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Implementing Employee Incentive Compensation

By AICC Staff

July 24, 2019

Everyone appreciates a pat on the back or a “job well done” from their employers. Employee performance reviews are an essential part of managing your workforce, and hopefully they give your employees the essential feedback that they need to improve their job performance. But is this enough to really motivate people to strive to improve? Over my 40 or so years in public accounting, I have seen many employee incentive programs. Some of them pay additional compensation for achieving specific goals, and others rely on things like employee awards, cookouts, etc. I have seen many programs that are based upon company profits, some that pay the profit-sharing bonus out on a discretionary basis, and some that have a formula for how to allocate it.

A key question in incentive compensation is whether giving employees the chance to earn more money motivates them to excel. This has been a hotly debated topic for many years among psychologists, sociologists, economists, and others, and no one really knows for sure. I have seen incentive compensation programs that work fabulously, and I have seen programs that were dismal failures. The devil is always in the design of the program and in understanding your employees. What motivates a flexo operator or a general helper may be very different from what motivates your customer service, design, and other office personnel or your senior managers. Another key question is whether company profitability should be a key factor in the size of the potential incentives. My opinion on this is that, as the fictional character Gordon Gekko said in the movie Wall Street, “Greed is good,” and therefore, most people want a chance to earn additional compensation. I also believe in creating the right incentive for the right class of employee.

If you do decide to go down the incentive compensation path, the first thing that you must institute is performance measurement at all levels. Most of you are pretty good at looking at machine efficiencies such as setup times and run speeds on equipment. Some of you have begun focusing on machine uptime and availability. But there are lots of other plant measurements that need to be taken into account, such as safety, waste, attendance, preventative maintenance done in a timely fashion, cleanliness of the facility, and others. But what about other classes of employees, such as customer service design, maintenance, shipping and delivery, etc.? What can you measure among these employees?

The answer is that you need to measure things that directly contribute to company profitability and those that measure employee performance, and tie them into your regular financial reporting. There are certainly some things that are common to all converters, but not every statistic or measurement is important to all converters. If you are going to go down the path of employee incentives, you need to decide what to measure and begin to measure it every day (every shift for the plant). The daily information must be summed up by weeks and by months and be given to the appropriate personnel so that they can act. So, the first step to developing an incentive compensation plan is to determine the key performance indicators (KPIs) for the overall business and for each major cost center within it.

The next step involves integrating these KPIs into your regular financial reporting, which will validate their effect on your company. Most financial reporting in the converting business expresses costs as either a percentage of sales, per ton, or per MSF. All the columns add down neatly, and everything crossfoots, just the way we accountants like things. But these statistics are often irrelevant. Why not consider integrating your KPIs right into your financial reporting? If you do this, then you may be evaluating your customer service department based upon head counts and number of orders processed instead of as a percentage of sales or per MSF shipped. Each cost center should be evaluated based upon its own criteria and not simply looked at as a percentage of sales.

If you decide to implement an incentive compensation program and you are satisfied that you have the correct KPIs for the overall company, the plant, and each major cost center, then the question becomes: What should you offer the employees for excellent performance? I can tell you from experience that if you put too much money on the table, they will get used to it and start to view it as part of their basic compensation. When they don’t hit their marks, it will be viewed as a “takeaway,” and you will have some very disappointed employees.

Another fundamental issue is whether you can afford to pay employee incentive compensation when profits are flat or down. Everyone can be hitting their marks, but sales have been down. I think you must differentiate between your senior management team and your other employees. Senior management should have the ability to affect profits, and some sort of profit-sharing bonus might be appropriate for them. The rest of your employees contribute mainly by being efficient at their jobs and should probably be rewarded for their own hard work and efficiency.

In my opinion, the overall upside to each employee should be in the 5%–10% range of their salaries. For example, a plant employee who makes $40,000 who can earn an extra $2,000–$4,000 per year will be motivated if the goals are not unreasonable. It should also be paid regularly throughout the year (monthly or quarterly) and not at year-end if it is to have any real impact. Incentive compensation, if implemented properly, can have a profound effect on overall company efficiencies. It should help you maximize throughput, minimize downtime and waste, and help you run with as few employees as possible. However, it must be implemented cautiously, and the goals for each category of employee must be thought out carefully to create a program that gives you the desired results.


width=150Mitch Klingher is a partner at Klingher Nadler LLP. He can be reached at 201-731-3025 or mitch@klinghernadler.com.