Profit-Sharing and Incentive Pay

Employers and workers discuss the pros and cons of linking employee compensation to company performance. November 4, 2007

I would like to get a profit sharing plan going instead of continuing to give raises. I'm hoping that this will help keep my employees while reducing my exposure if things slow down for a month or two. Anyone have ideas on to how to approach this? Monthly check separate from payroll is what I'm considering. What percentage do you consider appropriate?

Forum Responses
(Business and Management Forum)
From contributor L:
Been told by my CPA that you have to run it with payroll check, or just like one, and give IRS its share. Have heard of shops using gift cards to big box stores like Target, Walmart, Home Depot, etc., tools too. But only a rumor of course. Research has shown 250.00 bonus quarterly will do more to boost morale than raises, and help your exposure.

From contributor J:
I've worked for a couple of large shops that tried profit sharing, and it didn't work out so well. Neither of them offered to pay a percentage of all profits; rather, they each had a sort of baseline profit target and only promised a bonus on profits that exceeded that target. They held meetings, made promises, got people's hopes up... and then the profits never (and I mean not even once) crossed the threshold, and no bonuses were ever paid. Younger, less cynical employees (such as myself) worked harder at first, but when it didn't pay off, quickly went from being enthusiastic team players to feeling like chumps.

My guess is that (for good reason) few business owners are willing to make the process transparent by showing employees the books, so the whole arrangement breeds suspicion. ("They're making more money than they're telling us about.")

There's also the problem that such checks are likely to be based on whether the shop profits as a whole, but the choice to work harder or smarter is made by individuals. Any individual who works harder than those around him ends up watching the increased profits that he personally earned get put into everyone else's pockets. I hope there's a good way to set this sort of thing up, but I haven't seen it yet.

From contributor L:

Contributor J, as an employee, what do you suggest? Would we as employers be better off to reward you and make you sign a piece of paper that says you won't brag or talk about a bonus? This is only a question, not meant to be derogatory. We want to keep our best; how would you do it?

From contributor T:
I talked to my accountant about this a couple of years ago. The plan he suggested (not 401K, but something like that) would allow employees to contribute to the plan and me to match that to a point, say 5% of gross wages. If they were to quit, they got 100% of what they put in, plus interest. They were vested 10% per year and would get both contributions after 10 years, if they left. I think they can also draw it out for good reasons - emergency of some sort or to buy a house, etc. Best part, I could also be in this plan.

From contributor W:
To the original questioner: Lots of things effect profit that employees have no control over. You need a production incentive, so they have rewards in relation to their efforts. Your goal, after all, is to motivate them. I will get back to this in a minute.

Contributor J, being a business owner, I have been there: offer profit sharing in hopes that the crew will finally start producing enough to generate a profit for the business! And yes, the business needs a baseline profit to keep its doors open, but many businesses barely keep their doors open, so profit sharing never materializes. There's a Catch-22 in there somewhere.

For years I looked for a good way to setup a production incentive program, and generally found nothing except consultants that wanted to do it for a fee. But finally I added enough clues together to get something along the following lines. This works well for me, but I do have about 44 employees right now. I know you have to be careful so you don't give away money you don't have! I have done that many times.

Here are the mechanics... First you need something to measure productivity by that you can hold your employees responsible for. I make cabinet doors, so I cannot know what works for you (not all doors take the same amount of labor, so I had to invent a measurement that tries to measure labor equally. I came up with something years ago that started out as a guess on how many minutes it takes to produce a raised panel door, flat panel door, double panels, arches, etc.) I would imagine that maybe counting finished cabinet boxes, or counting lineal feet of cabinets, might work. It doesn't have to be perfect, just maybe 80% accurate for starters as to the relationship to labor input. Let's use an example of lineal feet.

Determine your minimum acceptable profit (10%, for example). Determine how many lineal feet must be produced per day so that even on short months (20 day months), and with the normal business ups and downs, you make 10% at the end of the month. (10 lineal feet, for example.) I am assuming you have already paid yourself something as salary first. Profit is over and above that.

Determine how much profit you make for each additional lineal foot over 10' per day. So for a 20 day month, say this is $900 additional profit for an 11' per day average. (These may be ridiculous numbers, but just examples).

The idea is to motivate: I suggest your payout be 1/3 of that additional profit to the crew, which would be $300 (per lineal foot over 10 ft). They make more, you make more. This is a win/win situation. Don't get stingy. You can't motivate with peanuts.

Now you want to determine what percentage to add to their monthly pay. Say you have $10 and $15/hour employees. Make an Excel spreadsheet that multiplies their hours worked (straight hours, no 1.5 for overtime hours) times their base pay. Now use a long month - 23 days. 23 days x 8 hours x $25/hour pay = $4600. You are going to pay $300, or 6.5% (rounded) of their base pay x hours worked. $120 to one guy, and $180 to the other in a long month

This is how you sell it to your employees - "For every foot over 10 feet average monthly production, you will get 6.5% of your hours worked x base pay for the month." Adjust the percentage up or down as you like. Supervisors get at least double the percentage of floor guys, and a shop foreman with 20 underlings might get 5X that percentage. This allows you to keep supervisor and foreman pay very modest if they are making minimum expected production levels. If they cannot achieve the minimum (average 10 ft per day), then you will be looking for new supervisors/foremen.

Now you have your guys talking at break about how they can do 13 lineal feet per day for May so they can get a healthy bonus. You have more self-directed, motivated employees. You are making more money.

All numbers and percentages are just used for the example. You have to determine what is right for your business. Remember that most months (longer than 20 days) you already have made more than your minimum profit before you start paying bonuses.

From contributor J:
Contributor L, yours is a tough question. I'm no longer an employee, having quit to work for myself a few years ago. While I don't have employees of my own, I've become more sympathetic to the challenges my former employers faced.

The local NPR station interviewed an author not long ago who'd studied employee happiness at many companies. She ranked "more money" as being fourth or fifth on her list of effective motivators. If I remember right, the most important thing was that employers/bosses needed to be aware that their employees are individuals with different goals, desires, and priorities. Policies that assume everyone wants the same things may be attractive because they seem evenhanded and easier to implement, but they aren't very effective. What works is to speak personally with each employee, find out what they want, and do your best to help them achieve it.

This author also covered the basics of what causes employee dissatisfaction. She had a list, but one that resonated with me was that people can't stomach working in the service of values they don't share. My last employer was very religious; dumb people who went to his church were promoted ahead of smart people who didn't. Jesus-talk was tossed around to a degree that made my skin crawl.

From contributor I:
I think the book you are referring to is "First, Break All the Rules: What the World's Greatest Managers Do Differently." This book is fantastic, the only management book I have read in years that is based on fact and not some Harvard MBA's thesis with no real research or facts to back it up. If reading and applying what the book talks about does not improve employee job satisfaction and performance and your management skills, I don't know what will.

To answer the original question, we have two bonus programs (talk to your accountant about why you should not call it profit sharing).

For sales and front office staff, we pay bonuses based on revenue goal attainment. We found with these people, who are money motivated, that setting a high but achievable threshold and then further incentivizing to exceed goals significantly is the best plan. We do not give partial credit (sales rep A achieves 80% of his monthly quota, he gets $0; sales rep B hits 120%, he gets 120% of his bonus).

Our warehouse, manufacturing, and team leads get bonuses based on measurable goals. Since we are lean and routinely make outsource/insource decisions, we do not pay bonuses based on production volume.

Our key objectives are:
Freight claims below 2% of revenue
Order mistakes (wrong item, etc.) less than 1% of revenue
Meet committed ship date 95% of the time
Unexcused absences by all staff less than 2 man days/month (we have 15 people in the shop)
No more than 4 tardy arrivals per month (across the staff of 15)

And a few more proprietary goals

We set a perfect score for each category that is weighted. Overall perfect score for the month is 1000, minimum score to get any bonus is 750. At 750 they get 75% of the available bonus pool, going up to 100% at 1000 points. We also offer to double the bonus for the quarter if we get three consecutive months of 975 or more (hasn't happened yet but we've been close). Any employee with a write up offense in the month is ineligible for bonus.

We have posters in the break room that I update every evening so the guys know exactly where they are at. We sometimes offer extra credit for things like volunteering to work Saturdays, exceptional customer service, key business or process improvement suggestions, etc.

All the managers are paid on MBOs that are measurable goal driven, like the shop/warehouse plan, but are also tied to the company's performance. Managers who don't meet goals (paid quarterly) are terminated after 2 sequential misses or 3 misses in a 12 month period of time. This has only happened once. Our sales staff average 60% of their total comp in bonuses, our warehouse and shop staff 40%, and our managers 70%.

From contributor D:
I had an employer at one time who gave out profit sharing quarterly. Stay away from it. It will give you attitude problems from the employees. First of all, not all quarters are that profitable and when that quarter rolls around and they don't get a decent check, it will piss them off. I know, I was in their shoes. Come Christmas time and they need that check, and it isn't what they planned on, it will take months for them to get their heads on straight again. I worked for a family business and they all drove new vehicles, all took nice vacations, had new Harleys and campers, but for some reason they said the company never made any money, thus our profit sharing checks amounted to squat. Needless to say, the company has some of the highest turnover, and the skilled cabinetmakers stay away.

In my opinion, give them more raises and give them other perks - buy them lunch occasionally or take them golfing or anything, but stay away from profit sharing unless you can guarantee them about the same checks every quarter.

From contributor J:
" I worked for a family business and they all drove new vehicles, all took nice vacations, had new Harleys and campers, but for some reason they said the company never made any money..."

I think we might've worked for the same family.

"...give them other perks - buy them lunch occasionally..."

That company also used to buy everyone popsicles on hot summer days. Employees were almost as disappointed when that stopped as when they quit giving Christmas bonuses - it's not just the measurable value of the benefit that counts, it's also the meaning of it; i.e., does the boss even notice that his employees are in a dusty, sweltering 90 degree shop while he's making phone calls from an air-conditioned office?

From contributor L:
What an eye opener! Gotta sell my Harley, camper, plane and helicopter. Okay, don't own any, but the answers from contributors J and D truly answer a lot and give me something to work with I hadn't even though of before. Thanks. Don't worry - I won't do the popsicle thing.

From contributor E:
I think the best thing you can do as an employer, is treat your employees as you would treat yourself. If you are making enough money to buy yourself toys like motorcycles and boats, you should be able to take some percentage of that profit and spread it around with the people that help you make that money. Of course this will not happen on every job, but most employees quickly figure out that some jobs are profitable and some are not, and if they see a reward on a profitable job, they may repeat the behavior that brought that reward. Some jobs are made unprofitable by poor bidding, planning or ordering, and that is usually beyond the control of the shop employees. Bosses need to realize that they are just as dependant on their employees as the employees are dependant on them - it's kind of like a team effort to produce work and make money. As soon as you develop the superior employer attitude, you are spending lots of time looking for new employees and complaining about not making money. Accept responsibility for providing an example of work, personal, and financial ethics. If you think that your employees don't know about your motorcycle and your vacations, you are kidding yourself. Unfortunately, some employers have never really worked for someone else, let alone in a production or factory environment, so they don't have a clue how the working man thinks. Employees have a tendency to empathize with employers who have come up through the ranks, and haven't forgotten where they came from; those people don't need to hear it from me, because they know exactly what I'm talking about, and how to reward an employee who helps them create a successful business.

From contributor L:
So would the best employee reward be a 401k that we contribute to for the long term employees? Or in addition to it, a bonus schedule based on performance for employees that understand the performance issue? Or a bonus that comes around unannounced?

From contributor W:
The best reward is one that an employee earns through their own actions, as proof of their excellent performance. What would mean more to you - winning $1000 in the lottery, or earning an extra $1000 because you kicked ass and took names? Winning the lottery may not be repeatable, but kicking ass and taking names is!

From contributor S:
The simplest plan is a 401K or a SEP for a small business. Less accounting fees, etc. Unfortunately, for the small, non-incorporated shop, they can be expensive if you have more than 2/3 employees. You can decide every year how much you want to put in for yourself, and the IRS dictates what the employees get. It is all tax deferred. A lot depends on your employee turnover. If your typical employee leaves in 3 years or less, go with a SEP. You don't have to contribute a dime for employees till they have worked 3 years, but then they get the same percentage of their gross pay "given" to them as you choose to contribute to yours. You can skip years. You can decide at the end of the year what you want to do depending upon on what it will cost for the employee contribution. A $25/hr employee will cost you about $7500 a year if you make a max contribution, but there are caps as well.

I owned a shop for 38 years. I retired at age 56. In the 25 years I had a SEP plan, only 2 employees were with me the required 3 years to qualify, and I put 15% of my net into it every year. I never found that it helped keep any employee even though it was explained to every new hire. I had a 3 man shop and worked right alongside the employees until they went home at 5, then I did all the owner required stuff till who knows when. I have a couple of boats, RV, paid for home, and every toy I ever wanted, all while paying high wages for my area and running a quality shop. Even with a plan that all the employee had to do to qualify for a 15% pay boost was to shut up and work. Believe me, they still eyeball what the owner has, know that it was earned on their back, and never give a thought to the millions the owner has invested that they don't.

If it makes you feel less guilty about having more than your employees, go for it. If you think it is going to make your crew more efficient, or keep an employee from hopping jobs for a 50 cent an hour raise, you are mistaken. Most employees don't think beyond next Friday's pay check. After all, we'll have social security when we get too tired to work... And you wonder why old people end up living on melamine laced cat food from China?

From contributor Q:
I am really not sold on this profit sharing idea. We wanted to get people showing up on time and taking less days off, so we offered an extra dollar an hour to everyone who worked over 35 hours a week. Didn't do a damn thing. The people who were showing up continued to show up. The people who weren't still didn't.

We used to do piecework. People used to make anywhere from 9.00/hr to 35.00/hr. Eventually all the high paid people quit because they didn't like the pace and burnout, and I was left with the slow workers, and was unable to replace the fast workers.

We now try to maintain a nice, clean, professional place to work. We try to help people with their careers, schooling, training, etc. People are not quite as productive, but there are less problems.

I think that the profit sharing deal is not worth the effort and headaches. I mean everyone who does it admits they pay their employees a smaller base rate, anyway.

From contributor R:
You can lead a horse to water, but you can't make it drink. If you have employees who are just biding time in your shop, then they won't be motivated by additional money. If I was you, I'd sack the people you aren't happy with, distribute some of the income you saved to your good people, and then try and attract some more good people with a higher wage. Basically, hire two people who can do the work of 3.5 guys, and pay them 1.5 times what you'd pay an average employee.

"Didn't do a damn thing. The people who were showing up continued to show up. The people who weren't still didn't."

That to me says it all. Not everyone is going to be a superstar, but when people can't be bothered showing up, why are you employing them?

We have about 20 guys on our workshop floor - the foreman and supervisor are all on a bonus that is a percentage of profit. They are on an above average basic wage, but they know that the bonus is the smartest way for them to increase their income.

We give away 20% of our profit - we pay profit percentage bonuses to the people who can improve our business as they influence other people or control/supervise areas. That's 18% - the last 2% is basically discretionary; we might pay .25% to a young guy who has just finished his apprenticeship but is doing a great job. We might pay .25% to our receptionist if she's made our life easier. We might pay .75% to our machine operator if he keeps the machine in good condition with minimal downtime and maximum output. We also basically give new kitchens to people who've given us good service - in the past two years we've "given" three employees a kitchen which would retail for around $25k.

Throwing out bonuses to everyone isn't going to achieve a lot - as you said, the good people will continue to be good, the bad people will continue to be bad. Case in point; we recently upgraded a young guy to our "Senior Group" - increased pay and responsibility which he'd been asking for; he's done a very good job since. A guy the same age as him, who is as capable, but has a terrible attitude - we sat him down and told him exactly what we'd done, the size of the other guy's pay rise, all the other stuff - no secrets. Told him that if he could improve his attitude and become a team player then we would increase his wage as well. But we told him it was non-negotiable; either he did it or he left, we don't want him if he's only half-here mentally.

Surprise, surprise, he's leaving. He started making noises in the workshop that he deserved more money and that he was going to look for another job - so we finished him up and told him to go find another job. We gave him the opportunity to make more money, but he'd rather continue to be an idiot. The best part was that a lot of our junior guys basically said get rid of him, he's being an idiot.

We've made it very clear to everyone - if you can improve your performance and it means that you can do the work of 1.5 people, we'll pay you 1.25 times the pay. We want a small, self-sufficient, self-disciplined workforce.

The other important thing, as evidenced here - don't promise bonuses and the like if you're full of shit. If you tell your guys you'll pay them a bonus if they reach a certain figure, and you reached the figure and then stiff them, you'll screw yourself.

From contributor G:
I agree with contributor S. The most often-asked question in corporate America has got to be "what can we do to motivate these people?" Truth is, you can't, at least not for long. Motivation comes from inside a person, a place you have no access to. Looking back over the years, the best answer for me has always been "hire better people" - but easier said than done. I feel your pain, and I wish I had a better answer for you.

From contributor O:
Oh man, what a can of worms you've opened. I've been on both sides of the desk and there is no good plan. The 401k plan stinks from the employee side, as they are thinking of vacation or taking the kids to the lake and need cash now, not in 20 years. Adding to the 401k means very little for most of them and is an easy out for you. A bonus plan has to be completely transparent and upfront. No funny business with the books and the formula needs to be explained as well, or else it will not give the desired results. All in all, if you have people who are "gittin' er dun," pay them. Do it now before they go somewhere else, as you can be assured that it's on their mind. People in your work force who you count on to get the job to the dock on time every time and actually do it and more are the ones you have to keep, and they are the ones you need to pay more. It's not their fault if you bid a job wrong and a profit is not made, they still did their part and did it over and above what was required. Don't abuse them by not paying them what they're worth. They will walk on you - that you can take to the bank.

From contributor R:
Motivation is a really tough question. After running a shop for over 15 years, I can say that some employees are worth keeping and some not. After trying a standardized approach that is performance based, production based, etc. it has come down to simply managing the people.

Hands down, nothing beats an honest, look them in the eye, talk. Tell him/her what is expected, and provide continuous feedback, with a heavy hand, loud on the praise, and a quick way to fix the screw up. I have made it a point to talk to everyone (about 85 people) and let them know where they stand at least twice a month. That approach has beat out all the convoluted bonuses, performance based targets, retirement plans, etc. we tried and then subsequently dismantled.

From contributor B:
As your typical libertarian free market man that wants to keep and reward the best and do away with the lesser at any individual position, I look for incentives whereever I can find them. I like the carrot and the stick. The carrot to employees to push in a positive direction and the stick is used as a measuring stick and to help weed out the employees that do not fit with the overall objectives of the company and need to find work elsewhere.

Similar to above I've used a specialized bonus to reward the behavior that I want my employees excited to perform at their individual task. It's important to include disincentives for poor quality, attendance, attitude, or whatever else you want to manipulate.

Don't be cheap, make sure it is well understood, and update bonus information for the employees to review (and make it accessible for their review as regularly as possible). What do I mean by not cheap? Give the potential for an additional 25% of gross wages.

It is also a fantastic recruitment tool. It won't take long before your town knows that you take good care of your employees. You want to be the employer of choice, not the employer of last resort. (Couple it with a substance abuse policy if you haven't enacted one already, give your folks 30 day notice that it is coming, if they want to keep their job, it’s time to get clean).
Atta boys are free and they need to be used. I want employees that are thinking about their retirement and so 401kf’s are fantastic, but I want my employees’ spouses happy that their sig other is working for me and that means a regular bonus.

A very wise man once told me "pay your good employees a little bit more than they think they are worth and you'll get it all back." He was right.