When I worked for large companies, the concept of sharing profits was limited to the upper echelons and was generally in the form of annual bonuses that were mysteriously calculated, paid 3-5 months after the end of the year and generally reserved for the “fat cats” in the organization! Payments never happened below the Department Staff level, and individual contributors, clerical and shop/line employees were never eligible; they were the “mice”!
Thus, figuring out the best way to “give back” some of our profits to employees took some time to get right.
The first rule for our profit sharing was that if there was not a profit, then there were no payouts; sounds simple but “effort” was not enough, profits are what counts. EBITDA is for the PE firms to work with, not for paying cash bonuses to employees, so we used earnings after interest, depreciation and amortization. Of course, if there were losses, we took the “risk” and we of course did not ask for loss sharing! The second rule was to pay out distributions quarterly, as close to the end of the quarter as possible and as soon as the books were closed for the month. Employees reacted much more favorably than when we started out with annual payouts; after all, they have expenses to pay and dreams to spend it on. Yes, we did have some end-of-year accounting adjustments that might have been worth waiting for, but not worth the delay. We generally targeted 10% of pretax profit for distribution, but never communicated an exact formula. In some quarters, payouts might be a couple of weeks of pay-in one year 13 weeks!
At first we applied all of the payments to employees’ 401k plans with the thought that this extra amount should be saved for retirement. Although no one offered to give back their payout, there were lots of complaints-they wanted the cash now. We settled quickly on 2/3 cash and 1/3 401k and things quieted down. We also agreed to provide a separate payroll check so that whoever was at home might not know about the cash windfall…we never asked why! You had to work the entire quarter to be eligible, so new employees got their first distribution after 90 days.
Now for the most unusual element of the system-all employees got the same amount, regardless of seniority or pay level. That’s right, the Sales Manager got the same as the third shift machine operator. The rationale was that everyone contributed to the success of the company for the quarter, and salary levels accounted for skill/competency but not for “effort”. It felt right to me and when you own the place, you can make your own rules! Employees understood the system and could relate well to how scrap, margins, raises, new orders and layoffs all resulted in changes in their quarterly profit sharing check. As we brought in a professional management team, we did institute a separate performance-based bonus to aid in recruiting.
Over a period of about 15 years, this system resulted in a loyal workforce and employees aligned with the business objectives of making a profit, every quarter. In a couple of great years, we paid out an equivalent of three months of pay for a shop floor employee and during recessions, nothing. It allowed us to put bad times behind us quickly and stay focused on the future. We did not tweak it much. We were consistent and attempted to be fair about it. When the company was sold at the end of last year, bonuses were paid to all employees based on their seniority during my ownership-in some case up to 3-4 months pay.
I learned that there are two things dear to employees’ hearts that must be thought through very carefully-their pay and their lunch break…I’ll save food for another lesson!
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AUTHOR’S BIOGRAPHY
Jim Sharpe (MBA `76) is one of the HBS Entrepreneurs-in-Residence for the 2009-2010 academic year, who ran an aluminum manufacturing business for 21 years while working with his wife, Debby Stein Sharpe (MBA `81) after both left careers at GE and large companies and sold the business in late 2008. Jim can be reached at: jsharpe@hbs.edu, 310 Rock Center, 617-496-6285.
