Benefits and Compensation

How to Set Profit-Sharing Based on Goals, Not $

In yesterday’s Advisor we discussed straight and hurdle-rate profit-sharing; today, goal-driven profit-sharing plans.

[Go here for 1. Straight and 2. Hurdle-Rate Profit Sharing]

3. Goal-Driven Profit-Sharing Plans

In a goal-driven profit-sharing plan, profits are used to establish an incentive opportunity, but employees also must earn that opportunity, based on achieving other goals. These other goals are broad corporate goals, rather than unit operational goals, which are used to highlight and focus all employees on the important behaviors for business success.

Usually, goal-driven profit-sharing plans are combined with a hurdle-rate approach, with or without pay at risk, in order to communicate the importance of these other drivers of profit.

For example, a company could fund an award pool based on 15 percent of incremental profits over business plan targets. If the excess profit equals $1 million, the incentive opportunity equals $150,000; however, the entire $150,000 is not automatically distributed to employees, as it would be under a hurdle-rate profit-sharing plan. At least a portion of that profit pool must be earned by the employees’ achieving other performance goals, such as cost control and customer service or quality.

One advantage of a goal-driven profit-sharing plan is that, compared to objective-based plans, it reduces risk to the company. The fund does not fund for attaining the other objectives until designated profit thresholds have been achieved.

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Another advantage is that goal-driven plans stress the importance of other goals for company success and, in this way, provide a forum for talking about what employees can do to achieve them. For these reasons, goal-driven profit-sharing plans are commonly used by companies to communicate their important business results.

Profit-sharing plans, including goal-driven ones, offer an organization flexibility, and they are easy to integrate with other reward and recognition programs.

A successful employee suggestion plan can be dovetailed with profit sharing  by matching the idea value under the suggestion plan. For example, an award of $1,000 paid for an employee idea can be matched by the profit-sharing plan when the profit-sharing plan funds. This feature reinforces the link between cost-saving ideas and company profits.

Companies are looking for ways to make employees stakeholders in the business and to communicate the need for new behaviors and activities, particularly around the customer and continuous-quality improvement. While not as effective in directing employee behavior as other group incentive plans that measure success “closer to home,” they do nevertheless provide a simple and easy way to include large numbers of employees in group incentive programs. When combined with pay-at-risk strategies, they can be effective ways to link compensation programs to company affordability.

Any kind of incentive or compensation plan has to be rooted in the basics of what the employee is expected to do, and that falls back directly to the job description.

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