Thursday, November 4, 2010


Fortune sharing is not a system. It’s a reality based on the simple understanding that all companies create and share wealth. The method and proportions of distribution rely on systems, perceptions, expectations, and an array of internal and external forces, sometimes coerced. The primary function of distribution - encouraging continued contribution - is often flouted, leading to the demise of the wealth creation activity itself. The inescapable truth is that no share can be so rigid as to ignore the volatility of wealth creation.

Historically, the most rigid of all has been individual pay. For decades companies have tinkered with flexible or variably pay systems to solve this problem. Research has shown that variable-pay systems do as a rule enhance productivity and rewards both for the shareholders and some individual employees. That is not to say that all have been successful; some have been dismal failures. The cost in terms of lay-offs, low morale, and employee stress and discontent under variable pay based on incentive is simply not known.

Variable pay is a very old concept. Its modern complexities may be at least partly due to our fascination with measurements and measuring tools such as computers, spreadsheets, databases and other software programs. In this too, I suspect, much of “what is being counted does not count and much of what counts is not being counted”.

The doyen of gain-sharing experts in the United States, John Belcher, has put variable-pay systems into three categories, each with a different formula for arriving at the rewards.

The first is cash profit-sharing. It is clearly determined by shareholder expectations being met at company level, although not necessarily only according to the standard headline earnings.

The second category is gain-sharing. While this term is often applied to all forms of variable or flexible pay, Belcher defines it as a system where the payout represents a share of financial gains. These are associated with improvements in team, group or organisational performance.

Thirdly, there is goal-sharing. Here a predetermined amount is paid for the achievement of team or organisational goals. These goals can be anything from monetary values to production output. Historically, gain-sharing has been developed from four roots:

· profit-sharing

· the Scanlon Plan

· the Rucker Plan

· Improshare©

The biggest drawback of most flexi-pay systems is that they are seldom fully understood by employees, especially at general staff and worker level. In most cases it is difficult to achieve “line of sight” (where the effect of actions are understood) and “line of effect” (where the effect can be measured) at the final accounting level. The image of profit-sharing schemes is severely dented when company reporting reflects less than the truth about performance. Puzzling executive payouts add to the distrust. In addition, some favourite bonus triggers such as EVA (economic value-added), EBIT (earnings before interest and tax), or RONA (return on net assets) and ROCE (return on capital employed) are often complex to the average employee.

My own biggest problem with profit-sharing is that it’s unrelated to common fate. As long as labour is viewed as a cost in accounting, shedding employees is the easiest way to improve profits. And if the purpose of incentives is to raise profits, then labour becomes the scapegoat and the profit-sharing scheme in effect exacerbates the divide between labour and capital. Some remuneration and gain-sharing consultants suggest that profit incentives be confined to senior management and executive staff, and productivity incentives be applied at a lower level. This can lead to a complete disconnect in benefits between the two groups.

Most productivity incentive schemes ultimately have a bearing on the individual and tend to cause internal competition and “angst” among colleagues that very few favour over time: even those who run away with most of the accolades. This is particularly so in many South African working environments.

Many companies have introduced share-ownership options for staff. These have been given different names such as SIPs (share incentive programmes) or ESOPs (employee share option programmes). Experience has shown that they work better at the executive level and less well at general staff level. In South Africa they have also become dubious instruments of BEE. They are in a class of their own and I have difficulty in defining them as flexible pay schemes. I will defer a more detailed examination to a separate article.

The Scanlon Plan is closely focused on cost-saving. Any reduction in costs is shared with employees as a gain. The scheme could be quite unfair but what softens it is that the measurements usually apply only to those areas where employees are in direct control. This feature adds substantial benefits in terms of understanding, credibility, communication and perceived fairness. But again, as long as labour is accounted for as a cost, some employees could benefit by lay-offs among their colleagues. The reason for Scanlon’s survival to this day and indeed for being reinvented in various forms is that it has tried to address these issues. But I dare say job retention is less of an issue in the developed world. Apart from relatively low unemployment, employees there have social security to fall back on.

The Rucker Plan was designed by American economist Allen Rucker after the Scanlon Plan was born in the 1930s. Despite many references to it in organisational theory, I could not find a case study showing where Rucker’s plan has been successful. Nor did John Belcher provide any in his writing. It’s nevertheless worth examining because it’s triggered by value-added or wealth created and it comes closest to a labour-empowering fortune sharing system.

Rucker toyed with the idea of a value-added statement (VAS) long before it became part of traditional reporting. That his gain-share system and the subsequent accounting format did not merge is quite surprising. Rucker’s critics argue that it’s the difficulty of the reporting format that made the plan vulnerable. I think I have already demonstrated that nothing is further from the truth. Contribution accounting, which is a derivative of the Value-added statement, is the most logical of all accounting conventions, the easiest to communicate and the least susceptible to expedient bookkeeping. The real potential of Rucker was in relation to common fate, which he unfortunately failed to recognise. Under his method, although the bonus payout is calculated at an organisation level, it’s still quite feasible and likely for employees to be given bonuses as a result of lay-offs of colleagues. This immediately detracts from common fate. The difficulty is not insurmountable, however, and it may be time for a Rucker revival. I will show how this can be done next week in examining how to account for a fully fledged fortune sharing system.

Improshare© was developed some time after Scanlon and Rucker. Whereas Scanlon and Rucker are based on monetary measurements (although Scanlon can include other physical accountabilities), Improshare© is based for the most part on physical productivity measurements calculated at team and individual levels. This meets a key requirement of “line of sight” and “line of effect”, and again makes for credibility, understanding and perception of fairness. However, when things are not measured in terms of monetary value one has no indication of how useful they really are. The concept of value-added puts a monetary value on the contribution one has made to the good of a customer. If the customer stops buying a product, the contribution ends – no matter what “inputs” of time, effort and mind are present. Physical measurements therefore have their limitations. You could be measuring and rewarding things that are adding no value.

There is nothing so useless as doing efficiently that which should not be done at all. — Peter Drucker.

At a practical level, the overriding message of variable pay today is that there really isn’t a generic template or formula that fits all circumstances. Consultants working in the field should avoid and be prevented from imposing their pet projects on a company. The system must be home-grown and be constantly polished in every detail. While crucial, design and implementation are less important than policy and intention. As always the “why” far outweighs the “what” and the “how”.

Variable pay can act as an incentive, or encourage involvement, or both. The two are not the same thing, however. What is true is that involvement will act as an incentive. But incentive will not always promote involvement by all; indeed it very often has the opposite effect. Involvement is about being focused on the contribution, whereas incentive is about reward. Variable pay can be empowering, compassionate and generous, but it can also become just another tool in the “what’s-in-it-for-me” kit.

In South Africa, the key outcome of variable pay should be to enhance involvement and trust, soften wage rigidity and counter unemployment. Conventional schemes can do the opposite: foster distrust, inflate individual wages and reduce employment.

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