How the Middle Market Kept Productivity High Through the Recession
By: Hal Conick
Sept. 29, 2016
As U.S. productivity crashed with the Great Recession, the middle market’s productivity stayed afloat. Here’s how they did it.
The Great Recession was an insidious force against the U.S. economy. Across the country, organizational production plummeted in step with the GDP, capital investment and jobs. The country was sent into a fiscal tailspin, with productivity left to swirl into its downward spiral.
Crashing productivity was less publicized than other failing pieces of the economy, but its pain was felt country-wide. According to the Bureau of Labor Statistics, nonfarm business productivity dropped 100% between the periods of 2000 to 2007 and 2007 to 2015 from 2.6% annual growth to 1.3% annual growth.
Middle market productivity, while not unaffected by 2007’s economic sinkhole, has been a proverbial lambent flame in an otherwise darkened economy. As U.S. productivity continues to languish in 2016, down 0.6% during the second quarter, midmarket productivity has been on the rise since the fourth quarter of 2015, according to the Middle Market Center. The sector experienced its third consecutive quarter of growth in the second quarter of 2016. Yielding 3.3% growth in the second quarter, it is closing in on its 2014 productivity increase of 4%.
Mary Josephs, founder and CEO of middle market investment firm Verit Advisors, posits midmarket productivity held steady due to one of its finest assets: the employee.
“I have a bias and a passion for the middle market,” she says. “The sweat equity of family and entrepreneurs building businesses in communities across the country is, to me, part of the foundation of America.”
Middle market companies, which contribute $6.2 trillion to the economy and employ 50 million Americans, have a unique combination of svelteness and monetary power, striking a balance small and large businesses normally cannot. For this reason, midmarket organizations are set up for employee engagement and productivity, Josephs wrote in a recent Forbes column.
The midmarket’s compact workforces allow for a protean work flow, easily able to turn on a dime, and, in theory, provide a greater level of productivity. Getting employees to consider productivity enhancements can improve the bottom line from 4% to 10% year-over-year, Josephs says. This can only happen at companies that combine culture, leadership, and talent.
“The families that are about building a business and sustaining a culture … tend to have extraordinary throughput,” she says. “I call that productivity, whereas, if it’s a privately held family business [that tries to] take out as much money as possible for the family—maybe not offering a retirement plan because that’s not required, or skimping on benefits, training, health care and leadership development—[that] is not [productive].” Such benefits, in Josephs’ experience, correlate to productivity, which correlates to value.
Finding Value Within
Thomas Stewart, executive director of the National Center for the Middle Market, knows how powerful an engaged, productive employee base can be. He’s written two books on intellectual capital within companies and says he’s endlessly intrigued by productivity. Stewart enjoys looking askew at productivity, but thinks there’s one tenet that’s important to remember: productivity’s equation is output divided by input. Increasing productivity means increasing outputs or reducing inputs. The question in 2016 often boils down to creating more with less, or perhaps finding greater value with the same workforce and tools.
“If I can have the same number of people, and they’re doing more work or more valuable work that I can charge a higher price for, then I’m increasing productivity,” Stewart says. “[If] I take the same number of workers and increase the number of widgets they produce per worker, but also increase the value of the stuff they produce, that’s a significant thing.”
Analytics and Big Data may assist in productivity improvements, no matter the employee base; however, executives at each midmarket company must ask what measurements of productivity are most effective in each case.
This is where the productivity of middle market companies can be made or broken. These companies are aggressive hirers, Stewart says, anywhere from 50% to 100% faster than small or big businesses in terms of net growth, but they usually hold off on capital spending until coming into additional funds. Any savings via productivity may mean an ability to make smarter investments.
“They’re really cautious about adding to their monthly costs,” Stewart says. “Whether that’s wages, plants or capital equipment, they want to maximize the output they’re getting.”
Labor productivity is the simplest measurement, Stewart says, and often tells less of a story than many think. Getting more complex—and perhaps sophisticated—means measuring total factor productivity, or the portion of the output not explained by the amount of input in production. This measurement determines how efficiently inputs are used on the production level, per Harvard Business School. Stewart says this may give a wider view of productivity across the organization and bring forth the question of where companies will look for additional productivity. Could it go beyond labor and into new equipment or technology, such as automatic drivers or drones?
“We may be on the cusp on a lot of labor productivity gains in places that have been resistant to it before,” he says.
Creating a More Engaged Employee Base
How is a more efficient, productive employee base cultivated? Josephs says the culture must be allowed to come alive with ideas. Some ideas will be good, some will be bad, but all will have the aim of creating more efficient business practices. This likely means promising employees their good ideas will not mean a round of layoffs, Josephs says. After all, no employee wants to make a suggestion that will slash their hours or end their job. Creating an atmosphere where mistakes and new ideas are not only allowed, but encouraged, may be a key to productivity.
“You get politics out of the way and [everyone] rowing in the same direction,” she says.
These changes must come from the top. Executives must believe in cost-benefit analysis, coaching, investing, recruiting benefits and encouraging employees to exchange ideas for the best result, Josephs says.
“That’s a leap of faith for some people. I think of people who came out of a very tough time in business. They have a mentality that all spending detracts from value. You have to believe that it’s not spending, it’s investment. You have to have permission to do it,” she says.
An employee stock ownership plan (ESOP) or other employee-owner agreement that gives employees a stake in the company may be positive for productivity and increase the willingness of employees to be more open, invested and creative, Josephs says. However, there must still be something the entire company is driving for, she says; a common goal of productivity must be in place. This, in the end, will help the company and employees make money.
“The exceptional companies have identified what some key drivers are in their business,” she says. “Maybe for factories it’s on-time deliveries. For retailers, it’s minimizing shrink and turnover. [In any case, they’d] have everyone knowing that these metrics are going to help boost share value, which is going to make the retirement accounts bigger.”
What’s Next for Midmarket Productivity?
Midmarket companies will need to find where opportunities to improve exist, Stewart says. This is likely where advanced data analytics will factor in, as he believes the productivity slowdown across the country is probably from the “easy gains” of the first wave of automation, digitization and offshoring. Avoiding a productivity lull will mean finding more creative ways to use what is already in place.
As an example, Stewart says if a company’s total cost of producing a good is $100 when it was made 25 years ago, (where 50% of costs were attributed to labor, 25% to IT and 25% to machinery) and the cost to produce is still $100, where could feasible cuts be made in production? Labor costs are likely down, he says; could technology be the place to look? Stewart believes so, saying the productivity of machines and IT, especially with technology getting less expensive each year, could be a sensible place to save money.
Now, with automated systems and leaner employee bases, Stewart says midmarket companies need to ask, “What’s next?” This may go beyond labor and into finding a greater level of productivity in technology. “People who can crack those nuts might make some really big gains,” he says.