Linking Financial Results to Workplace Safety - a case study of Alcoa
From 1987 through to 2000 Paul O’Neill helped transform the fortunes of one of the world’s largest Aluminium companies, Alcoa. While highly effective, O’Neill’s strategy was also unorthodox - driven almost entirely by workplace safety.
Paul O'Neill became CEO of Alcoa at a weak point in the company's history. Bloomberg characterised the Alcoa of that time (1987) as a "wheezing industrial giant with an unremarkable financial record". Worse, this pessimistic outlook was mirrored internally. Alcoa was seen to occupy a so-called 'mature industry' where the locus of control had drifted. Commercial possibilities were no longer created through ingenuity or innovation, but instead dictated by external market conditions over which the company exerted little or no influence. The business was in vital need of rejuvenation and required a wholesale shift in perspective.
"It [Alcoa] was just another wheezing industrial giant with an unremarkable financial record and a workforce that was biding its time."¹
A Business Transformation
Over the next 13 years, Alcoa reformed its outlook appreciably under O'Neill's direction - delivering results that garnered attention across the business world. To this day, Alcoa's turnaround is featured in case study materials published by Harvard Business School and the Kennedy School of Government. By the year 2000, the company had almost quintupled sales while improving profitability by 14%. Moreover, Alcoa's progress was not simply a function of linear expansion. Underlying productivity per employee had also improved by 45% over the same period - demonstrating fundamental gains in operational efficiency. Against this backdrop however, O'Neill highlighted one metric in particular. 'Time lost to employee injury' had declined 85% relative to the US industry benchmark. According to O'Neill, this element was far from incidental, and in fact served as the cornerstone of his entire strategy. This of course begged the question: by what mechanism could 'workplace safety' have driven such a radical transformation in commercial outlook?
*Figures sourced from Bloomberg Business²
O'Neill argued that latent business potential could not be quantified from financial metrics alone. Instead he proposed that careful investigation of non-financial indicators (such as workplace injury rates) would lead to a deeper understanding of pivotal operational processes that drive P&L on the surface. Paying close attention to non-financial indicators was the business equivalent of taking of an X-ray photograph. It provided company directors with a more helpful, explanatory picture of business activity, highlighting key control points, and unveiling concrete opportunities for risk mitigation and value-creation that might not otherwise have been apparent.
"You can't make safety better without having a profound understanding of your process"³
Improving Information Flow
How does this actually work in practice? The new emphasis on H&S reporting had the generalised side effect of improving vertical information flow between employees, management and the board of directors. This translated to better oversight and vastly more responsive operational control - both fundamental to effective decision-making and cost management. Better flow of information also translated to more productive engagement with staff, who could now be confident that their feedback was used constructively in the running of the business.
"[O'Neill] said to the hourly workers, 'If your management doesn't follow up on safety issues, then call me at home, here's my number'" ⁴
Elevating factory floor feedback also created an environment conducive to innovation. New ideas could be readily suggested by those most familiar with operational challenges. These ideas would then be explored, tested and refined - leading to gains in productivity.
There was also a motivational element to O'Neill's strategy. The focus on workplace safety supplied an emotive impetus which enthused and accelerated otherwise dry but necessary operational reforms. After implementing a series of new safety provisions, O'Neill told his teams "We shouldn't celebrate because we've followed rules or brought down a number. We should celebrate because we are saving lives."⁵ This sense of purpose (combined with better information flow), breathed fresh vigour into the business. It also galvanised trust and cooperation in an environment which had previously been described as "rife with management-labour hostility"⁶.
By deepening engagement with employees, the new safety measures catalysed more fluid cooperation on reform efforts generally. This allowed O'Neill to target a wider array of non-financial indicators beyond workplace safety. Over time, Alcoa management was able to successfully uncover and resolve issues of waste and inefficiency which had lain unaddressed for decades. The aggregate effect of these reforms supported the remarkable turnaround in Alcoa's commercial success.
ESG... before the label
How does all of this relate to ESG? ESG did not exist as an acronym in the 1980s and 90s - however the underlying contribution of environmental, social and governance factors to company performance held as much veracity then as it does today. The Alcoa case study is useful because it exemplifies how social factors (in this instance a robust approach to workplace safety) can dramatically enhance commercial outcomes in ways which are not necessarily intuitive or obvious at first glance. Alcoa provides an illustration of the concrete mechanics which drive the much lauded correlation between ESG criteria and financial performance.
Capital, conditions & context
Understanding the causal mechanics of ESG is critically important. Without this, CIOs lack the ability to look beneath the surface of published ESG ratings and evaluate their significance in a given context. The risk is that CIOs end up chasing surface-level correlations blind to the underlying conditions under which ESG inputs translate (or not) to real-world performance. It is clear for example, that workplace safety generated significant impact at Alcoa partly because of the high risk industrial setting (bauxite refineries), and partly because internal processes were so poor prior to O'Neill's arrival.
In a different context workplace safety, while still important for other reasons, may not have achieved results on the same scale. Capital allocation models should be especially attentive to the conditions and contexts in which ESG factors exert their effects. Certain business environments will be more sensitive to some ESG factors than others (E,S & G may weight differently), while the current status quo in a business will determine whether ESG drives appreciation or simply preserves value.
FOOTNOTES AND LINKS
¹ How O'neill Got Alcoa Shining - Michael Arndt - Bloomberg Business (5 February 2001) (https://www.bloomberg.com/news/articles/2001-02-05/how-oneill-got-alcoa-shining)
² How O'neill Got Alcoa Shining - Michael Arndt - Bloomberg Business (5 February 2001) (https://www.bloomberg.com/news/articles/2001-02-05/how-oneill-got-alcoa-shining)
³ Varley, P. and Moore, M. (1992) 'Vision and Strategy: Paul H. O'Neill at OMB and Alcoa', Harvard Kennedy School, pp. 12. (https://store.hbr.org/product/vision-and-strategy-paul-h-o-neill-at-omb-and-alcoa/KS1035)
⁴ Charles Duhigg (2013) The Power of Habit: Why We Do What We Do, and How to Change : Random House Books, p.117
⁵ Charles Duhigg (2013) The Power of Habit: Why We Do What We Do, and How to Change : Random House Books, p.117
⁶ Milton Moskowitz, Robert Levering, Michael Katz (1990) Everybody’s Business: A Field Guide to the 400 Leading Companies in America : Doubleday Currency, New York, p.517