Profit Sharing: Entitlement or Motivator?

by Harvey Wigder

Background
Geiger Challenge
Plan Design
Questions and Concerns
Results
What were the unintended consequences?
Conclusions

Geiger Bros., a fourth generation family owned and family managed business, has been providing profit sharing to its employees since it moved from New Jersey to Maine in 1955. Recently, Geiger restructured its profit sharing program to motivate employees to understand and care about company results.

Background

Many family businesses believe deeply in profit sharing both because of personal values and a belief that profit sharing motivates employee loyalty and performance. This second conviction remains firm even though research shows that for incentives to impact behavior, there must be a clear link between the behavior and the reward. Most jobs are far removed from a direct impact on profits so this condition is seldom met.

Employees are unhappy when they do not get profit sharing, and are happy when they do. Thus, profit sharing can have a positive impact on employees' feelings about a company. However, it does not motivate performance.

Geiger has provided profit sharing to all of its employees--executive through hourly workers--since moving to Maine in 1955. The original purpose of the profit sharing plan was to reward employee loyalty and to compensate them 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 to 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 its industry.

Geiger Challenge

A few years ago I was hired to conduct a systematic review of all compensation programs with the aim of ensuring equitable and competitive compensation, including effective 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. This was distributed to employees in same ratio as individual wages to total wages. Management felt that employees didn't understand the plan and were distrustful of the way it was administered. They wanted to turn this around and get employees to share some of management's concern for profits.

Plan Design

The most dramatic change in the new plan was to base the program on company and business unit earning targets that were clearly stated at the start of the year. This meant that instead of having to wait for year-end to learn about his or her share, employees were given "score-cards," so they could keep track of company results and their own share of profits.

A scorecard for a non-management employee is below. Each employee is presented the financial targets for the company overall, and for his or her division and department. Each employee's incentive is linked primarily to the performance of his or her Department, but at the same time it was decided that everyone should have no less than 25% of the incentive linked to the results of the company as a whole. Geiger hoped everyone would feel part of the total Geiger "family" result√Ďand be willing to pitch in across organizational boundaries.

Due to budget constraints, hourly employees were targeted to earn meaningful, but modest 2.5 per cent of annual compensation if targets were achieved and proportionately more if the targets were exceeded. Some selected managers had higher targets consistent with increased impact of their positions on overall 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 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 for the next round and motivate morale and common effort.

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.