Here’s the good, the bad and the ugly of profit sharing.
Incentive programs are always among the most engaging topics in business management workshops. Every owner or manager sits up straighter and leans in closer to hear how other contractors implement incentives for better productivity and efficiency. And while there’s no perfect system, there are many systems better than no system at all. Following is an analysis of the benefits and pitfalls of a few.
Why they work: Quick feedback at the end of every job is extremely effective. When every foreman quickly shares in the successes of well-executed jobs, he’s far more likely and motivated to bring in jobs on time and for profit.
Why they fail: It’s extremely difficult and time consuming to track net profit by job. Tracking hours accurately is a lofty challenge for many companies.
Adding daily equipment, material and yard inventory tracking, as well as unused materials returned to the yard, is an immense amount of information every day. If you add variables such as warranty hours, multiple crews on one job and the fact foremen can’t control overhead, the complexity thickens.
Job net-profit incentives are time and resource intensive—and they often lack accuracy. Prepare to spend half an office salary each year tracking daily information. You’re also likely to miss tracking costs; therefore, job net profits are often overestimated.
Why they work: Gross profit is a measurement of revenue versus job costs, which are largely (but not exclusively) controlled by the crews doing the work. Crews are incentivized to beat the hours and reduce overtime, material costs and waste. Because bonuses are calculated on a per-job basis, crews can be given prompt feedback on their successes and failures.
Why they fail: Like the aforementioned net profit example, gross profit is difficult to track. Crews even learn to “forget” to track expenses such as inventory materials as often as possible. There’s also a temptation to lump as many hours as possible into nonbillable tasks, such as loading, unloading and driving. If those forgotten or unassigned costs aren’t caught, jobs look more profitable.
Equipment costs also are a Catch-22. As a job cost, crews often forget to record all their daily equipment, making jobs look more profitable. If equipment is treated as overhead (to avoid daily tracking), jobs that use more-than-average equipment look far more profitable than they really are.
Why they work: Crews exercise the most control over a single factor—man-hours. It’s a simple goal that’s easy to understand and relatively easy to track. The feedback also can be fairly quick because crews know at the end of each job if they stand to receive a bonus or not.
Why they fail: It’s easy to give bonuses too often. Take a crew that completes three jobs. The first two are under budget by 10 hours each, and the third is over budget by 20 hours. If you’d given bonuses after the first two jobs, you’re left absorbing the losses on the third job. You can mitigate this by issuing only estimated versus actual bonuses on a monthly, quarterly or annual basis, not at the end of each job.
Why they work: It’s based on a simple, profit-sharing formula thousands of companies throughout the world follow to help share their successes with their employees. The risk is low because a company only gives bonuses if there’s net profit leftover.
Why they fail: There’s far less individual accountability. High-performing crews or foremen are more likely to work just at the same level as their peers. The long gaps between bonuses make day-to-day motivation challenging.
Net profit also is a number that can be manipulated easily through depreciation, equipment purchases and overhead spending. Unless a company practices open-book management, most employees are distrustful that they’re being cut their fair share. Big corporations have the need to show strong financials to shareholders; small businesses generally are inspired to keep numbers secret and show as little profit as possible to avoid taxes. There are formulas, such as EBITA (earnings before interest, taxes and amortization), which make these calculations more “fair,” but it’s easy to understand why employees are skeptical.
Why they work: Crews are given a simple formula: the labor ratio. Add the wages of the crew together (e.g., $90,000) and divide by the company’s or division’s labor ratio (e.g., 25 percent) to determine a revenue goal for the crew (e.g., $360,000). Simply track invoices to the crews that completed the jobs and, at the end of the year, compare revenue earned to wages paid. If the crew generates more revenue without increasing payroll, it earns a share of revenue more than its goal.
This system is based on the two factors over which crews have the most control: payroll costs (labor hours) and revenue earned (jobs completed). Warranty work, unbillable time at the yard, drive time and vendor pickups are avoided because they use valuable production hours, which cost opportunities to boost sales and bonuses.
Why they fail: Bonuses are awarded annually, usually at the end of the year. Employees have to see the big picture, or they’ll lose faith. This pitfall can be mitigated by updating foremen with the revenue they generate monthly. If crews frequently share jobs, it also can be difficult to accurately credit the revenue each crew generates. The system also doesn’t guarantee profitability because owners and managers must carefully manage overhead, equipment and material spending according to their budget.
There are literally hundreds of different ways owners have tried to help their staffs become engaged and share in the successes of the business. But by far and away, most owners never try at all. Incentives have been a significant factor in our success, and they remain a strategic advantage for us over many of our competitors.
Whatever system you like, you should start with the simplest one that works for you. Too many companies end up spending too much overhead salary tracking too much data nobody trusts at the end of the year. Keep it simple, keep it easy to measure and keep your crews engaged throughout the year with the results.
Quick tip:
Quick feedback at the end of every job is extremely effective. When every foreman quickly shares in the successes of well-executed jobs, he’s far more likely and motivated to bring in jobs on time and for profit.
Photo: ©istock.com/SidharthThakur
