Variable pay in gold mining.

Are the risk-sharing proposals in current wage negotiations built on serious fault lines?

At last there is some significant movement towards flexible pay in one of South Africa’s biggest employers – the gold mining industry. As Geoff Candy reported on Mineweb this week, gold producers are looking at some form of pay at risk to counter Union demands for much more than the 5.5% pay hike employers have offered. This could add another 1% based on performance linked to factors such as the gold price, gold revenue, gold produced or cost savings.

It’s doubtful whether this will have a significant impact on reducing the gap between the employers’ offer and the up to 100% demanded by some Unions. In addition, even a superficial glance at the proposal reflects some serious flaws that could be detrimental in the long run to both labour and employers. One can only hope that these flaws do not scuttle the concept itself and delay the inevitability of some form of fortune sharing in the industry.

Fortune sharing in mining has been a desperate need for a long time. It’s a volatile industry, consuming large amounts of high risk capital that has to be ploughed into a depreciating asset, and which simply cannot sustain inflexibility and constantly rising costs.

The graphic below of Harmony Gold mine’s Contribution Account, which I have extrapolated from its latest Integrated Report is an alarming reminder of just how close to the cliff edge most mines have come. The 68% share of wealth to labour is simply over the top. When I consulted to some mines in the 90’s that share was about 50% even in marginal operations. For South Africa as a whole, labour share of GDP is less than 50%.

While some argue that mining is a labour intensive industry, it is far less so than your conventional labour intensive operations such as retail or financial services. It’s a capital hungry industry. The 23% which goes to “savings” or retained income does not have the normal effect of enhancing equity value. It is consumed in capital expenditure such as underground development, shafts, headgear and plant -- most of which have no resalable value. You cannot sell a big hole in the ground – unless someone wants a giant long drop somewhere in the Free State.

In the end, the share of wealth creation should be a fair reflection of the contribution each of the constituents have made in response to the needs of the market – which in gold and most other commodities is an unforgiving place that simply has no interest in your needs and wants, fights and squabbles. In other industries you may get away with imposing such adolescent pettiness on the market through profiteering, collusion, price fixing, bid-rigging and lack of competitiveness. There’s no place for that in mining.

Ultimately, and for any business, real tangible value is created through having served and supplied its customers. That is indeed the common purpose of all of its participants or direct stakeholders.

This is the first serious flaw in the gold producers’ proposals. You can never forge a common purpose through rewards, only through contribution. While that contribution is vague in an industry that is market led rather than customer driven, the production and supply of gold to a world that needs and wants it, is the only common purpose that all involved have. Common purpose based on rewards breaks down when the reward of one is reduced by the reward of another, where higher profits are achieved through reducing the wage bill whether through lay-offs or lower wages; or vice versa.

A well-constructed variable pay system, particularly its ultimate form of fortune sharing, should never be a knee jerk response to wage demands. Flexible pay is not about incentive, but about involvement and engagement, about common purpose and common fate.

Variable pay is about flexibility and viability of the enterprise itself. It should never be a threat to profitability and sustainability. The industry has had an example of this where, some years ago, one marginal mine constructed a bonus scheme based on cubic meters mined underground. Month after month, employees were called in to receive bonuses for their huge and exhausting efforts. At one time, they were all called in to be informed that most of them had to be retrenched. While tons milled had shot up, both the ore grade and gold price had slumped, putting the mine over the edge into bankruptcy.

Virtually all of the proposed “triggers” in the current producers’ proposals can have the same effect. The exception is profit sharing itself, but this carries the danger of rewarding some at the expense of others which breaks a fundamental rule of common fate.

The only common fate metric that exists in any business is cash value added or wealth creation itself. It captures all eventualities and is, after all, the pie that feeds all. Sensible sharing has to be based on two fundamental principles: it has to meet the legitimate expectations of all of the stakeholders and it has to ensure continued contribution. But before you can even get there, the way that pie is currently divided has to reflect some balance. From Harmony’s figures, it would seem the industry is very far from that.

But it can be done. If the employers’ are prepared to let go of their silly, over prudent cap of a 1% increase on current wages to variable pay, they may even convince the Unions to peg current wages and sacrifice say half of their gains from an increase in wealth to restoring the balance. When this balance is restored, or at least comes close to being restored, there is no need for a cap. Indeed given an improved outlook for gold mining from a firmer gold price, cheap rand, containing outside costs, and lifting production through fewer work stoppages one could easily envisage average value-added for the industry lifting by between 10% and 20%. In the current state, retrenchments have to be seen as part of restoring balance but for those left, it would in principle imply at least a 10% increase in pay, albeit at risk. I say in principle because from there one can construct the actual split in a variety of ways to accommodate merit bonuses, safety performance, and specific cost savings.

Then there are many other, perhaps even more serious flaws in the proposal, which I dealt with in a recent article, but will repeat here:

There are four absolute pre-requisites for any form of flexible pay:

· It must be simple and understandable,

· It must have a clear line of sight where employees can see the effect of actions or events on wealth creation and their pay,

· It has to be accompanied by regular and understandable information sharing.

· Pay-outs or feedback must be regular – at least quarterly if not monthly.

Conventional profit sharing schemes can seldom meet these requirements – share option schemes even less so.

While the current proposals are a very far cry from the ideal, they at least represent the beginning of a shift to a more sustainable dispensation.