Signaling and Screening Approaches in Car Manufacturing

Signaling and screening are key approaches to minimize judgmental errors in situations where there is asymmetric information. One such situation occurs when a firm wishes to assess individuals for consideration as a prospective employee.

This report reviews and applies the different concepts studied to a car manufacturing company, Audi. The structure of the paper will be as follows: elaboration on various signaling approaches, an evaluation of the firm’s effectiveness and relative costs with respect to Audi, followed by showing the business outcomes subsequent to the use of different approaches. Finally, recommendations are made to allow Audi to boost its effectiveness in identifying the most suitable applicants.

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The Audi Group (AG) has been named one of the most successful car manufacturers in the premium and supercar segment. A total of 1,751,007 cars have been delivered by the company to clients compared to the 1,634,312 cars in the past fiscal year. Conversely, a new record was constructed when the main brand ‘Audi’ amplified its total number of units delivered by 8.3% to 1,575,480 vehicles.

The AG manufactures in ten sites worldwide and these production sites consist of two plants in Germany while another eight other facilities are in Belgium, China, Hungary, India, Indonesia, Russia, Slovakia and Spain. Moreover, its front-line logistical practices; synchronised Audi assembly system and an extremely competent workforce of approximately 73,751 assure uniform standards globally.

Since each Audi production site attains high standards of excellence, productivity and conservational suitability, this could be the reason for the many awards received by the AG in 2014 which includes the ‘Best Employer Award ’and ‘World Car of the Year’.

While some theories hold common views, others have conflicting ones. For instance, the human capital theory identifies that an increase in level of education has critical impacts on profitability and productivity. On the other hand, pure signaling theory states that education does not result in productivity towards the society and questions the investments which individuals made when seeking them.

Under human resource management, signalling often occurs during the recruitment process. This is illustrated by Spence (1973), where it shows that signaling theory is concerned with reducing information asymmetry between two parties.

Spence (1973) developed the labour market to showcase education as a signal. As employers have limited information regarding on the quality of job applicants, these applicants thus obtain education to signal their quality and reduce information asymmetries. Hence, Spence’s model emphasises on education as a way in transmitting characteristics that are unobservable of job applicants.

The next signaling theory utilises two variables- high and low quality firms. In this model, imperfect information exists, where firms know its own worth, while external sources such as investors and customers do not. A choice is then made by each firm on whether to signal its true qualities to outsiders, based on the different payoffs that are presented to them.

For each of the different quality firms, two payoffs will result for the various decisions made. The high-quality firm will receive payoff A if it chooses to signal and B if it chooses not to. As for the low-quality firm, it will receive payoff C and D for the respective decisions. Since both firms are assumed to make rational decisions, they would choose whichever option which gives them a higher payoff so as to be better off.

With this assumption, there would be a separating equilibrium where high-quality firms are motivated to signal and low-quality firms are not (i.e. when payoff A is greater than payoff B and payoff D is larger than payoff C). It also effectively enables external sources to identify high-quality firms from low-quality firms. However, a pooling equilibrium occurs when both types of firms benefit from signaling (i.e., A > B and C > D) and outsiders can no longer differentiate between the two firms.

From the financial economists perspectives, firm debt and dividends are used as representation of signals on firm quality. These signals will influence the external environment of its opinions on the quality of firms. Ross refers to this quality as ‘‘an unobservable skill of the business to earn positive cash flows in the future using financial structure and/or managerial incentives as signals’’. By doing so, only firms of high-quality are able to make interest and dividend payments over a long period of time as low-quality firms cannot bear such payments.

Understanding the concept of quality is important since it is a distinctive factor in most signaling models. Quality refers to the fundamental, unnoticeable capability of a signaller to satisfy the demands or needs of an outsider observing the signal. This idea of quality may be similar to reputation and prestige, but are essentially derived from the signaler’s unnoticed feature.

Based on the understanding of concepts from various approaches, three elements of the signaling process are identified: the signaller, the signal and the receiver are looked upon. Moreover, each of these elements below will be illustrated using Audi, the selected manufacturing company.

Firstly, signallers are known as insiders that can acquire information concerning an individual, product or organisation that external parties are not entitled to. The insiders include directors or executives of the Audi Group. Information obtained can either be positive or negative and usually consists of confidential and high level details on Audi’s products or facilities. As the information is confidential to the insiders, it allows for some aspects of privileged perception on the primary quality of the individual, product or organization.

The next element is the signal itself. This is the point when insiders make a decision on whether to share the information to external parties. In a signalling theory, the focus is on relaying positive information to achieve positive organisational attributes. For example, distribution of shares is a form of negative signal which displays that executives believe the company’s stock price is overvalued. The insiders’ main aims are to reduce information asymmetry while the negative signals sent are often an unplanned consequence of the insider’s action.

An efficacious signal comes in two forms – signal observability and signal cost. ‘Signal observability’ refers to the extent to which external parties are able to notice signals. When the steps taken by insiders are not easily detected by outsiders, communication with receivers will become unlikely.

‘Signal cost’ under the signaling framework will contain the fact that a number of signallers can absorb the associated costs better than others. For instance, the costs related with gaining ISO9000 certification (a certification which considers different aspects of quality management) are high due to the process of accreditation being relatively time consuming as well as preventing false signaling.

Nevertheless, a high-quality manufacturer would find ISO9000 certification less costly unlike a low-quality manufacturer as a manufacturer that is of lower quality would need to implement more changes in order to be presented the accreditation.

False signaling occurs when a signaller does not have the basic qualities connected with the signal but trusts that the benefits of signaling outweigh the costs of producing the signal. Therefore, in order for signaling to remain effective, signaling costs have to be planned so that false signals do not pay.

The final element is the receiver. Based on the signalling models, receivers are the exact opposite of signallers whereby receivers do not have access to information regarding Audi but wants to have it. Hence, there is a conflict of interest such that any deceit would allow the signaller to have an advantage over the receiver.

Signaling ought to have a strategic outcome which typically comprises selection of the signaller in favour of other possibilities. The approach on this signaling is that outsiders will benefit directly or collectively with the signaller from the decision made based on the data attained. To illustrate, the receiver can choose between hiring, purchasing, or investing. By reading the signals carefully, interested applicants will be able to identify if the skills and capabilities that the individual have are the right fit for respective firms and thereby do a self-selection for the firm to consider the applicant on hiring prospects.

Audi engages using various aspects, besides putting in place attractive monetary benefits, to send out indirect but positive signals to show that Audi cares about the employees’ well-being. These aspects include the provision of job security, professional development, and healthy working environment between coworkers and supervisors along with other attractive non-monetary incentives.

Audi is dependent on the skills and commitment of employees of excellent traits. Thus, feedbacks are often performed amongst employees to measure the extent of satisfaction levels.

Due to its prominent existence and continuous international growth, Audi is capable of using its national and international ratings to signal themselves as an attractive employer worldwide. For example, it is known that Audi has the biggest manufacturing facility in Germany and has even invested in an institution that provides training and learning opportunities to employees. This effectively allowed Audi to become the few top employers in the region with over 33,729 employees.

Employers need to find ways to motivate employees in order for signaling to be effective as dedicated and well-trained staff is vital for Audi to progress and succeed. One way is through personnel development where employees are led, challenged and cheered on in the beginning so that their fortes and ideas can be applied. Thus, an organized, intensive and reliable model for the ideal improvement of all workers is being executed.

The organizational structure of Audi is another signal that attracts many job applicants. What the company looks for is neither the rank nor the period of service of an employee, but rather the loyalty, performance and capabilities that makes them an asset to the firm. This shows that Audi has a decentralized hierarchy where specific knowledge is required and responsibility is at all levels. Hence, being a recruit may not necessarily be a disadvantage.

Moreover, supervisors evaluate an employee’s performance by making the decision on his/her wages increment and future prospective of the individual by communicating with each other. This method is also closely linked to promotions where Audi uses the concept of ‘‘good performance – good opportunities’’. It gives an employee the opportunity to learn as much as possible from various divisions through a manner of ‘on- and off-the-job’ selection.

Most companies use salaries to signal applicants and/or employees. Audi has effectively put the signal to right use when the rewards received by employees are considerably greater than the initial negotiated amount. With profit-sharing distribution, satisfaction levels are likely to increase, in turn driving motivation.

Each individual employee’s credentials, proficiency and former experiences determine the amount of remuneration he/she receives. Audi ensures that new entrants are assured a healthy work life environment where a range of benefits are available and entitlement to ‘‘open-ended contracts’’.

These benefits cater to families where childcares are taken into account for employees; and to individuals where health insurance is of utmost importance to maintain as a strong health-focused workplace. More importantly, Audi takes care of its employees even after retirement through the ‘old-age pension scheme’. This may be the reason for Audi’s recent achievement of the ‘‘Best Employer 2014’’ title as employees are never hesitant about praising the company to others.

The above section desribed many effective signals which Audi uses to attract potential employees. However, due to the outcome of demographic change and overall value formation processes, Audi still faces the risk of a shortage of professionals and/or skilled workers. As such, the human resource division are found to be focusing heavily on individual development, supporting the employees with extensive training programs to help them develop multiple skills. However, Audi failed to realise that these signalling approaches are very costly to the firm and needs to be reviewed through the following recommendations which could reduce cost significantly and at the same time achieve efficiency.

In this model, there are two periods considered: the probation period and the non-probation period. Audi can adopt the probation model by first assessing employees during the probationary period with a relatively lower pay. If the worker is able to pass this probationary period, then a high wage is given subsequently. This effectively ensures productivity and constant monitoring of employees so that the right type of applicants is attracted to the company.

By having an ‘old-age pension scheme’ for its retiring employees, it shows Audi’s valuation and treatment of its employees. A suggestion to allow senior employees of various specialties to join the senior management or board of directors for recruitment assessment of new applicants could be a relatively more cost-effective measure and the risks of selecting the wrong applicants would definitely be lowered as senior employees have the knowledge and experience to screen for potential employees.

Self-selection, in the context of recruitment refers to a process whereby the right employees for the business decides to apply while the wrong employees does not.

Hence, it is crucial for organisations to send signals to attract applicants and it would be an added bonus if signals are presented such that individuals perform self-selection for consideration. Bearing this in mind, Audi may consider a ‘‘piece-rate contract’’ which indicates the pay levels received by the individual when he/she attains a certain level of productivity. Thus, Audi will be able to deter less skilled workers from applying and only skilled workers are being screened.

Besides conducting satisfaction surveys, Audi should instead implement a suggestion scheme where employees can provide valuable inputs to improve productivity and ensure the safe operation of manufacturing. To encourage participation, a reward in the form of extended off-day leaves or sponsored specialized education can be provided to the employee whose suggestion is acted upon by Audi.

Audi can consider including other forms of incentives which consists of individual incentive plans and/or team incentive plans. Individual incentive plans can be ‘‘straight piece-work’’ system where work is less challenging and more acceptable by employees since it can be easily understood. This ensures that employees are more comfortable with the task given and will be motivated to produce efficient work.

While it has been noted that Audi uses profit-sharing distribution on top of bonuses, it would probably be a better incentive for the firm to use stock ownership or options as awards instead since the effect on financial statements would be minimum and the additional profits earned by the firm could be used for further enhancement in research and development.

Overall, the signaling theory is a useful indictor to describe the conduct of individuals or organizations when information is available. Normally, the sender will decide on the method and audience to send its signals to while the receiver learns to interpret those signals.

However, the use of signalling approaches needs to be an appropriate fit to the business so that additional cost would not be incurred at the extent of the organisation’s and employer to employee relationship growth. Taking Audi as an example, if Audi is able to improve on its signalling approaches, the business will continue to be an attractive employer worldwide in the long run.