Nine out of ten new businesses fail within their first year. This is an alarming statistic that may in fact be more of a myth than truth. However, recent data suggests the same trend just not as extreme. According to Brian Headd and data from the U.S. Census, a more realistic figure suggests that 62% of businesses close within the first six years of operation (Headd 2). This raises the question of: What makes a successful business? By analyzing and dissecting the intricacies of Lincoln Electric’s consistently stellar performance as well as paying close attention to several interesting financial pitfalls an answer can be found.
Value in the Individual
An organization at its core is made up of individuals and equipment. Now which of these has the most influence over the success of that organization? Most emphasis must be placed on the individual because he is the one that can be creative, motivated, skilled, efficient, and responsive. The proper function of management is to draw out these characteristics and encourage their growth in a productive setting. A large portion of Lincoln Electric’s (LE) success can be attributed to this unique and effective management style which ultimately leads to a competitive advantage. No matter the economies of scale a huge corporation such as GE can offer, the increased productivity level of a properly motivated individual production worker can easily compensate for it. This management style is further fostered through a combination of structural, strategic, and cultural norms within LE.
Structurally, Lincoln Electric aims to flatten the hierarchical structure and eliminate nonfunctional middle management positions. To do this, LE has fostered an “open-door” policy between production workers and executives as well as created an Advisory Board that has representatives of the workers who meet with executives twice a month. Strategically, LE pushes for an integrated approach of maximizing output and reducing costs. Though this seems straightforward and simple, the effectiveness is in the details. Cost reduction will be explored at a later time, but to maximize output, Lincoln Electric draws from its motivated employees. However, these employees are not naturally motivated. This is the role of James Lincoln’s Incentive Management System. This system provides a tool to motivate all employees through bonuses that redistribute a large portion of the corporation’s yearly profits. Two main results stem from this redistribution. First, there is a heightened sense of ownership in the company from top to bottom because if the company as a whole does well, everyone is compensated for it respectively.
Secondly, there is increased personal performance. This performance boost is the result of a sort of quiet competition within each work group. A specific bonus pool dollar amount is allotted to each work group, and the bonuses are then distributed to the members of that group according to their quantified relative performance on the semi-annual Merit Rating. Now the Merit Rating’s function is to counteract some of the pitfalls of a strategy based on speed and efficiency. Generally the result of an emphasis on speed is the sacrifice of quality and safety. Each tenet of the Merit Rating (including Dependability, Quality, Output, and Ideas/Cooperation) is a reaction to the common shortcomings of a traditional production worker. By being rewarded for attendance, work quality, and contribution of ideas on top of their piecework output leads to a well-rounded final product that is produced at the proper specifications in record time.
To further the speed of production, LE places a strong emphasis on idea generation and worker input. This allows for creative ideas and suggestions on the production process to be spread over the whole corporation. As a result, there is a strong and steady increase in LE’s productivity per worker. The Merit system also serves to increase coordination by rewarding teamwork while at the same time introducing an element that is historically known to be one of the greatest efficiency drivers of all time: competition. Though this seems like teamwork and competition would be in conflict, they are not. Since there are only a certain number of possible Merit Points available, competition over these points between members of the work group exists. However the total payoff at the end of the year is split up based on the profit of the corporation as a whole; therefore encouraging teamwork and idea sharing. This comprehensive Incentive Management System unifies the direction of the workforce and leads to a balanced and efficient set of goals that yields a strong competitive advantage over rival companies. In a commodity industry it is the process, not the product, that must prevail and be differentiated. Lincoln Electric has found the perfect process, but is it a universal process that can apply overseas?
Cost Reduction and Market Expansion
The blind pursuit of profit can easily lead to poor decision-making. That is why the means to creating income is vital. The question is how does a company increase margins? Two simple choices exist: Reduce costs, or increase output through expansion and efficiency. Lincoln Electric has identified this dynamic duo and integrated it into the general business strategy. To reduce costs, LE uses a variety of strong business tactics. There are three shifts on equipment, so it is constantly rotated and allows for no downtime on equipment. This prevents having excess capacity which leads to unnecessary overhead costs. Also, LE has aimed to flatten the structure of the company and eliminate levels of the organization that detract from the established open communication environment between workers and management. This reduces salary expenses and ultimately increases profit margin.
The concept of guaranteed employment is another brilliant cost-reducing idea of James F. Lincoln. The cost of retaining employees on payroll is less than the cost to recruit and train motivated and creative workers. As a result, during downturns, LE did not layoff workers but would retrain and deploy them elsewhere in the company. This would encourage loyalty to the company and highly reduce employee turnover, once again reducing cost to Lincoln Electric through a variety of quantitative as well as qualitative means. Lastly, there is the concept of limited benefits enhanced profits. This enhancement reflected back to bonuses and worker’s piecework compensation which put more control in the hands of the individual with the allotment of money and compensated for their lack of benefits. LE’s approach to maximizing output was explored previously, and the general consensus was a focus on developing a creative, motivated, and efficient production worker who consistently puts out more effort than a similar production worker in another firm. Another option to increase output is expansion into other markets.
Lincoln Electric first expanded to Canada by opening a manufacturing plant in Toronto in 1925. About twenty years later, LE Canada adopted the Incentive Management System (IMS) including its annual bonus and piecework facets. Due to the similar cultural norms between the U.S. and Canada, this adjustment flowed smoothly. However, poor decision-making led to this application of the IMS in other markets, including Europe and South America. Friction resulted because the cultural values of the production worker are different. Also, government regulation in Germany and Brazil led to major adjustments that undermined LE’s incentive efforts. In Europe, workers valued benefits such as vacation time over annual bonuses. It was discovered that annual bonuses did little to increase individual production efficiency without the piecework aspect of the IMS. Piecework was in fact illegal in Germany.
Obviously if more planning or research had been done, this crucial fact would have been discovered and LE would have avoided expansion into Germany. The root of Lincoln Electric’s troubles began with the quick expansionist mindset of George Willis. The main trouble was the speed of the expansion. LE incurred long-term financial debt for the first time in the corporation’s history. The added interest expense and permanent liability hurt future income statements heavily. A study of Lincoln Electric’s Consolidated Income Statement as well as the Balance Sheet reveals some interesting financial facts.
Starting in 1987, LE had no long-term debt. This skyrocketed along with the push for expansion in subsequent years to over $220 million in 1992. As the Income Statement suggests, the height of this long-term debt matches with the first net loss of Lincoln Electric. Failure to control spending and keep costs low (the historical competitive advantage of LE) undermined the desire to increase output through expansion. Another interesting fact is that as sales leveled off in 1992 and 1993, general costs and expenses failed to coincide so they continued to rise until 1994 which happens to also be the first posted net income after the losses of 1992-93.
This analysis of cost-reduction and market expansion raises several questions. How can Lincoln Electric prevent similar losses in the future? How closely correlated is the 1992-93 net loss with geographic expansion? What can Lincoln Electric do in the future to maintain its historical rapid growth and competitive advantage?
So decision time has come about Indonesia. Is Indonesia ready and willing to match up with Lincoln Electric’s strategy, or will it repel the incentives that are the key competitive differentiators? After analysis of Indonesia’s economic and financial situation, I recommend slow expansion into their welding market. The current distribution network of Tira and SSHJ should be altered so that it can be refined and expanded. Though smaller, SSHJ’s strategy coincides with LE’s more so than Tira’s strategy. I suggest using only SSHJ salespeople because they highlight the cost-savings and benefits of Lincoln Electric’s products while aiming to draw in new customers via LE’s name recognition and reputation for high-quality. LE should utilize cooptation to provide the company with local contacts and recommendations so that previous errors in incentive management can be addressed and altered. Exact details of my recommended Indonesian expansion are specified in the following list:
o Combination of piecework and salary with a salary representing a figure slightly lower than the average Indonesian manufacturing worker wage of 250,000 rupiah.
o No annual bonus because the economy is so shifty and volatile that it would most likely not affect daily effort.
o Guaranteed employment would exist through the understanding that economic change would not threaten a workers job. Job security would encourage intense loyalty and be a strong factor in building a consistent workforce.
With this comprehensive entry strategy into the Indonesian market, I feel that Lincoln Electric will only be met with success. This strategy encompasses the strongest aspects of LE’s Cleveland incentive system while tailoring it to be profit-maximizing in the specific Indonesian environment. Gillespie should have no worries as he presents these plans to his colleagues because the foundations of this plan are rooted in the historically successful traditions of Lincoln Electric, and have been adjusted to compensate for the differences that hindered previous global expansion.