Performance Related Pay

John Walters of 1-2-1 Business Consulting brings us insight on the topic of "pay for performance." This excellent compensation model is something many business owners can readily implement.

Many small business owners reject Pay for Performance Plans without a proper understanding of the potential benefits of introducing such mechanisms to their organization, and before conducting a proper evaluation. This could be for a variety of reasons, but the fact is that Pay for Performance Plans, when correctly designed, can be very attractive for a number of reasons:


1) Pay for Performance Plans are usually self-funding, meaning that you only pay out based on increased profitability.
2) They enable you to pay out more to your employees without adding to the on-going cost base of the organization. This can be very attractive, particularly when facing uncertain times.
3) Pay for Performance can be used to direct attention to improving a specific area of the business.

4) Since Pay for Performance systems usually result in some form of incentive compensation, employees tend to be more focused on results when it directly impacts their compensation.
5) Some Pay for Performance programs; for example Gainsharing, enable you to directly involve and unite groups of employees towards a common goal. Improved profitability may result from increased sales, waste reduction and or cost reductions from reduced spending.

Taking a closer look at gain sharing programs. Let’s assume that you want to drive improvement through increased sales, waste elimination and by cutting back on administrative spending.

What is Gainsharing and how does a Gainsharing Program work?
Let’s assume that a business is interested in increasing sales, eliminating waste and reducing their administrative spending.
1.Increase sales revenue. we will assume that a 10% improvement equates to $10,000 in increased profitability.

2.Waste Elimination: we will assume that a 2% scrap reduction equates to $8000 in additional profitability.

3.Reduced Administration spending: we will assume that reduced Administrative spending flows directly to bottom line improvement and that a 10% reduction equates to $2000.

We develop a Gainsharing Plan that targets a 10% increase in sales, a 2% reduction in waste and 10% reduction in Administrative spending. We then communicate to employees that we will payout on actual results, with a 50-50 split between the company and employees.

Let’s assume the actual results are as follows: A 2% improvement in sales, a 1% reduction in scrap and 5% reduction in administrative spending. i.e. $2000 +$4000 + $2000. This will result in an aggregate pool of $8000, meaning that $4000 will be paid out to employees and $4000 is retained by the Company.
The advantage of the above is that the program is that it is 100% financed out of the improved results, with both the employees and the company benefiting. More important, you have raised employees’s compensation without increasing the on-going overhead structure of the organization. Furthermore, you were able to create a team environment and get collaboration between Sales, Operations and Administration employees.
Here is a guideline that may help you when developing and implementing a Gainsharing Program for your organization:
1.Make sure that you are clear about your objectives and that you can translate them into quantifiable, measurable targets. One of the biggest mistakes made in the implementation of Gainsharing Programs is the company’s failure to accurately measure results. This can lead to a company losing money with a Gainsharing Program because the company compensates employees for “artificial gains”

2.Make sure that you really understand the savings that will flow from the program and that they are sufficient to ensure that the program is capable of funding itself.

3.Be clear about the rules of the program. Who is eligible to participate in the program, when results will be communicated and the schedule for making payments to the employees.

4.Be transparent about how you will calculate the savings and the % that will be distributed to employees.

5.Communicate openly and often. When employees have an opportunity to receive compensation, it is amazing how they become much more interested in the success of the business.

Should you need additional support to design and execute a Gainsharing Program for your organization, then please contact “121” directly. You may also find more compensation strategies to enhance stretch budgets and build performance in OED's Online Community, and via special events located at OEDGlobal.org.