auto supply industry to explore the determinants of average-cost reduction for a sample of around 200 plants in the United States and Canada between 1988 and 1992. Specifically, she examines the relative success of two methods - the "traditional" and the "voice" approaches - in reducing costs. She finds that both approaches achieve equal amounts of cost reduction: almost 3 percent per year in real terms.

The two systems arise from different views about the determinants of cost reduction. For the "traditional" approach, competitive markets are very important, because they allow firms to switch (and threaten to switch) to cheaper workers and parts suppliers. With the "voice" approach, suppliers do not just provide tangible parts for current production, they also are important providers of ideas for improving the process in the future. Thus, firms try to reduce costs through discussion with their existing suppliers and workers. These relationships have led to significant performance improvement in areas such as product development productivity and lead time, product quality, and inventory levels. But such a close relationship requires both parties to disclose proprietary information and to invest in learning about each others' process. A supplier will not take such actions without assurance that it will have the business long enough to earn a reasonable profit. Giving such assurances makes it more difficult for the customer to switch business partners, reducing its bargaining power. Similarly, workers need some commitment if they are to be willing to provide suggestions that may make their jobs unnecessary.

The two approaches reduce costs in very different ways. Those plants with suggestion systems (or with labor-management committees with policy power) -- the voice plants -- achieved cost reduction primarily through information-rich relationships with customers and workers. Plants with both worker participation and high wages reduced costs more than firms with neither or with only one of these practices. (For a firm with a suggestion program and 10 percent of its costs coming from direct labor -- the sample average -- a small wage premium would pay for itself in cost-reducing ideas.) Firms which had voice relationships with workers also benefitted from voice relationships with their customers. In contrast, the no-suggestion --or traditional -- group achieved cost reduction through volume increases, and by the ability to lay off workers made redundant by process improvement efforts.

Helper tells of a firm in Wellington, Ohio, which puts anti-corrosion and other types of coatings onto fasteners used in automotive engines. This firm uses the traditional approach to cutting costs and increasing profits. The firm's competitive advantage is that it has figured out how to use tumblers, jiggled by an electric motor underneath, to orient small parts so that the coating can be applied by machine rather than by hand. Cost reduction is the job of engineers, who do it by figuring out how to automate the coating of ever trickier parts. They do not receive help in these efforts from either operators (who usually leave after a year or so), or from customers (who worry about making design changes that would lock them into using that one supplier).

In another case, a firm making printed circuit boards for the auto industry, consultants worked with a team of engineers and supervisors from the plant to rethink the entire process. This team was able to eliminate a time-consuming process step, increasing output per hour by 25 percent. Because the firm was able to lay off all workers on the third shift, the increased productivity translated into substantial savings.

A third firm in Plymouth, Michigan -- the Industrial Strainer Corp. -- is struggling to adopt a voice approach to production. In 1994, Ford made a big push to teach its suppliers, including this firm, kaizen techniques. After a week-long process, a union-management team was able to reduce from four to three the number of workers required to assemble oil separators. They did this by re-arranging machines to reduce time walking between them, and re-arranging tasks so no operator was idle while others worked. Also, ergonomic improvements in packing crates and storage increased productivity and reduced costly injuries.

In addition, Industrial Strainer's workers made 170 cost-saving suggestions last year. Key to this was management's commitment that no one would be laid off as a result of productivity improvements, notes Helper.