Gainsharing or Profit Sharing? Choose the Right Tool for Your Organization - Part 2Robert L. Masternak
April 19, 2010 — 2,868 views
Article one of this two part series focused on Profit Sharing and how it is often confused with Gainsharing. The history and purpose of Profit Sharing was explored as well as the delivery of Profit Sharing in the form of either compensation or as a benefit. The appropriate organization climate and culture for Profit Sharing was also discussed. The focus of article 2 is Gainsharing, what it is, how it evolved, and how it might best serve and organization.
Today many people view Gainsharing strictly as a bonus or group incentive plan. This narrow view has caused more than one Gainsharing plan to fail. Gainsharing should be considered to be much more than a compensation plan. It helps drive a change in the culture. Employees feel that they are more valued and respected. As a result, people develop a higher sense of teamwork, ownership, and identity. People are more engaged which leads to a higher level of performance. There are four relatively simple principles for understanding why Gainsharing works. All four are incorporated in the strategy used to install and maintain a successful plan. The four principles address equity, identity, involvement, and commitment. The four principles are interrelated and mutually reinforcing.
In order to fully understand the concept of Gainsharing, one must examine its roots. Gainsharing dates back to the 1930's when a labor leader, Joe Scanlon, preached that “the worker” had much more to offer than a pair of hands. The premise was that the person closest to the problem often has the best and simplest solution. Moreover, if the worker is involved in the solution, most likely he or she will make the solution work. Scanlon is often credited for developing a system that promotes involvement in the workplace through employee ideas and suggestions.
Basically, employee teams are formed to solicit and review suggestions from other members of the workforce. The teams are permanent groups that meet on a regular basis to discuss ideas and suggestions. The teams are given limited spending authority to approve and implement suggestions. Suggestions that are approved by a team, but are beyond their spending authority, are advanced to a higher level in the organization for final approval.
The involvement structure not only is intended to encourage participation but also is meant to enhance two-way communications regarding company goals and objectives. The idea system helps foster respect and cooperation. In other words, if employees feel their ideas are listened to, are given prompt feedback, and see their ideas promptly implemented, they will feel that they are respected.
Unlike a traditional suggestion system, Scanlon’s system does not provide individual monetary rewards for improvement ideas. The thinking is that the review, investigation, and implementation of employee’s ideas are truly a collaborative effort. Suggestion systems that pay individual awards based on the projected savings from the idea promote behaviors in which employees may conceal their improvement suggestions rather than freely share and collaborate with others to advance the idea. Originally the Scanlon approach didn’t have an employee bonus component. However, a few years after the plan’s initial implementation, Scanlon devised an organization-wide bonus formula that provided a more frequent and line-of-sight measurement system than Profit Sharing. The idea system and other improvement efforts drove the performance measures, and in turn gains (savings) generated through the measurement formula are shared with everyone in the organization. Basically the Scanlon philosophy says, “As we work together to improve the operations, everyone shares financially in the savings.”
The Scanlon Plan became know as, “a frontier in labor-management cooperation.” Scanlon went on to work at MIT to help other labor leaders and managers. As a result the Scanlon message gradually began to spread. In the 1950’s Scanlon developed a group of disciples including Frederick Lesieur and Carl Frost. As companies moved forward with the concept, interest in academic and government circles grew. One of the earlier studies was done by the General Accounting Office and was entitled “Productivity Sharing Programs; Can they Contribute to Productivity Improvement?” The 1981 study examined 36 “productivity sharing” firms. The GAO reported that “while productivity sharing plans are not the panacea for every firm in the solution to the Nation’s economic problems, they warrant serious consideration by firms as a means of stimulating productivity performance, enhancing their competitive advantage, increasing monetary benefits to their employees, and reducing inflationary pressure.” The report was published in the hope of encouraging organizations to implement performance-enhancing tools that better engaged the workforce.
As time passed, the term “Scanlon Plan” evolved to “Gainsharing Plan.” The Scanlon term mistakenly had become associated with a single bonus formula focused on people productivity. The “Gainsharing” term became more associated with the use of tailor-made measures that still focused on the line-of-sight.
In the mid-1990’s the Total Quality Management movement led to further interest in the Gainsharing concept. As TQM attempted to involve the workforce, employees began asking “What’s in it for me?” Gainsharing was one answer. More recently interest in Gainsharing has again surfaced as companies cycled through Lean Manufacturing and Six/Sigma initiates. An important point is that all of these improvement initiatives are nothing more than tools to better engage the workforce and to promote involvement. Simply put, these tools are an extension to what Scanlon had preached in the 1930’s.
Unfortunately many of today’s companies that study Gainsharing see the concept as an incentive, thinking that if you simply put a carrot in front of people, you will put “fire in their belly.” These organizations focus on the bonus/incentive side of Gainsharing, and may lack the understanding and appreciation of the cultural and employee involvement origins of the concept. They believe that a bonus system lacking employee involvement, will somehow miraculously lead to a positive result. The problem is that they are putting the cart in front of the horse, the incentive in front of the involvement.
Line-of-Sight & Measurement
After focusing on the cultural and employee involvement heritage of Gainsharing it is appropriate to turn to the bonus/incentive side. Basically, to provide Gainsharing’s incentive an organization measures performance through a pre-determined formula which, in turn, shares the savings with all employees. The organization’s actual performance is compared to baseline performance (often a historical standard) to determine the amount of the gain. The gains and resulting payouts are self-funded based on savings generated by the measurement formula. Some plans may utilize broad financial measures that closely resemble Profit Sharing. However, it is more common to find Gainsharing companies that utilize more narrow operational measures such as productivity, quality, customer service, on-time delivery, and spending. Typically gainsharing plans have multiple measures. In order for a gain to occur, the performance pie must improve.
As the pie expands, so does the improvement (gain) causing a greater financial benefit for the company and employees. The key point is that there must be an improvement before any sharing occurs. A critical point is that since gains are typically measured in relationship to a historical baseline, employees and the organization must change in order to generate a gain.
It’s very important to point out that employees do not have 100% control of any measure. No matter what the measure: spending, productivity, cycle time, yield, customer service, or on time delivery, there are always outside factors that will influence the result. The point is that employees have more control of operational measures than profitability.
However, unlike Profit Sharing and depending on the Gainsharing plan’s design, employee payouts can potentially occur even during periods of profitability decline. Companies with this type of Gainsharing model argue that even though profits may be down, profits would have further declined if not for the savings generated from the gainsharing measures. In this example the company is sharing “savings” and not necessarily “profits.”
Plan Participants - Another line-of-sight feature of Gainsharing relates to employee eligibility. All employees at a site are generally included in the plan, including hourly, salaried, and managers. The objective is to improve the line of sight by having the plan applied to employees “housed under the same roof.”
On the other hand, a Profit Sharing plan may exclude lower level or hourly employees, or profit bonuses may be paid out on a hierarchical basis. In other words, the bonus payout percentage is reduced as the Profit Sharing cascades down the organization.
Compensation or Benefit - Another Gainsharing line-of-sight enhancement is that Gainsharing is always paid in the form of a cash bonus. Gainsharing’s intent is to be based on the “pay-for-performance” concept as compared to a “benefit/deferred compensation plan.” In addition, the frequency for possible payout is greater for Gainsharing than Profit Sharing. The payout of Profit Sharing plans is typically an annual arrangement.
Year-end Reserve - Another important feature regarding Gainsharing is that typically a portion of the employees' share is placed in a year-end reserve account that is paid to all the eligible participants at the end of each plan year. In periods of deficit performance, the employees’ share of the loss is deducted from the annual reserve account. In other words, employees will see consequences for worse performance and longer-term thinking is reinforced. If at the end of the plan year the reserve is negative, a company will typically absorb the loss and start the next plan year at zero. The reserve concept helps further develop a sense of employee identity and ownership to the organization. For example if a company measured scrap and shared 50% of the gain and 50% of the loss (through the reserve) in a sense employees would own 50% of the financial value of the scrap. Obviously the sense of ownership would drive many new behaviors.
Site Specific - Unlike Profit Sharing in multi-site operations, Gainsharing is typically site specific. The measures and resulting gains are specific to the facility rather than gains being aggregated from multiple locations and in turn distributed across the organization. Again, the concept is to increase controllability and the line-of sight. On the other hand, unlike group incentives, Gainsharing typically measures across department/units/functions. The concept is to build cooperation and communications between departments instead of building silos.
Plan Development - Another distinction between Profit Sharing and Gainsharing relates to the method of plan design and development. A Profit Sharing plan is typically developed at the top of the organization. In larger corporations the plan may be designed and developed by compensation executives who in turn are granted approval from an executive committee made up of board members.
However, the development of a Gainsharing plan often involves employees in many aspects of the plan’s design and implementation. Often a cross-functional Design Team is assembled that mirrors the makeup of the total organization. The Design Team sorts through a number of issues related to measures, policies, and communication. After upper management’s approval, the Design Team is responsible for conducting all employee kick-off and promotional meetings. The objective is a sense of employee ownership for the plan. In a sense the Design Team members become disciples of the plan and help lead a process for improvement and change.
Should a company consider installing a Gainsharing plan?
So should a company consider installing a Gainsharing plan rather than Profit Sharing? Again, the same questions related to Profit Sharing must be asked. What is the objective? If the objective is to drive organizational change by influencing attitudes and behaviors, then Gainsharing may be the right answer. However, the company needs to have the horse in front of the cart. There needs to be the understanding that Gainsharing is an employee “involvement system with teeth.” Simply instituting some type of bonus formula is not enough. A second question: “Should the organization consider a broad financial measure of performance (ratio of spending to revenue) or more narrow operational measures (family of measures)?” All other things being equal, the use of more narrow, “line-of-sight” measures will more likely yield significant changes in behaviors which in turn generate positive results. As the measure becomes broader, the more the Gainsharing plan aligns with the problems associated with "Cash" Profit Sharing.
Gainsharing is a very common-sense system. However, sadly some organizations embark on installing a plan without an adequate understanding of and respect for the concept. A key theme is that Gainsharing is a powerful tool to promote organizational change. Gainsharing is more of a process to develop human assets rather than strictly a compensation program.
The following are some of the critical factors for success:
· Each plan must be specifically designed to fit the unique location and operation. There is no one perfect plan or formula.
· Employees must be involved in the process of designing and installing a Gainsharing plan. Identity to the plan must be developed.
· The bonus formula drives the specific behavior that the organization desires to achieve, whether it is productivity, quality, cost, or other organizational goals. Employees must perceive the linkage between pay and performance.
· The bonus calculation must be fair to the company as well as employees. It must not be overly complex, but enough so that it accurately reflects the needs of the business.
· Progress must be closely monitored in order to ensure the viability of the plan. Changes need to be made that reflect the business as well as employee perceptions of fairness.
· Employee involvement is a critical element of a Gainsharing plan. Higher levels of involvement lead to new behaviors and improved organization performance. It is a process of evolution, changing as the organization and its human resources develop.
· Training is critical. A solid foundation of management, supervisory, and employee training enhances the chance of success.
The top manager needs to be a champion of Gainsharing and believer in their people.
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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