Gainsharing or Profit Sharing? Choose the Right Tool for Your Organization - Part 1Robert L. Masternak
March 30, 2010 — 1,218 views
Many people who confuse Profit Sharing and Gainsharing view them as being one in the same. Employees have an opportunity to earn a financial reward under both approaches, but that is where the similarity ends. I find many companies that install a Profit Sharing plan have selected the wrong tool and quickly become disappointed that they have been unable to foster a change in behaviors or to drive improvements in company performance.
There are several questions that need to be asked if an organization is considering implementing either a Profit Sharing plan or a Gainsharing plan.
What is the organization trying to accomplish? What is the purpose for the plan? Is the objective to drive operating performance? Is it to help instill in the workers the concept of “common-fate?” Is the organization primarily interested in providing a monetary reward to motivate employees in their efforts? Is it more interested in providing a benefit to recognize loyalty and service? Is the organization considering the appropriate rewards system for the culture, growth, and demographics of the work force?
The purpose of two articles is to explain the similarities and differences between Profit Sharing and Gainsharing. The first article addresses Profit Sharing and the second article's focus will be on Gainsharing.
Profit Sharing History
Profit sharing certainly is not a new concept. One of the first documented Profit Sharing plans in the United States was introduced in 1794 at New Geneva, PA, Glass Works. At the time the company was recognized by the Secretary of the Treasury under Presidents Jefferson and Madison as applying “the nation’s fundamental democratic principles to an industrial operation. However, Profit Sharing arrangements were far from prevalent until the end of the Civil War. As America became more industrialized, Profit Sharing began to grow through the 1920’s. Profit Sharing companies held the belief that sharing profits would unite workers and management in the pursuit of the same common goal. In addition, Profit Sharing was offered as a means to discourage unionization, but after the Depression through the 1930’s many of these Profit Sharing plans were discontinued.
After World War II there was a rebirth of Profit Sharing. Most of these plans were deferred compensation plans driven by the desire to avoid a tax on excess income that had been imposed during the war. In other words, companies would place a portion of the profits aside to fund employee retirement plans. This was especially popular among private, “family” owned companies that saw employees as an extended family. The concept was also one of “common fate.” In good times a family would be able to share more, in the bad times, less. Employees often spent their entire working career with the same company. There was mutual loyalty on both the employer’s and employees’ behalf.
In the late 1980’s some companies began to deviate from the deferred compensation nature of Profit Sharing and to the cash or bonus concept of the 1920's. These plans were designed to include all employees including hourly and salaried, non-exempt employees, not just executives and managers. In other words, all employees have an opportunity to share in the profit pie by having an opportunity to receive a year-end cash bonus.
When profits are up, “I get more.” If profits are down, there’s no consequence. Companies that install these plans hope to enable employees to share in the organization’s success, to motivate workers to improve profits, and in turn to act in the best interest of the company.
Unfortunately many companies that have a “cash” Profit Sharing plan find that workers view the system as an entitlement. People are happy when they get a bonus and are upset when they don’t. Employees feel that when they receive a profit bonus they “earned it.” When they don’t, “it’s the company’s fault.” In lean years, the employee response is too often complaining, whining, and mistrust in the company.
Should a company consider installing a Profit Sharing plan?
The clear and simple issues are that for most organizations Profit Sharing plans provide very little or no “line-of-sight” in terms of what employees do and what they are paid. The general employee population has little understanding of how they directly impact a broad financial measure of profitability. Even those who have an understanding of the financial data find their efforts insignificant in relationship to key management decisions and external market conditions. To make matters worse, some may feel that the company may manipulate the numbers in order to take advantage of tax regulations or influence the investment community. These feelings are further exaggerated in large multi-location organizations where employees are distanced from top management. Also these multi-site organizations may calculate profit company-wide rather than on a location-by-location basis.
So, should a company consider installing a Profit Sharing plan? It depends on the objective. If the focus is to share the organization’s success and to reinforce a sense of ownership, then Profit Sharing might be the appropriate answer. However, the organization's management needs to clearly understand the result will most likely be in terms of impacting employee attitudes rather than driving behaviors. This is especially true in organizations that have an absence of a high degree of employee involvement.
If an organization decides to move forward with Profit Sharing, how should it be delivered? In other words should the Profit Sharing plan be a compensation system in perhaps the form of an annual bonus, or should it be designed to be used as a benefit, a method to help finance employee retirement or 401-k plan? If history is used to predict the future, the organization may be better served to incorporate Profit Sharing into a retirement scheme.
Profit Sharing as a Benefit
If a company decides to choose to have Profit Sharing delivered in the form of a benefit, a way to help fund retirement, employees would see their retirement security grow in tune with the company’s growth and prosperity. In other words, both employee and employer would share in a “common-fate.” This would certainly satisfy the objective of sharing in the organization’s success. The plan would give employees more of a long term outlook and strengthen the sense of identity and ownership. In today's world loyalty and identity is on the decline. On the other hand, if the objective is to influence behaviors, in terms of how people do their work, communicate, and cooperate with others, the organization needs to take special care. Profit sharing most likely will be the wrong answer, particularly if the organization has more than a handful of employees or does not have an advanced level of employee involvement. Why? Again because employees don't understand how they directly impact profits. The line of sight between what people do (behaviors) and the bonus they may receive is extremely fogged and cluttered.
Profit Sharing as a Bonus
The use of a Profit Sharing bonus scheme as a tool to impact behaviors may make sense for some organizations; the very special ones, the truly enlightened organizations. These companies have worked hard to build a highly developed work force, a work force that is very involved and has a high degree of identity to the organization. If a company plans to install a Cash Profit Sharing arrangement with the intention of impacting behaviors, the organization needs to answer "yes" to the following questions.
1. Communication is ongoing, up, down and sideways across the organization.
2. Employees are extremely knowledgeable about their jobs and have a solid understanding of the business.
3. There is a high level of trust and confidence in the management of the company.
4. Training is readily afforded to employees in terms of skills and individual development.
5. The company practices an open book style of management; the financial results are shared openly on a regular basis.
6. Managers are willing to admit mistakes.
7. The workforce is highly engaged, people at all levels are involved in some decision making.
8. Employees have a strong understanding of how they influence profitability.
9. The work force has an understanding on how the external markets impact the business people.
10. Employees identify with the business and view themselves as stakeholders.
11. The company demonstrates loyalty to the workforce.
A company that can answer "yes" to these questions has a lot of flexibility with Profit Sharing. Companies that can answer yes can deliver their Profit Sharing plan in the form of compensation, or the plan can be delivered as a benefit in the form of a retirement or 401-k. Better yet, the company could have a Profit Sharing retirement plan to promote loyalty and identity and consider installing a Gainsharing plan to help drive behaviors and attitudes.
About the Author:
Robert Masternak, founder of Masternak & Associates a specialized consulting firm focusing in Gainsharing design, installation, training, and monitoring activities. Mr. Masternak is an internationally recognized consultant with over 22 years of Gain sharing experience and is the author of the book “Gainsharing - A Team Based Approach to Drive Organizational Change.” He has installed "tailor-made" plans in well over 200 companies including: chemical, plastics, iron, steel, aerospace, health supplies, healthcare, pharmaceuticals, machining, lighting, energy, automotive parts, mining, footwear, glass, defense equipment, distribution, aluminum, metal fabrication, printing, paper products, food manufacturing, and furniture. If you are interested in further exploring Gainsharing, please call Mr. Masternak at (330) 725-8970.
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