Rediscover investment effectiveness to exit The Productivity Crisis

We all know we have a productivity problem if we measure it appropriately, as I presented in the previous two articles in this series – What is capital engineering and why is it unproductive? and Have roles & seniority decoupled from skills & experience? An organizational self-assessment. You likely have observed a need for change as an employee, supervisor, executive, or investor. June 2023 Bureau of Labor Statistics (BLS) report shows a continuing decrease in Labor Productivity and Total Factor Productivity.

So, what is our way back to building sustainably profitable companies?

There are two levers that companies and employees will have to use to improve their ecosystems' productivity. The first lever is a company's overarching investment philosophy. Is it an opt-in or opt-out mindset? The second lever is the quality of its human capital investment.

Keep the themes "too many cooks in the kitchen," "less is more," and "diminishing returns" in your mind as we explore these levers. Let's discuss how a company's choices on these two levers will impact the workforce and the company's overall trajectory.

The first lever: Adopt an opt-in investment mindset.

Companies invest more when monetary and fiscal policies are favorable and cut investment when macroeconomic factors turn sour. Typically, everyone is spending or cutting too much. The general implication of high or low investment is undifferentiated if treated as a blunt instrument to follow the market.

We have already seen the Fed try to slow down the growth-at-any-cost train skidding off the track with interest rate hikes. Investors abandoned overvalued companies to some extent. Companies have been addressing short-term needs to show profitability or deal with liquidity challenges from rising interest rates. Even a company that must re-up its debt has to demonstrate profitability as banks slowly work towards tightening their lending standards for companies.

What is the quickest way to improve earnings? Cut costs. For non-capital-intensive businesses, the easiest way to cut a massive share of cost is by cutting people.

Established companies have led with minor job cuts, and companies with tighter cash flow situations have followed suit. There is a feeling that layoffs are prevalent. Bureau of Labor Statistics also reports monthly employment statistics, including Monthly Hires and Monthly Separations broken down into three categories: number of quits and voluntary separations, number of layoffs and involuntary separations, and retirements. Using these figures and the total size of the workforce, which changes over time, I calculated the Monthly Separations and Monthly Hires as a percentage of the Total Labor Force. See the infographic below. The important takeaways from my BLS analysis are the following:

First, there have been increasing voluntary and decreasing involuntary separations since 2009. Employees have increasingly spent more time looking for the next job and onboarding than performing optimally in any given position. This correlates with the easy money era and is a predictable part of any expansion cycle, as we can see from the rise in quitting figures leading to The Financial Crisis. Even with the recent layoffs, the highest monthly involuntary separations as a percentage of the labor force are only 0.9% through this crisis compared to 1.7% after The Financial Crisis, as you can see in the first chart.

Second, total monthly separations as a share of the total labor force have steadily declined since the financial crisis. The rolling 6-month average of total separations was between 1.3% and 1.5% of the total labor force before The Financial Crisis. This figure has steadily declined to below 1% since Covid. The second chart shows that recent layoffs haven't moved this figure above 1%.

Third, in an economic correction, hiring would inevitably be overshadowed by total separations, as seen from the Dot Com Bust and The Financial Crisis. As you can see from the third chart, Total Monthly Hires have tracked above Total Monthly Separations consistently since 2011, and it remains so. Although we feel job losses are aplenty, the data says otherwise. This pattern will reverse before we get through The Productivity Crisis.

Combining this job data with the macro-economic and company-level realities that I explained in the two articles – What is capital engineering and why is it unproductive? and Have roles & seniority decoupled from skills & experience? An organizational self-assessment – we can surmise that impact of The Productivity Crisis is yet to hit us.

We have only used total investment as a must-use lever to satisfy short-term financial metrics. We continue to use an opt-out mindset for investment, which means we will cut if necessary. We have not been using this lever to improve behaviors. This mindset is inefficient and continues to contribute to unproductivity in our ecosystem.

Taking an opt-in mindset for investment decisions will improve how a company invests strategically and operationally and engrain productive behaviors across teams and employees.

For example, the CEO of a mid-market manufacturing company operating sustainably described his mindset as, "I don't set team-level spending budgets. My team wants me to give them Carte Blanche authority to choose projects and hire people. I want us to make rational situational decisions. It's not about the total spending, and I want to ensure I am not incentivizing my team to blow through a budget."

"We have money in the bank" and "I have a budget to spend this year" are government mindsets and not optimal for sustainable, profit-oriented companies. Effective company-level investment prioritization and decision-making constructs will make a comeback among sustainably growing and profitable companies.

What will this mean in practice?

Start with a deeper look at all initiatives and projects that have been green-lit in the past three years. Companies embracing a sustainable growth mindset will cut unvetted ideas previously approved as formal projects. Decisive executives will write down business integration efforts around recent mergers and acquisitions that are unlikely to create incremental value. Overeager geographic expansions will reverse. Stopping the flow of good money into past suboptimal choices is a necessary starting point. But this retrospective clean-up effort does not improve future behaviors.

Next, sustainable growth companies will invest in maturing their approach to making future investment decisions. Improving future decision-making starts with a cohesive and comprehensive corporate strategy and strategic plan, which sets a guardrail for every dollar the company invests. Most companies will likely need a more effective strategy and strategic plan that align with a sustainable growth mindset. Curtailing efforts to chase suboptimal customers and attempting to create and deliver offerings well outside a company's wheelhouse will require investment discipline.

Beyond an effective strategy-led plan, the underlying execution of significant initiatives will require effective tactical investment decisions. Redeploying existing capital with discipline instead of adding new investments at every turn characterizes an operationally mature ecosystem. Companies must restart using effective decision-making frameworks and objective decision forums. Creating necessary investment constraints using such tools allows organizations to avoid stifling productivity through operational inefficiency.

An opt-in investment decision mindset will also more profoundly impact the number of people employed as companies cut unproductive in-flight projects. Layoffs and involuntary separations will increase as a result. Voluntary quitting will decrease as the opportunity to jump to other companies easily will continue to shrink.

These trends will reverse the recent pattern where workers jumped around companies looking for increased pay and titles without an actual case behind those moves. As gut-wrenching as it sounds, escalation in involuntary job losses is necessary for us to return to a healthy and productive ecosystem.

Many workers will be affected by investment optimization decisions at sustainable growth companies. Workers at companies that don't adopt an opt-in investment mindset will be affected as those companies struggle downstream.

Due to our recent overinvesting history, many companies lag in effective organization designs or objective performance management approaches. So, the upcoming involuntary terminations will involve many subjective decisions that will feel hurtful for impacted workers.

Almost everyone is still hoping to go back to the scheme we had going until Federal Reserve raised interest rates. But the sooner we accept that we have been on steroids for a long time and that stuff has side effects that catch up, we can start relying on healthier habits to achieve outcomes.

Adopting an opt-in mindset will be hard enough. But, however painful it feels to cut off a finger or two, it is not enough to address the skill and behavioral misalignments in our economy's bloodstream for a long time. We need to adopt a second lever to address our productivity challenges.

The second lever: Optimize the quality of human capital investment.

There is a murmur in the market about efficiency drives. For instance, when Mark Zuckerberg announced cutting 25% of Meta's workforce in 2023, he explained it as a "year of efficiency." What could Zuckerberg mean by efficiency? Simply put, it is a pivot away from the human capital investment behaviors of the last decade.

In the second article in this series, I explained the decoupling of job titles and seniority from skills and experience as one form of mutation that is triggering The Productivity Crisis. The solution to this decoupling is a painful realignment of human capital investment to value creation.

Wall street journal recently reported that employee happiness jumped from 42% to 65% between 2010 and 2023. That is the highest figure since the 60s and worth celebrating. The primary reason for this fast rise in employee satisfaction is increasing pay and flexibility. Still, it has come at the expense of value creation. This contradiction with the productivity challenges we discussed makes this trend unsustainable.

Start-up investors often say, "We are investing in the founders." Simplistically, this translates to choosing founders with the best entrepreneurial traits. The same applies to how a company must invest in employees.

Align human capital investment to skills, experience, and competencies that create tangible value for internal and external customers.

This second lever optimizes human capital investment to transform operational definition, organization design, hiring, performance management and promotions, and compensation. These must align with the intrinsic value created rather than perceptions of value.

The first step in deploying this lever is to shift the human capital investment mindset from focusing on the volume of hires to effective problem-solving. The days when executives and middle managers bank on adding new teams and staff or adding external contractors to address essential aspects of their roles are behind us. Executives and supervisors must shift their attention from staffing and hiring to problem-solving.

Effectively translating information from customers, internal operations, and the market into optimal problem definitions and cost-effective and sustainable solutions will become the new measure of an effective supervisor or executive. Improving the value delivered using existing human capital investment, including coaching internal staff and measuring external service providers, will be paramount. The skill to teach and upskill while possessing the experience to manage performance objectively will become necessary.

The second step is the toughest one. The CEO and board must address executives and supervisors struggling to transition from the investment-heavy recent history into a problem-solving and investment-effectiveness ecosystem. Due to the title inflation trend of the past decade, we rapidly thrust many inexperienced individuals into executive and supervisor roles too quickly. Executives and supervisors who have yet to hone their problem-solving and decision-making abilities and are learning the basics on the job will likely find this transition hard.

Optimization of a company's human capital investment requires the occupation of executive and supervisor roles with objective and experienced decision-makers and skilled problem solvers. It is also a better growth ecosystem for younger workers to receive coaching and mentorship from top-notch supervisors and executives. It is essential to refocus on meritocratic staffing if the company has a history of passing on skilled and experienced individuals based on age or other subtle biases.

The first two steps are prerequisites to further a company's human capital investment agenda. When the experience and depth of expertise of executives and supervisors improve, so can the actual maturity of the organization. For instance, several employees at a company struggling with maturity after growing gangbusters told me that "we structure the organization to accommodate the people that have been here for a long time." This self-serving existence of folks managing human capital investment stifles all other maturity efforts.

With a critical mass of effective problem-solvers and objective decision-makers in senior executive and supervisory roles, the third step can commence. In this third step, we must improve the operational design of the company. Maturity improvements in processes, including how the organization sells and delivers value to customers and uses data and technology, are a prerequisite to assessing human capital investment effectiveness. An adequate operational definition must precede organization design and underlying skill-based role definitions to ensure that human capital investment aligns with tangible value creation.

Once objective executives and supervisors with leadership skills and focus on fundamentally relevant topics are in place, creating efficient operational definitions and an organizational design is possible. We can glean gaps in skills and experience required for each role to create intrinsic value for internal or external customers from effective processes and organizational designs.

The fourth step is a complex transformation to elevate the skills and experience of roles framed in the optimized operational design. Employee roles will need to realign with tangible skills and knowledge. This step reverses the skill-to-role decoupling I described in the second article in The Productivity Crisis series.

To sustainably optimize human capital investment, existing resources with enough competencies will have to upskill further to step into the well-defined, skill-based roles described in an optimized operations definition and organization design. Radical shifts such as role reassignments or terminations may become necessary for skill- or experience-mismatched employees in critical roles.

Imagine a marketing role at Company ABC. Anyone can search Google or ChatGPT with "give me a marketing approach" and export one or repurpose one from a prior employer that might look legitimate. But how does anyone know what 'good' looks like for a relevant and prescriptive marketing plan that takes Company ABC's specific growth stage and customers, product, and market conditions into account? All four steps above are pertinent to ensure that Company ABC's human capital investment has the appropriate skills and experience to create, assess, and deploy an effective marketing plan.

Organizations that embrace a sustainable growth mindset will objectively measure the competency and performance of resources in the context of the optimal operational design and organization design in step 3. Subjective assessments to cut staff without going through steps one, two, and three above are masking a short-term financially motivated spending cut while calling it a skill- or performance-based cut.

Embracing this four-step human capital investment approach to increase focus on value creation and productivity will take time. More importantly, it will require clarity of vision from CEOs and their closest partners. Change is hard. The experience and objectivity of executives and critical supervisors will prove essential to making such a difficult transition stick.

Driving systemic changes where specific expectations are set for roles and objective measurements are used to monitor activities and interim outcomes will be a herculean change management effort. Executives with the clarity of vision and the grit to stand their ground on difficult decisions are prerequisites for such a transformation.

A simple tactical shift to improve employee engagement has been to bring employees back to the office. Even such a tactical decision has been challenging for many companies. Imagine reversing human capital investment effectiveness comprehensively!

The next decade must be one of practicality rather than one of popularity to address our productivity challenges.

Companies can take one of four divergent pathways based on choice of investment levers.

The 2-by-2 infographic below highlights the four paths companies can take based on their choices for the two investment levers we discussed. Let's work our way up to the optimal path.

The least optimal is Path D, where a company isn't reading the writing on the wall. Here, a company avoids optimizing its overall investment approach and the quality of each dollar invested in human capital. Value-focused investors are not interested in institutions that operate frivolously. Path D would be ill-conceived with near-term ramifications for almost every institution. These two suboptimal choices will compound in a downward spiral to financial and value creation challenges. Any institution hoping the economy will revert to the easy-money era is pursuing this suboptimal path.

It's hard to pick between Path B and Path C because both have significant pitfalls. Path C is a reversion to the company's recent past by reducing its overall cost without improving the quality of the remaining investment in human capital. This path is cutting out recent investments in people and projects. Path C is only conceivable in the near term when the company has a very established core business that it is reverting to and away from recent poor investment decisions.

Path C is one of short-term financial viability and risks repeating the same investment mistakes in the future because the ecosystem's maturity is unlikely to have improved. Returning to the recent past implies sticking with decision-makers that made suboptimal choices that had to be reversed. It is worth asking, "What has changed?" Without improving the quality of human capital investment, overall investment effectiveness will prove problematic over time.

Path B is hard to pull off and is primarily motivated by a desire to avoid difficult decisions. Some companies have the cash and financial runway to avoid cutting costs for a while. In this path, the company attempts to mature its investment decisions and work through the organizational improvements discussed above. But the impact will be illusive. Imagine convincing a lifelong wealthy person to change their adult spending habits without removing access to family wealth. Changing those habits will require creating constraints. Total capital investment discipline via an opt-in mindset is necessary to improve productivity through higher-quality human capital investments.

Path A is the optimal one. It combines an opt-in mindset around total investment. It also ensures that every dollar of human capital investment maximizes sustainable value for internal or external customers. It is the only growth path that balances the incentives of all stakeholders and financial sustainability. An organization can radically increase the productivity of its investment in labor, capital, energy, materials, and purchased services through Path A.