Profit Sharing: Entitlement or Motivator?
April 26, 2010 by Harvey Wigder
Background
Many business owners believe in profit sharing because of their personal values and also because they believe that profit sharing motivates employee loyalty and performance. This second conviction remains firm even though research shows that for incentive to impact behavior, there must be a clear link between the behavior and the reward. Because most jobs are so far removed from a direct impact on profits, this condition is seldom met.
Employees are unhappy when they do not get profit sharing and are happy when the do. Therefore, profit sharing can have a positive impact on employees’ feelings about their company–but it does not motivate performance.
The original purpose of Geiger’s profit sharing plan was to reward associate loyalty and compensate for lower pay during a period when the company was struggling for survival. Third generation President, Ray Geiger, promised to his new employees, “If you help us earn a profit, we will share it with you.”
That period of struggle has long been over, and Geiger is now one of the largest and most stable companies in the industry.
The Geiger Challenge
A few years ago I was hired by Geiger to conduct a systematic review of all compensation programs with the goal of ensuring equitable and competitive compensation, including incentives at all levels.
The mechanics of Geiger’s profit-sharing plan were typically straightforward. After the end of the financial year, the company allocated a portion of profits to a profit-sharing pool, which was distributed to associates in the same ration as individual wages to total wages. Management felt the associates didn’t understand the plan and were distrustful of the way is was administered. They wanted to turn this around and get them to share some of management’s concern for profits.
Plan Design
The most dramatic change in the new palm was to base the program on company and business unit earnings targets that were clearly stated at the start of the year. This meant that instead of having to wait until year-end to learn about their shares, associates were given a score-card to keep track of company results and their own share of profits.
At the start of the year, each associate is presented the financial targets for the company overall and for his or her division and department. Each associate’s incentive is linked primarily to the department performance, but at the same time it was decided that everyone should have no less than 25 percent of the incentive linked to the results of the company as a whole. Geiger hoped everyone would fee part of the total Geiger “family boundaries.
Due to budget constraints, hourly associates were targeted to earn a meaningful but modes 2.5 percent of annual compensation if targets were achieved–and proportionately more if the targets were exceeded. Some selected manager had higher earnings targets consistent with increased impact on overall results.
The plan had a minimum threshold for overall company profitability below which no payments would be made to anyone. Employees were told how their payment would increase, decrease, or fail to be paid depending on actual results.
Questions and Concerns
In the process of designing this program, management had numerous concerns and questions about the plan design. Here are some.
• Keeping It Understandable. It is very easy to overcomplicate a plan so that employees don’t ..understand how it works. If they don’t understand the plan, motivating value is lost. Indeed, lack of ..understanding may even result in a negative effect if people feel something is being put over on them. ..This suspicion existed with the previous plan.
• Non-Financial Performance Measures. The company had quality metrics for its Departments. They ..could be part of the scorecard. Theoretically, it would be preferable to base bonuses on some ..combination of profits and other metrics. However, this would be too difficult administratively. It was ..decided to continue to provide feedback on the quality measures but base the profit sharing payoff only ..on profit targets and results. The question remained: Were profit targets (which were more removed ..than team quality targets) be enough to drive performance?
• Making it Meaningful. The bridge between individual jobs and Department results is more direct than ..that between corporate results and individual jobs, but not as direct as desirable. The way to make the ..connection was with good communications and through wide spread problem-solving meetings. Could ..management pull this off?
• Size of Rewards. Were the target bonuses too small? The $775 shown in the example translated into ..about 1.3 weeks’ pay. Some employees even had smaller dollar targets, depending on annual wage. ..Was this amount large enough to make employees care about whether the company and their unit ..achieved its goals?
..Difficult Economic Times. The industry and company were going through difficult times. Because the ..economy was weak, client advertising budgets were down as were company revenues and profits. Did ..it make sense to launch a plan like this in a year when it was possible that there would be no profit ..sharing bonuses?
• The Unknowns. There were probably unanticipated consequences. What would they be? Would they ..be damaging?
Geiger management decided to implement the plan despite these concerns and evaluate results, making modifications as appropriate.
Results
The company’s experience in the second year of the plan shows the value of connecting the profit sharing plan and individual rewards to unit performance. Company revenue ended significantly below plan, yet profit exceeded targeted profits. As a result most employees received profit sharing payments that exceeded their original targeted amounts.
Why did this occur?
• Managers reported monthly (verbally and with graphs posted) to all employees how their units were ..performing compared to target. The CEO issued quarterly reports the overall company performance. ..Employees knew of the sales struggle and understood the need to focus on cost reduction
• Employees clearly understood that cost cutting was necessary if they were to get bonuses and put ..pressure on management to do so. Was the size of the potential reward large enough to motivate ..employees? The result indicates that potential bonuses were enough and additionally, that employees ..understood how the system worked for them.
• One large unit did not achieve bonuses the first year. What impact did that have on morale? The unit ..was particularly diligent about costs the second year, and successfully achieved bonuses. The first ..year was very disappointing for that unit. This disappointment seemed to focus the unit. When the unit ..made target and bonuses were paid the second year, there was a big celebration.
• The company had training programs for managers and employees on leading teams and motivating ..quality performance. This helped the process on involving employees in cost cutting and other ..improvement strategies and minimized resistance to implementation of the plans..
What were the unintended consequences?
The pressure on managers to achieve targeted goals came from above and below. In particular, the head of the largest division understood that the performance of her unit was critical to the company’s overall profits and, therefore, to whether the company reached the minimum threshold for any bonuses to be paid at all. She reports lost sleep over the challenges. The plan can hurt morale in units that get low bonuses because of unit performance. It is up to the unit leader to mobilize people.
Some scorecards had to be fine-tuned to better reflect circumstances in the unit. The biggest adjustment to the plan was in the sales organization. In the first year, bonuses were paid on profit as in other units. The results were as indicated above: costs were cut and profit targets were made. However, there was concern that this worked against building new business. Therefore, for the sales organization there was a major change. Now, half of the target is for building revenue and half for profits. This made the job of the sales executives more complicated but prevented the plan from motivating only cost cutting.
In any planning process, some executives will provide stretch targets while others will be conservative to both protect themselves and make bonuses more attainable. It is very important for a plan like this to provide a level playing field. Management must be diligent to prevent “sandbagging” and make goals uniformly realistic.
Conclusions
Everyone Understood The Link Between Profits and Their Personal Reward. This plan was dramatically successful in getting employees involved in the profitability of the business. It gave them a meaningful stake in the business’s success. Everyone at the same organizational level in the same unit had the same scorecard. Therefore, the plan provided group rather than individual incentives.
Hourly and Management In Same System. The plan proved meaningful to management and hourly employees and tied them together with a concern for company profits.
Beyond Entitlement To Earned Reward. Employees are still disappointed when there is no bonus. In this regard such a plan is no different from when profit sharing is seen as entitlement or a benefit. However, when bonuses are received they are seen as something earned and are celebrated. Structuring a plan in this way allows profit sharing to impact business results.
Employees Understood Rules and Wanted to Play. The success of this plan also reinforces research that indicates it is not the size or amount that counts. What counts most is making the ground rules clear and giving employees a means of making an impact on whether they receive a reward.
Ongoing Involvement By Senior Management. Finally, and most important, Gene Geiger and his management team wanted this program to succeed. He and his management team believed in sharing success and in profit sharing. As a result they were willing to invest effort in the communications and the process of reacting to events and making changes when necessary to make the program succeed. Their reward was that the profit sharing plan helped them improve corporate performance.
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It was great to have the clarification. Thanks for the help.