Employees aren’t Partners

Many of my clients are recovering from the recession. They are running lean, and have restored their profitability, even if at lower revenues than prior to 2008. Those that had to reduce or freeze employee compensation are seeking ways to share their recovering success.

When cuts were made, whether layoffs, wage reductions, curtailed working hours or just freezing costs, profitability was the universally quoted reason. “We are losing money” or “We have to maintain a safe operating margin” were the battle cries of thousands of difficult conversations with employees.

Usually, those statements came with a future promise. “When things get better, we will (fill in the blank.)” In some cases the promise was simply to go back to full employment or wages. In others it was to “share the wealth” of increased profitability.

Now that the company is profitable again, owners are deciding how much they have to do to live up to these somewhat vague guarantees.

First, employees may need to be educated on the need to restore working capital and retained earnings on the balance sheet. The fact that a company is profitable this year doesn’t make it profitable retroactively. If the last few years decimated liquidity ratios, they must be rebuilt. A strong balance sheet is what carried you through this last downturn, and you have no idea when the next one will happen. Repairing your reserves sooner rather than later is the smartest use of restored profits.

From the same perspective, employees must understand that a return to acceptable profitability does not mean that you are going to pretend the last few years didn’t happen. Employees often expect that you will “make up” any missed raises or lost pay. It is your role to explain that we are going to start acting like a profitable company today, not make it retroactive.

But the biggest danger is the concept of profit sharing. Many employers are telling staff that they will share in the profits. One company I know is earmarking a specific percentage of the profits for distribution. Another is giving every employee a fixed-amount bonus as “profit sharing” for achieving the overall profit goal.

On the surface, it seems to make sense. Employees should understand why profit is a necessary requirement for owning a business. Cutting them in as “partners in profit” on an ongoing basis, however, isn’t necessarily a good idea.

Setting employee expectations of a “right” to profits opens a huge can or worms. What if you decide that the business needs to retain more earnings for future growth? What if a hot market or a big transaction hikes profits disproportionately? Should the bonuses compensate employees far beyond their market value? Is the fact they stuck with you in a single bad business cycle (when there may have been few other choices) a ticket to lifetime largess?

Profit-based compensation should be reserved for those employees who 1) make decisions that directly impact profitability, and 2) are compensated well enough that they can survive if they receive no incentive. Everyone else should have incentives based on their performance, not how the company fared overall.

Sharing profits after lean times is rightly a one-off event. It is a thank you for previous deprivation. Doing it more than once is creating an entitlement that has little effect and big implications.

Categories: Incentives, John's Opinions, Leadership, Managing Employees, Strategy and Planning... Bookmark this post.

3 Responses to Employees aren’t Partners

  1. Ted Reynolds says:

    This is an excellent article and I completely agree with the concept that only Exectuive Mgmt should profit share. Incentive based pay for the employees is a good practice, but needs to have flexibility to ebb and flow with the needs of the business being met first and foremost.

  2. Larry Amon says:

    John, I disagree. I used profit sharing with my employees for 15 years. Each employee in my company contributed to the profits of the company. We were a maufacturing company and everyone contributed, not just the managers. We did set up a system whereby each employee’s share of the profit was based on compensation, years of service, and a performance factor. We met monthly with all employees and reviewed our financials with them. They knew where they could help by controlling expenses and where they could cut costs. they knew the cost of the materials that they were using in the process and could increase the yield and productivity of the operation. When the company was sold the employees were given over $500,000 to be dived up according to the previous criteria. After 25 years they are still there.

    • John F. Dini says:

      That sounds lile a great system, Larry. I note you said “performance” was a key criteria. I have absolutely no problem with using company profitability as a funding scale for incentive programs. My piece criticised companies that distribute profits as an entitlement, without defining what individuals need to do to earn their share.

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