The focus of a productivity-based excess-profit incentive system is to reward the employee based on the work performed over and above the minimum profit standards established by management, as opposed to a bonus given based on entitlement.
“Every company has several obligations,” says Mike Rudd, director of client services for International Profit Associates, a consulting firm that works with businesses across North America and Canada. “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.”
Rudd says the concept of excess-based profit incentives was developed as a methodology to ensure the business maintains the profit margins required to thrive and provide employee motivation based on specific performance criteria.
Smart Business spoke with Rudd about key principles that need to be addressed in order to establish and maintain a good incentive program.
What’s the first step in developing an incentive program that works for a specific business? You have to define the minimum gross profit your organization must produce in order 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.
Should you have one incentive for all employees or individualize incentives to each employee?
In order to be effective, 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. If you try to create a one-size-fits-all approach, you could run into problems where an employee’s incentives are dictated by factors beyond his or her control. That can be pretty demotivating.
Is there a specific way to account for the incentives on the books beyond a category called bonuses?
The financial reporting system must reflect the distinct/discreet operations of the company so it will be possible to measure the performance of 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.
What components are critical to any incentive plan?
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 all employees of the company based on their specific contributions to the overall success of the company <m> the greater the responsibilities, the greater the reward. This includes senior management, administrative personnel, supervisors and line employees, down to the least-senior positions.
How often should incentives be distributed?
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.
What impact do these types of plans have on the overall net result of a company’s operations?
Excess-profit incentive plans force employees to pay attention to the work at hand. They have the greatest impact on profitability and whether management pays because they do not want to disappoint the employees. Done correctly, it can be an extremely powerful tool for your business.
Mike Rudd ([email protected]) 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.
