August 20, 2006
An appeal to business owners to look past bonuses to a new way of structuring incentives for their employees
Economic indicators are heating up, and Federal Reserve Chairman Alan Greenspan is worried that the evil genie of inflation will be released from its bottle and undermine the economy.
Thoughtful executives in the tube and pipe industry are reviewing their operations to see how they can function with the necessary efficiency as the economy softens. Some executives are looking internally to see how they can cut unit costs by boosting productivity. Others are outsourcing production and pressuring suppliers to cut their unit costs by being more efficient. Both avenues look to curtail costs by making operations more efficient.
To achieve such better cost control, many original equipment manufacturers (OEMs) and their suppliers have rushed willy-nilly into incentive programs to improve employee efficiency. How effective are such incentives?
In the last 20 years, the economy has changed enormously, mainly in the area of global competition. Ever-increasing quantities of goods started flowing in from Japan and Europe, followed by a tidal wave of products from Taiwan, South Korea, Hong Kong, Singapore, Mexico, and others. U.S. producers of tube and pipe producing and fabricating equipment no longer could raise their prices as their costs rose, because foreign competition could undercut them.
The inability to raise prices because of global competition led to the growing use of incentive programs to motivate work forces to do their jobs better, smarter, quicker, and with less waste and rework and fewer rejects.
Use of incentive plans has increased during the past decade. The largest jumps were in profit sharing, 401(k) plans, and group pay incentives (gainsharing). As Frederick Taylor once said, "You cannot get a man to do an extraordinary day's work for an ordinary day's pay." This is what incentives are supposed to do.
Few tube and pipe companies give much thought to how incentive plans work, which plans are productive, how they affect different work force groups, or which employee behaviors the programs are supposed to improve.
In the business section of any newspaper, the year-end headlines tell of the enormous bonuses earned by executives. Business Week recently ran a survey of compensation of top executives of 100 companies. In every case, in addition to a very healthy salary, bonuses (often in the form of stock options) were added for performance. Some bonuses are tied specifically to short-term profits, while others are linked to sales or market share or to share price.
Smaller companies in the tube and pipe industry (with little following on Wall Street) or privately held companies are limited in their ability to offer this stock option bonus to their executives. However, almost every company in the tube and pipe industry provides managers and executives with the opportunity to earn a bonus, usually in the form of profit sharing and 401(k) plans.
For the hourly work force, bonuses often are based on standard piece-rate systems, merit raises, attendance, etc. Bonuses may include money, gift certificates, tickets, coupons, etc.
At the same time, various forms of profit sharing and 401(k) plans have been extended to include hourly employees. However, these programs have become so common that they no longer are considered to be incentive bonuses. They are regarded as entitlements. In many cases, workers get them just for showing up to work.
More than 460,000 companies, including almost all tube and pipe companies, have profit-sharing plans. Most such plans pay their members upon retirement, although about 10 percent of profit-sharing plans have a yearly partial cash payout. With the remaining 90 percent of plans, however, does the idea of a pension 30 or 40 years hence change or motivate a young employee's day-to-day behavior now? Obviously, not much.
Other companies offer their workers 401(k) plans, which allow the employees to invest pretax dollars for their retirement, usually with a company contribution to fatten the retirement pension. 401(k) plans are similar to profit sharing; about 90 percent of them are used as retirement vehicles. As such, they tend to bind their higher-paid employees to the company, but they have little effect on short-term motivation.
Many managers boast about their 401(k) plans, but few have stopped to think that the typical tube and pipe plant's hourly employee's pay simply does not leave enough disposable income to save some every week.
For example, the Federal Reserve Bank of New York staff report from March 1998 finds that only 36 percent of hourly workers participate in 401(k) plans. The report states: "...our findings show that a large number of workers, particularly those with low incomes, do not use 401(k) plans ..." Yet because executives are motivated by 401(k) plans, they assume that it motivates the performance of hourly factory floor workers as well.
As the Fed's statistics show, perhaps the most effective motivator is a carefully designed gainsharing plan under which employee efforts are measured in a way that supports a company's strategic needs. Employees are rewarded immediately when they achieve success as a group.
A gainsharing plan is a group incentive program whereby employees earn group bonuses for cooperating to improve overall performance—boosting productivity (thereby cutting unit costs) and improving quality (thereby diminishing rejects and rework expense) by working smarter and harder. Successful plans result in productivity and quality improvements of from 17 to 22 percent. The amount of the bonus depends on the dollar value of the gains and how these dollars are shared between the work force and the company.
Bonuses are paid and earned only if employees achieve target levels, thereby augmenting employee income and providing the company with equal savings. Some 5,100 companies today use some form of gainsharing programs, up from about 3,000 in 1996.
What should a thoughtful executive do about all this? One good effort would be to review the company's motivation/compensation systems to ascertain two things:
Executives may wish to hire an outside consultant to perform the review. In any case, there is no one-size-fits-all company incentive system that works equally well for all segments in the company. Incentive programs must be carefully tailored to the needs of all employees and the competitive realities and specific objectives of the company.
Woodruff Imberman is President of Imberman and DeForest, 1740 Ridge Avenue, Evanston, Illinois 60201, phone 847-733-0071, fax 847-733-0074, e-mail IMBandDEF@aol.com, Web site www. imbdef.com. Imberman and DeForest is an international management consulting firm specializing in compensation and incentive systems linking employee pay and performance. For a brochure on gainsharing, write Dr. Imberman.