Every company has several obligations -- to generate enough cash flow to meet the company's daily cash requirements, produce a profit commiserate with the risk involved in the business practice, allow the owner(s) to maintain a good quality of life and assure the employees a fair wage and safe work environment.
The concept of excess-based profit incentives was developed as a mythology to assure the business maintains the profit margins required to thrive and provide employee motivation based on specific performance criteria.
There are a few key principles that need to be addressed to establish and maintain a good incentive program.
- Define the minimum gross profit your organization must produce to maintain its return on risk. The amount of incentive is calculated on the gross profit generated in excess of this amount. This allows the company to increase profits as the excess profit is shared with the company and employees.
- Incentives must be tied to cost areas that employees have control over. This could be labor hours, material costs, overtime, reworks and waste and scrap, small tools, and consumable supplies. This is in direct contrast to an incentive plan that does not take into account the individual contribution of the employees.
- The financial reporting system must reflect the distinct/discreet operations of the company so it will be possible to measure the performance of the employees. If a company lumps all of the direct job/production costs into one ledger account, it will be impossible to measure where either improvement or poor performance is coming from.
- The way to hold employees accountable is to have a program that rewards good performance and negatively impacts the incentive amount if the performance is subpar. For example, if the employees maintain a waste and scrap budget below what is established by management, the incentive paid to employees increases. If the waste and scrap budget is exceeded, the incentive is decreased.
- The incentive plan should reward the all employees of the company based on their specific contributions to the overall success of the company; the greater the responsibilities, the greater the reward. This includes senior management, administrative personnel, supervisors and line employees, down to the least senior positions.
- Rewards on a consistent basis monthly or quarterly maintain motivation but reduce the administrative burden on management. Do not fall into the year-end bonus syndrome. The bonus is generally arbitrary, is not based on performance, leads to entitlement and is often paid because the employees expect it regardless of the financial ability of the company to absorb the expense management pays because it does not want to disappoint the employees.
- Excess profit incentive plans force the employees to pay attention to the work at hand. They have the greatest impact on profitability and whether the management pays because they do not want to disappoint the employees.
Mike Rudd (firstname.lastname@example.org) is director of client services for International Profit Associates. IPA's 1,700 employees offer consulting services to businesses throughout the United States, including Alaska and Hawaii, as well as Canada. Reach Rudd at (847) 808-5590 or at www.ipa-iba.com.