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Aug 27Glen Katlein

Sharing the Profits Requires Some Tough Calls

Aug 27Glen Katlein

In my search to set up a profit-sharing program, I thought carefully about ways to make the plan predictable and rational. Eventually, I arrived at the conclusion that it should be based on two metrics that we could easily track: our actual costs and our actual output, measured as the value of work that we ship in a given time period. But there were still a number of thorny issues to hammer out.


How often should we pay bonuses?


I don’t like the idea of giving out one bonus at the end of the year. I don’t think it can be an adequate reflection of performance over such a long period of time. I want to calculate our progress more frequently, but what is the best interval? Our cost accounting procedures aren’t strong enough to generate profitability statements per job, and our daily and weekly statements don’t mean much. The revenue side of our profit-and-loss statement consists of the sum of the value of the jobs shipped, and those numbers vary from the low thousands to more than $100,000 per contract. Our bills come in uneven chunks, too. We often do large-value jobs that are built one month and ship the next, which skews the sales numbers. But a quarterly report provides sufficient aggregation to smooth out unevenness in costs and shipment value. A quarterly payout would also distribute the hits to cash flow that the program (if successful) will require, so that I don’t have to worry about one giant payout at the end of the year, when cash can be tight.


How big should the bonus pool be?


I wanted the payout to be large enough to provide real motivation, and, in the best-case scenario, to serve as a significant supplement to everyone’s paycheck. I can’t tell you how many times I’ve seen a so-called motivation program that consists of something like, “If you perform heroically, you and your co-workers will be eligible for a monthly drawing for a $50 gift card!” That strikes me as insulting. If I want people to work harder, I should be willing to pay a serious amount for their efforts. I discussed this with my Vistage chairman, Ed Curry, and he told me that in his previous company, profit distributions had sometimes added up to 30 percent of an employee’s annual pay. That seemed like a huge amount to me.


Then he told me of another concept that seemed more appropriate, that when considering how to distribute value that the company generates, it’s frequently allocated one third to investors, one third to the person whose idea led to the business and one third to those who execute the concept. I decided this would be a good way to distribute profits, with a slight modification: 35 percent to the investors (my brother, my father and me), 35 percent to the idea man (that’s me), and 30 percent to the workers (I would leave myself out of that pool, even though I still work every day). Thirty percent might seem like a big number, but keep in mind that up until recently there haven’t been a lot of profits. If we can generate some by working faster, everyone will win. And 30 percent will make a difference to each worker.


I also decided we would determine the profit pool using the actual QuickBooks numbers for revenue and costs. We use accrual accounting, which means our revenues are the value of jobs that leave our premises — not our cash collection. One odd scenario we run into is that we occasionally have completed work ready for shipment that we have to hold because a customer’s project is delayed. Parked jobs wouldn’t count as sales — they haven’t been shipped — even though all of the costs to build those jobs would have been incurred. They would, however, provide a boost in the subsequent quarter, so it would all even out in the end. As for depreciation and other adjustments to profits, we don’t have much at the moment, because all of our major equipment is fully depreciated and our smaller machine purchases get expensed.


Who gets to participate in the bonus pool?


We have salaried workers, hourly workers and two salesmen who get a salary and a commission on the deals they close. Should we treat everyone the same? The salespeople are already getting 2 percent of the money they bring in, so there was some thought of excluding them entirely — but we want to encourage them to sell profitable jobs, not just to close any old deal. On the other hand, our profits are driven by how much work is built and shipped, and that’s almost entirely up to the production workers.


I mulled this for a long time and then settled on this concept: I would split the 30-percent profit pool into two parts. If we made a profit, half of the pool would go to all eligible employees, including the salesmen. And if we hit specific shipping targets, the other half of the pool would be split among the production workers, including the nonselling engineering staff in the office. Our costs for the preceding quarter had been averaging about $185,000 a month, so I set the shipping target at $600,000 a quarter, which works out to $200,000 a month. I believe that this division will encourage all employees to do their best to bring us to profitability.


How should the bonus pool be divided among eligible workers?


By the beginning of April I had a scheme for determining the size of the profit pool, how often we pay it, and who participates. The last big question was how to divide the pool among the individual workers. I was going to be out of town the first week of April, so I challenged my operations committee to come up with a way to do this while I was gone. Before I left, we had a brief discussion, and I suggested that it might be good to make the split proportional to the number of hours worked by each person in the quarter. That would provide an extra reward for those, like our finisher, who often have to work a lot of overtime. It also recognized that even our lower paid workers are critical to getting a job out the door — they work on packing and shipping — and are frequently required to put in long days when deadlines loom.


The committee members’ consensus: they didn’t like the hours-worked idea, because it might encourage dawdling. Instead, they suggested splitting the pot in proportion to each worker’s quarterly pay. The highest paid workers, presumably the most valuable to the organization, would get the biggest shares. I probably should have expected something like this, given that the highest paid guys sit on the committee. I thought about it — and then realized that my original idea and their suggestion were going to cause an administrative nightmare for me. It was going to be hard to get the numbers, because our biweekly pay periods don’t coincide with the months of the year. I was going to have to spend a lot of time digging through our Paychex statements to figure out exactly how many hours each person worked and earned each quarter. Also, I wouldn’t be able to make a public prediction of how much the pool would be worth to each person.


No one would know what they were going to get until long after the quarter ended, and nobody would want to tell any of the others how much they had received. Unequal division, either on hours worked or pay rates, would encourage jealousy and prevent transparency. My final decision was this: do it based on head count. Sixteen workers — everyone but me — would get an equal share in the part of the pool based on making a profit, and the 13 production workers would also get an equal share of the part based on hitting a shipping target. This division presumes that everyone’s efforts contribute to hitting the goals. Individual pay is the best place to reward for different skill sets, and overtime pay provides additional reward for those who work long hours.


What happens if we don’t make a profit?


If we don’t make a profit in a quarter, there will be no bonus distribution. And losses from one quarter will get subtracted from the profit in the following quarter before determining the size of the pool. However, I will not try to claw back a previous bonus if there’s a loss in a succeeding quarter. That’s the risk of ownership and one of the main reasons that I’m keeping 70 percent of the profits for myself and my partners. If we repeatedly lose money, quarter after quarter, that will mean that the plan isn’t working, and it will be terminated.


It took a lot of words to describe this program, but it can be expressed in a diagram that is considerably simpler and that I have attached below.


Paul Downs founded Paul Downs Cabinetmakers in 1986. It is based outside Philadelphia.


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