ALLIStON INStRumENtS

Alliston Instruments is a manufacturer of specialty medical instruments located in south- ern Ontario. Manufacturing involves two types of processes. First, individual workers produce the components for the medical instruments in batches of various sizes, using a variety of machine tools and equipment. Then other workers assemble the compo- nents into finished products. Assembly is done sequentially, with each product passing through four to six workstations before completion. The quality of the products, which is crucial, depends on both the quality of the component parts that are produced and the quality of the assembly process.

It is late January 2016 and the financial statements for 2015 have just been released. They are grim. For the first time in the company's 50-year history, the firm has shown a loss. The company's chief executive officer believes a lot of this has to do with produc- tion problems. The 2015 production reports indicate that although the number of units produced per employee showed a slight increase last year, the number of defective units reached an all-time high. In addition, there was a high rate of wastage of raw materials and other supplies. Although total sales (and therefore total production) are down from the previous year, total labour costs are up. As a result, costs per unit are at an all-time high.

Because you are an expert in human resources management, the CEO has asked for your help. As background for your work, the CEO briefs you on industry condi- tions. Until two years ago, the firm had enjoyed increasing sales over many years. It had also had increasing profits, with a record profit of over $3 million in 2012. However, in the last two years, the medical instruments industry has become more competitive. High-quality medical instruments are now being produced by several Asian firms, two of which entered the Canadian market in 2013. (Previously, the main competitors in the Canadian market were U.S. and European firms, but they are not much of a problem because their products are very high priced.)

Because of low labour costs, the Asian firms are able to price their products attractively; however, buyers initially held back, concerned about potential quality problems. So for a while, it appeared as if Alliston's customers (mainly hospitals and health clinics) would remain loyal, even though they were themselves under pressure to cut costs, due to budget cuts. But in late 2013, an Asian competitor made a major sales push by slashing prices, and this cut dramatically into Alliston's 2014 sales. In mid-2014, Alliston laid off 50 employees. Although the firm had laid off employees from time to time in the past during production lulls, this was the largest layoff in company history.

To make up for the loss of sales, Alliston added a number of new products to its line. (Over the years, the company had tended to stick with the same set of products, although new products were being put into use in the hospitals.) While some of these new products sold well, they didn't really make money, because production costs were higher due to the need for new equipment and extensive employee training. Moreover, most employees preferred to work on the old products, so supervisors had to use a lot of pressure to get them to work on the new products.

Alliston's 250 production workers have been unionized since the 1960s. In 2012, they staged a short but bitter strike. Because product demand was so high, the company did not want a long work stoppage, and the union was able to win significant wage increases for 2013 and 2014 (a two-year contract was signed). Since then, union-management relations, never very good, have been quite strained. Relations between supervisors and workers are no better. Supervisors complain about lazy workers who don't care if they do a good job or not, and workers complain about overbearing supervisors who allocate work unfairly and spend all their time watching and harassing employees.

Interestingly, the employee turnover rate is low at Alliston. Pay at the firm is above average, and the benefits package, which increases with seniority, is very good, com- prising about 25 percent of total compensation. Comparable alternative employment opportunities in the area are quite scarce.

In late 2014, in an effort to increase efficiency, the firm persuaded the union to accept an incentive system in which employees would receive, in addition to their hourly wages, a bonus based on individual output, rather than an increase in base pay for 2015. A standard per-hour production rate for each item or assembly operation was established, based on estimated 2014 production levels. (However, because the firm had never kept detailed records, these standards were simply based on the estimates of supervisors.)

Under the new system, if production per hour for a particular item exceeds 2014 levels, the employee receives a fixed sum for each piece produced over that level, in addi- tion to the normal hourly pay. Of course, employees do not receive a bonus for items that are not of satisfactory quality, and supervisors are expected to deduct these from the employee totals. However, there are no set standards for quality, and each supervisor seems to set different standards.

There seem to be many problems with this new pay system. For example, workers complain that the production standards for some tasks are set too high and that they have no chance of earning a bonus on these items. Everybody tries to avoid these jobs, and productivity on them is poor. On the other hand, there are some jobs that every- body wants to do, because substantial bonuses can be earned, and productivity is up dramatically on these jobs. But the net effect is that overall units produced per employee have not really changed at all, while substantial sums are being paid out in bonuses.

In the past year, ten production workers have retired or quit and not been replaced, but this workforce reduction was made possible by the drop in sales during the year, not by increased productivity. However, this reduction in the workforce has been partly offset by the need to hire two additional supervisors to handle the increased needs for supervision, inspection, and administration of the bonus system, plus one additional full-time clerical person in the payroll department just to handle the calculations for the new bonus system.

Supervisors have complained bitterly about the new system, saying it is placing additional pressure on them. They say it is causing increased conflict with employees because nobody wants the "bad" (i.e., poor-paying) jobs, and that employees resent it when these "bad" jobs are assigned to them. They find that employees don't care about quality as long as output meets minimum standards, nor do they care about the high wastage of raw materials. Supervisors have to supervise more closely to deal with these problems and try to keep quality and productivity up on the "bad" jobs.

And to top it off, supervisors are now making less money than some of the workers, since they are not eligible for the bonus system. The fact that none of the non-union employees received any pay increase last year does not help their mood, either. During the year, three experienced supervisors have quit. The firm had never had more than one or two supervisors quit in a single year before.

Although the union is generally opposed to individual performance pay plans, it had accepted this one in return for a clause in the collective agreement ensuring job security for the current unionized workforce. Any workforce reductions occurring from greater efficiency will have to be achieved through attrition. Management had agreed to this condition because they did not expect to have to lay off employees. They had expected the new bonus system to reduce unit costs of production so that Alliston could lower its prices and win back the business that had been lost.

It hasn't worked out that way. Financial data for the last four years are shown below. They indicate that sales peaked two years ago at $31 million and have since fallen to $24 million. Customers are complaining about product price and quality. However, the company cannot afford to reduce prices, because unit costs are so high. It is clear to management that something needs to be done, and quickly, but exactly what should be done is not so clear!

2012

Revenues: $27,000,000

Total Employees: 320

Labour Costs: $ 9,000,000

Other production Costs :$13,500,000

Other Costs: $1,350,000

Net Income Loss : $3,150,000

2013

Revenues: 31,000,000

Total Employees: 350

Labour Costs: 12,000,000

Other production Costs :15,500,000

Other Costs:1,550,000

Net Income Loss : $1,950,000

2014

Revenues: 25,000,000

Total Employees: 300

Labour Costs: 11,000,000

Other production Costs :12,500,000

Other Costs:1,500,000

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2015

Revenues: 24,000,000

Total Employees: 293

Labour Costs: 12,000,000

Other production Costs :13,000,000

Other Costs: 1,444,000

Net Income Loss :($2,444,000)

1. You are a team of top-notch compensation consultants hired by Alliston Instruments. Analyze the pay system at Alliston Instruments. Why is the new pay system apparently not working? Do you think that the individual production bonus system could work if some changes were made? What changes? Is the individual performance pay suitable for this company? If management insists on some type of individual performance pay system, what type would you recommend?