Columnists, Thom Finn, V3I2

Incentive Plans

I have no doubt that employee bonus plans, or incentive plans, work. Most production workers will get really smart, really quick, when they realize they have a good chance to earn more.

I don’t think it matters if compensation is the number-one reason to keep employee engagement and morale high. It’s enough to know that what a person is paid is one of the top three motivators. From my own research with the hundreds of companies I’ve worked with, compensation is normally ranked in second or third place among surveys of workers gauging satisfaction.

Actions like being sincerely thanked, recognition, being part of a team, praise for a job well done, and feeling a sense of accomplishment are highly valued among employees. These leader-generated soft skills are usually in first and second place.

Incentive plans work best with a company that has a strong foundation of giving one-minute praising, setting clear expectations, and giving quick reprimands when needed. Most of the available advice on incentive plans is on the fluffy, feel-good stories about why they are good. But here is some advice on how to create one.

Incentive plans based solely on production make me nervous. I have seen too many manufacturers who paid out just on a production number and ignored what the profitability looked like. What if the cost of a raw material went up, and you are still paying out an incentive on work that could be losing money? Thankfully, most instances of increased production mean increased profitability, but the few times that it has not scared me enough to insist that it’s done on the dollars, not the sweat.

The first rule of incentive plans is that they must be win and win, or no deal. The company must win before the employees can win, or we have “no deal,” or no incentive pay.

I learned this mistake firsthand many years ago as a young and inexperienced entrepreneur who paid out so much incentive bonus pay that it negatively affected my profitability. Going through the math work needed for a sound incentive plan may seem excessive, but I strongly recommend it (and insist for existing clients) so that you know how the incentive pay plan will affect the bottom line net income.

Your job is to come up with an incentive plan that is attractive enough for your team to improve profitability in the ways they can control, but leave some of the profit left over for the company. Therefore, the term “profit sharing” is a great way to describe this. Some profits go back to the team for their hard work, and other parts of the profit stay within the business.

Explain up front to team members that if they can influence the profits of the business, you are willing to share in these newfound profits. It is important to stress newfound profits; you are not giving them a share of the profits for what they are already doing.

Employers and employees have agreements.They show up to work, follow the rules of the game, and complete the minimum expectations of the employer. In return, the employer gives them an agreed upon rate. In your case, you have further agreed to provide vacation, bonuses, and other rewards in exchange for this minimal work performed. This is sometimes called a gain payout. The crews help you gain new levels of profit and you pay out for it.

Profits are shared when the profits exceed the minimum expected amount. If the team is expected to finish their work on a shed in five days with two men working, then that is the minimum expected. If the same two men complete work on the shed in four days, then the profitability of this job increased. This newfound profit will be shared jointly between the owner and the team.

Consistent quality is a given in profit sharing incentives. The underlying rule that the team must remember is that quality will not be permitted to slip. If a job is done in less time, but with less quality, the incentive is invalid.

But if through creativity, efficiency, or plain old grit, the team is able to put more points on the profit scoreboard, share the wealth with them. After you have spent some time getting familiar with your business numbers, come up with what your profit goal is and make sure it protects the longevity of the business. Next, determine what percent split you will share with the team. Once I was secure in knowing what the business required to stay alive, and I added some to keep as the owner, I would gladly give away 60 percent of the newfound profits to the team.

I have hours of experience with two types of incentive plans. Method A pays out incentive bonuses on jobs or projects, like in construction. Method B pays out for periods of time (weeks or a month) in a continuing workplace, like a production line. Both methods are paying out based on gross profit. Hopefully you have read Instant Job Costings, where I stress that you know your own net profit percentage. Gross means the big profit; net means the smaller profit.

Remember that gross profit is the sell price. The cost of goods sold is usually labor and material. Net profit is all of your overhead, or fixed expenses, taken off of the gross profit.

You want to incentivize the crew by sharing the wealth on those variables they can control. They can control quality, efficiencies, and rework, all of which are used in figuring gross profit percentage. But they cannot directly control your marketing, your insurance, your debt interest rate, the leases you make, or the coach you hire. It will not work if you incentivize a man on things he does not have control over. That’s what you should be doing in your role as the leader, making sure you are controlling your fixed expenses or overhead.

Once you have an incentive plan set up, you magnify your return by just a few more action items. To double your investment on the agonizing work you spent with your numbers, consider a few of these best practices I have used
or seen firsthand:

1. Train, talk, discuss, and communicate to the guys the specifics of what they can do to improve the gross profit, and thus their gain payout. Since you and the team now have a shared goal to raise gross profit, they will be more willing to hear your observations and advice. You have moved from dictatorial manager to coach-type leader. I once had an employee who spoke no English. As soon as I put her on incentive pay, the first words out of her mouth in a clear understandable voice were “Let me get this straight. You are telling me I can earn more if I … ”

2. Get their input on ideas to improve gross profit. Having a common goal made leadership so much easier for me because I was no longer trying to motivate a team who saw no benefit for themselves. “WIIFM: What’s In It For Me?” now had an answer. And once they realize they directly influence how much they earn, I expect them to come up with ways to innovate and improve.

3. Conduct post-mortem autopsies on completed work. If you did not reach the goal and they didn’t receive an incentive payout, discuss why together. And if you did win, be sure everyone knows what you did right so it’s easier to repeat.

4. Be warned that this could put pressure on the salesperson. If
you or your salesperson is out there lowballing on price, no matter how smart and hard they work, there will be very little profit to share. I’ve had employees get in my face when I quoted work too low because I was destroying their chances for the bonus. Talk about accountability.

5. Don’t be greedy. Don’t keep raising the bar to keep the profits higher and higher. Your guys will see you as the wolf in sheep’s clothing and start to work against you, not with you.

6. Keep the records up to date, quickly. Get the team to hold you accountable by committing to completing the analysis of the jobs, or the week, within two business days. Another way incentive plans will work against you is if you never get around to paying them out.

I have spent a lot of frustrating and slowly progressing hours on a tactical guide on how to set up an incentive plan. As a thank you for reading this far, drop me an email, or call Kristen, and we’ll send you copy of it.


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