Profit Sharing Incentive Plan

Question (orig. at WorldatWork): 

Do you have a profit sharing incentive plan?  If so, what % of eligible wages does an award equate to?  What % of your company’s profit does the pool represent?

Any info would be appreciated.  Thanks.

Answer by Dan Walter

“Profit Sharing” is a term that is often misunderstood.

On one hand you may mean a formal, tax qualified, profit-sharing program that is subject to ERISA requirements etc.

On the other hand you may mean an STI or LTI plan that use profit amount, profit growth, profit margin or a similar metric, or combination of metrics to deliver cash or equity compensation.

The first type of profit-sharing is subject to some very well-defined rules, mainly via the IRS.  These rules tend to drive some similarity in the plans across companies.  But, these rules often are viewed as too difficult to deal with and this results in less companies using these plans than you might expect.

The second type of plan does not provide the tax advantage, but it is far more flexible in design, features and eligibility.  These plans are fairly common and there is not a lot of commonality between companies (nor should there be).

I am happy to chat with you about either type of plan or, if you provide a bit more detail here, I may be able to expound on this answer.

Baking is to Science as Cooking is to Art, Pay = Both

Stickman Baker Cook

Baking = Science, Cooking = Art, Pay = Both

Many great bakers are average cooks. Many great cooks avoid baking all but the simplest of things. Baking requires precision in measurement and actions. Even a small mistake can result in an inedible mess. Cooking requires creativity and flexibility. The best outcomes are usually a result of unique twists that match the food to the audience. Compensation requires you to be both a baker and a cook.

A client recently had a member of their board ask that a new analysis be done for a new executive in exactly the same way as performed for a prior executive a couple of years ago. The company is unique in industry, location and compensation philosophy. Its peers have continued to grow, change and even disappear over time. It is simply not possible to replicate the exact recipes and processes used to create the numbers from years ago (or even more than a few months ago.)

Executive pay is often more like cooking than baking. You are beholden to the ingredients that are fresh at the time you perform the task. Data sets, like great veggies or herbs, are often only available in small quantities at certain times of the year. Some professionals thrive in this environment, loving the swirl of possibilities and the frequent changes that must still result in predictable success.

Broad-based pay can often be more like baking than cooking. The data sets are larger and less volatile. Like flour, butter and other less perishable ingredients, you can expect some level of consistency throughout the year. You have a specific recipe that you can follow with only perhaps a replacement of the fruit that goes in the pie or muffin. Many professionals live for this organization, process and exactness.

What we seldom recognize is the precision required to create great art or the creativity required to make a recipe better.

Cooks must practice new things all the time while being flexible with both the ingredients available and their patrons’ tastes. They must learn flavors and techniques to build meals from a wide range of disparate sources. All of this practice must come together at the time of execution so that quick decisions can be made and executed without fear or hesitation. Differentiation is easy and variety allows for many different choices at every meal. Execution is often as much a matter of taste as it is technique. Incentive pay professionals are chefs.

Bakers must work and rework recipes, sometimes for years, to create something that is completely new and confidently repeatable. Differentiation is hard since the ingredients are so similar. Since there are also fewer opportunities for baked goods in any meal, the final product must have wider application and appeal. Execution is about rules and techniques first and taste will generally follow. Board-based pay professionals are bakers.

In reality, most compensation professionals do a little of each of these nearly every day. They are less likely to be as specialized as the pastry chef at a five star restaurant and more like the head chef at the local family café. In other words, you are right. Your job is probably harder than most people realize. When you do it right, most people simply get what they expected all along. When you do it wrong it is obvious to everyone.

In your current position do you identify more as a baker or cook? Which is more enjoyable for you?

Dan Walter is the President and CEO of Performensation a firm committed to aligning pay with company strategy and culture. You may want to get a copy of “Everything You Do in COMPENSATION IS COMMUNICATION” written by Dan Walter, Ann Bares and Margaret O’Hanlon of the Comp Café as a practical guide to improving the communication process. Dan has also co-authored of several other books you may find useful including “The Decision Makers Guide to Equity Compensation”, “If I’d Only Known That”, and “Equity Alternatives.” Dan welcomes connections on LinkedIn. Follow him on Twitter at@Performensation and @SayOnPay.

The ABCs of Communication ROI

Stickman ABCs of ROI

The math of compensation communication budgeting

It’s time to talk about communication. That means it’s time for everyone to get out their calculators (or spreadsheets) and do a little math. (Woohoo! We get to do math today!)

I meet very few compensation professionals or members of executive management teams who strongly believe they are doing a good job communicating their pay programs. And yet, companies continue to short change communication budgets even though we all know that “Everything You Do in Compensation is Communication.”

After years of working with all types and sizes of companies, I have come up with a little math project that has helped my clients and may help you and your management determine a reasonable budget for compensation communications.

Start with the total amount your company spent on compensation over the past three years. Use the amount of compensation expense recognized by the company in one set of calculations. Use the actual amounts delivered (including things like equity gains, benefit or pension payouts etc.) in another set of calculations.

Break the three-year total into amounts for each major pay elements (if it accounts for at least 5% of pay, assume it is major).

For each major element of pay, estimate the percentage of total value that employees perceive the element to be worth to them. We will call this the Pay Perception Value.

Then for each major pay element estimate, as a percentage, how well your employees understand how each pay element works and why the company uses it. We will call this the Pay Understanding Value.

Next, multiply the amount by the percentage of perceived value. This is the value that your total rewards are providing to employees for the purposes of attraction, motivation, engagement and retention.

Now multiply Pay Perception Value by the Pay Understanding Value and subtract the result from the Pay Perception Value.

This is the bare minimum of wasted compensation dollars. Your original compensation data may tell you that your company pays in the 50th percentile, but to your employees, it probably feels like the 25th (or worse).

Now imagine you started with a 3 year total compensation number that was 5% less. In this case, it would be $85,500,000. Imagine if you spent just half of this savings ($2,250,000) on better communication. Before you say “Dan is INSANE!” What if this investment in communication improved your Pay Perception Value by 10% and your Pay Understanding Value by 15%?

It doesn’t require some astronomic doubling of success for this approach to begin showing returns. Of course, this is not as simple as the example shown here, but I challenge every reader to do these quick calculations for their own company  (use estimates to within 5%) and post the results in the comment section of this post. Most companies don’t spend even 20% of the amounts this calculation shows. When you spend the time and effort to dig into the Pay Perception Value and Pay Understanding Value percentages, you may find that you are doing a great job. You may also be shocked to discover how little your employees buy into their pay.

What is your “break even” point for the enhanced communication approach? Can you show your management team how paying less will result in people feeling like they are paid more?

And a couple of examples of the basic math behind this approach…

Example 1:

Company spends $90,000,000 in total compensation over three years.

(Maybe $100,000 – $200,000 spent in total communications)

Pay Perception Value is an average of 75%.

Pay Understanding Value is an average of 65%.

$90,000,000 x 75% = $67,500,000

$67,500,000 x 65% = $43,875,000

Minimum wasted compensation = $23,625,000

 

Example 2 (enhanced communication approach)

Company spends $85,500,000 in total compensation over three years

Company spends $2,250,000 in enhanced communications

Pay Perception Value increases to an average of 85%

Pay Understanding Value improves to an average of 80%

$88,500,000 x 85% = $72,675,000 (an increase in Perceived Value of $5,175,000 over the higher legacy pay)

$72,675,000 x 80% = 58,140,000 (an increase of $14,265,000 over the higher pay package)

Minimum wasted compensation = $14,535,000 (you throw away $9,090,000 less)

 

Dan Walter is the President and CEO of Performensation a firm committed to aligning pay with company strategy and culture. You may want to get a copy of “Everything You Do in COMPENSATION IS COMMUNICATION” written by Dan Walter, Ann Bares and Margaret O’Hanlon of the Comp Café as a practical guide to improving the communication process. Dan has also co-authored of several other books you may find useful including “The Decision Makers Guide to Equity Compensation”, “If I’d Only Known That”, and “Equity Alternatives.” Dan welcomes connections on LinkedIn. Follow him on Twitter at@Performensation and @SayOnPay.

“I wish this book had been around decades ago…it’s a must have”

Peggy Andrews, PhD, SPHR, Lecturer in Management & Leadership Curriculum Coordinator at Hamline University School of Business recently reviewed “Everything in Compensation is Communication.” the new books from pay exerts Dan Walter, Ann Bares and Margaret O’Hanlon.

Here’s what Ms. Andrews had to say:

“I wish this book had been around decades ago when I started my career – it’s a must have..and one I recommend to all my management students”

“In my 20+ years of experience in HR and Organizational Consulting, I have seen 3 typical reactions to compensation discussions depending on who is leading the charge.”

  1. Overexcitement about the mysteries of spreadsheets and micro-changes in numbers (Finance);
  2. Order-taking (HR Administrators);
  3. Feigned boredom as a cover-up for nervousness/fear (Unskilled Managers and HR Staff). 

The result is that far too many organizations have legally compliant and operationally effective pay plans, yet are missing out on an incredible opportunity to use compensation dollars to communicate their business strategy to employees and build organizational performance.  Thankfully Bares, O’Hanlon and Walter have come to the rescue with this clever book that demystifies the process of designing and implementing a compensation program that will orient and motivate employees around organizational strategy and performance objectives.  With deceptive brevity and wit, this easy read provides a comprehensive outline that shows HR Professionals and Managers step-by-step how to engage stakeholders, identify the real compensation challenges and opportunities in your organization, bring employees into the conversation, and measure the effectiveness of your program.”

ewdic book quote 2b 20150217

Woulda, Coulda, Shoulda: An Incentive Compensation Story

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Yolanda was very good at her job. She planned her year well and executed with the precision of a heart surgeon. She brought creativity to her communications and structure to her base pay and Continue reading

Quick Fixes May Not Be Good Fixes

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I have seen many broken incentive plans similarly repaired. Incentive plans are tightly Continue reading

The Mind Heart Body and Spirit of Total Rewards

Stickman Mind Heart Body SpiritWorld at Work defines Total Rewards as:

“All of the tools available to the employer that may be used to attract, motivate and retain employees. Total rewards include everything the employee perceives to be of value resulting from the employment relationship.”

We have invented more tools with corresponding rules, regulations and variations. And our employees have become more diverse. Explaining the totality of Total Rewards has become increasingly difficult for many in and Continue reading

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Let’s first state the obvious. No compensation plan, Continue reading

I Was Wrong. Pay for Performance Doesn’t Work!

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Would You Like Mayo and Lettuce with that Noncompete?

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Noncompetes are not only hard on HR and legal departments; they can also be an issue for compensation professionals. At the most basic level, comp pros are paid to attract, motivate, retain and Continue reading