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PocketWatch On March - 1 - 2011

This is the eleventh in a series of articles that will hopefully educate readers and illuminate the process of doing business in a simple to understand, nuts-and-bolts way.

To read all the articles in this series, click on any of the following:

In past articles, we have finally developed the tools necessary to rationally evaluate the past performance of the business, and a way to look into the future based on your plans for the business in a realistic and meaningful way.  Last time, we covered the idea behind a rational and psychologically sound employee incentive plan.  In this article, we will build the plan itself.

A Quick Review

As I said in Part 10, the basis of a sound employee incentive plan is that extra effort needs to be rewarded.  Employees have to know that they will see something for going “above and beyond.”

In Part 3, we discussed Job Descriptions.  Remember that a good job description is a comprehensive description of not only the job, but who reports to who, and, most importantly, a set of metrics that the employee must meet in order to do their job properly.

In Part 2, we discussed the Business Plan, which contains the Financial Plan, and put all that together to emphasize that Job Description metrics must be integrated with what you plan for the business and must meet the financial goals of the Financial plan.  If you plan on growing sales 5% in the coming year, what will that mean financially?  What will be the expected Net Profit?  How will that impact staffing?  Will you have to add people to take care of the increased load?  How many of each product will each employee have to produce?  How many service calls will have to be made each month to meet your goals?  Once all that is determined, it needs to be gone over again.

As you can see, proper planning that is integrated and complete is not a simple thing.  But having a plan is more than halfway to meeting your goals.  Do not ignore it!

Exceeding Expectations

Everyone wants to do better than they planned.  The best way I know to get people to exceed expectations is to reward them for it.  Basic pay is for meeting expectations.  Performance incentives are for exceeding expectations.  The metrics in the Job Descriptions will get you to meet your Business Plan goals if you map it out properly.  Getting beyond that requires a little more.  So, how do we build an incentive plan that gets your employees and staff to succeed?

The Group

The first thing to do is to group your employees by function.  Remember we built an Organization Chart by function?  This is where that comes in really handy.  Administration and office functions are in one group.  Sales is another, and operations is still another.  Let’s say you have a small manufacturing company with a bookkeeper, a couple sales people, and some shop people.  Those are your groups.  A retail store might have counter staff, a bookkeeper, and a stock boy or two.  A plumber might have a bookkeeper, a salesman, and a road crew or two.   Every business is different, but is important to make the groups so that they do not overlap in function.  One person may be in more than one group, but each grouping needs to be fairly separated in function.

Group Responsibilities

One of the keys to a successful incentive plan is to ensure that each group is responsible for only those things they can control.  Let me repeat that…

The group is responsible for only those things they can control.

It is unfair and can be a huge disincentive to punish shop guys that are productive above and beyond expectations if the procurement person messes up supplies orders.  Admin staff cannot be responsible for a lack of sales or sales orders that are poorly written.  Sales staff cannot be penalized if the shop is not producing according to preset metrics.  If you allow those things to happen, please, do not even consider implementing a plan like I am going to describe.  It won’t work, and will create huge morale problems.  Commit to doing this properly, or don’t do it at all!  Half measures and unfair dealing will explode in your face.  Every failure at implementing a proper incentive plan I have ever seen was the result of an owner not being fully behind the idea and committed to the entire process.

So, you have a small group of administrative staff… an office manager, a bookkeeper, and maybe a procurement person.  They all have job descriptions that they are aware of and know what metrics are expected of them.  How can I get more from them?  Well, savings comes to mind… What do these folks do?  They buy stuff and account for it.  They pay the bills.  They keep track of things.  They keep things organized.  They send stuff out and receive supplies and materials.  They do a lot.

What  if the office manager can save on supplies by shopping and making deals for quantity?  What if the bookkeeper manages the cash flow and saves on interest payments?  How about the if procurement person works to keep unneeded inventory down and reduces cash outflow, which affect interest payments or late payment fees to vendors?  Is any of that important to you?  It should be!  At a 10% Net Margin, every wasted dollar means that you have to sell $10 in goods or services to get back to break even!

Let’s say that traditionally that running the office – including interest costs, fees, supplies, phones, janitorial, insurance, internet, maintenance and repairs, and all other “back office” costs – runs $2,000 a month.  Let’s further say that the team you make responsible for these costs manages to save the company 10% on these costs each month over historic norms or $200 each month.  If you keep track of that amount over a fiscal quarter and make a “money pool” that is posted, they will have saved $600 per fiscal quarter.  If the owner keeps 50% of that pool, the employees in the group get to split the rest.

This is a win-win.  The owner, by making his back office employees responsible for things they can do something about, and making it clear that they will share in successes, has set up a situation where he or she no longer has to worry so much about those things.  Those employees will do everything they can think of to make that pool as large as possible each quarter.

If no savings are achieved, and everything stays the same, there is no money pool to split.

On the other hand, if someone on the team causes a loss that they should have been able to see coming and avoid, that loss counts against the pool.  No incentive plan works if there aren’t negative consequences as well as positive ones.

Similarly, a shop crew is organized in the same way.  Each job or object manufactured has a certain amount of labor assumed in its cost, a certain amount of material cost, and predictable supplies costs as well.  If the shop crew knows explicitly what those man/hours and other costs are for each job, they can work to beat those numbers.  Reducing waste, fewer man/hours, using supplies judiciously, all will contribute to savings.  If all of that is kept track of and posted weekly over time, the shop crew can build their own “money pool.”  As with the admin staff, that pool can be shared and split according to a plan each quarter.  Shop supervisors or crew chiefs no longer will have to try and motivate people to watch materials and supplies or to do work in a productive manner.  People will want to do those things as they see that pool grow through their efforts.

Likewise, excessive waste, inefficiency, wasting time, and ruined work is held against the pool, and those things are known and accounted for as well.

Sales is a special case. Most sales people have commissions, and that is their bonus package.  However, if they do not, a similar bonus pool can be set up in the same manner.  When sales exceed norms, money can be added to a pool according to a predetermined formula, and deducted the same way.

A little psychology

There area few points to make here having to do with the psychology of such a system.

First, it is obvious what happens when people can see how a bonus pool grows over time, so they must see it.  Just keeping records in your desk and popping out a number each quarter does no good. No one will believe it, no matter what that number is. Use a white board or a large piece of poster paper and update it each week as you see the pool change.  Post WHY the numbers changed.

Groups will become self-running.  People that are lazy or don’t care are literally taking money from others in the group.  As soon as the others realize this, no manager needs to be involved.  Motivation will take care of itself, or low performers will be driven out of the group.  This will give you the opportunity to hire a better worker.  I know that sounds harsh, but, in the end, do you really want someone working for you that doesn’t care or is a low performer?  That is not fair to you OR to them.

Resist the impulse to move the bar once this starts to yield results.  This is cheating.  You can rework metrics once a year based on your new, revisited Business Plan.  Don’t be greedy.  After all, if everyone is performing above expectations, and you planned and committed to a 10% Net Margin, these incentives are yielding ADDITIONAL profits.

By the way, remember a dollar saved has literally no costs associated with it.  Savings go straight to Net Profit.  This type of incentive plan does attach a cost, but instead of 90%, the costs are much lower, and have the added benefit of retaining excellent workers while weeding out under-performers.

And finally, this is the main tool you are going to need to get off the 80-hour week grind and begin to have a self-running business.  It will take planning, hours with spreadsheets and calculators, more planning, strategy, thinking problems through, and lots of record keeping that you are not used to.  But, in the end, all that hard work will be well worth it.


Please contact me offline at [email protected] with any comments, suggestions or ideas for future articles that you may not want to share here.


Written by PocketWatch

I am a small town boy from northern Wisconsin, who grew up in the quintessential American family. Dad was a carpenter, mom stayed home, two brothers and a sister. Our politics, and we were political, was always Democrat. My dad always said all you had to do was to look at what each side was fighting for, and it was easy to see, even as a kid, that Republicans were all about big money and rich businessmen, whereas the Democrats were more about social solutions. I spent 6 years in the US Army in the VietNam era as an electronic instructor for NSA, worked as a Field Engineer for a computer firm based in Massachusetts, spent another few years building paper mills around the world for a firm from Washington state, drove long haul truck for a while, did 10 years of servitude in NYC for a large multinational market research company as the Business Manager, spent some more time on the road as a Business Consultant, and the last bit as the Business Manager for a manufacturing firm here north of Houston. I am trying to start up my own consulting firm using all my experience to help small and medium sized businesses stay out of trouble versus waiting until they get into trouble. No one teaches people how to properly run a business. Business schools and MBA programs really don't. There are very basic nuts and bolts that are either assumed or are ignored, and like the house built on sand, businessmen and entrepreneurs ignore these solid foundations at their peril. (Now retired and doing some substitute teaching at a couple of small K-12 schools here in northern Wisconsin. Living in a small hamlet of 340 people, quiet, peaceful, serene.)

8 Responses so far.

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  1. Artist50 says:

    I think this series has been wonderful -- almost makes me want to jump back in again! My family was in the retail jewelry business for over fifty years. My ex and I had our own store in probably too small of a town but closed it mostly because we weren’t getting anywhere. We never lost money, but we weren’t saving for retirement and health insurance costs were prohibitive. We were only forty and felt like we were better off both working for someone else with benefits.

    With our sons off to college we moved to the city, life happened and we ended up divorced. So here I was a former Art teacher that never liked sales and really didn’t know how to do anything but run a jewelry store. I sold myself as a systems person and got a job at the most elite jewelry store in the city as a liaison between the shop and the sales staff. The owner was a young brilliant businessman that put many of your suggestions into practice. We accounted for all parts, labor by tenth of hour, metal, etc. -- so we could cost out our jobs all in code. The problems we got into were artistic and sales estimation as you could imagine. But the more we could prove to our sales staff how much a custom job cost the better they got at estimating -- though we really preferred they used me or a designer for an estimate. Another thing that impressed me about the owner of this small business (about 15 million) is that unless he was out of the store he looked at every cost analysis of every job that came out of the shop. He truly knew where his numbers were.

    • PocketWatch says:

      Artist, thanks. I know that there are some owners out there that “get it.” Sadly, too many do not. One way I solved the Sales/Operations problems in a custom manufacturing concern was to have all major bids go through an approval process that included Operations. A salesman HAD to have the Ops Mgr sign off on the man/hours and materials costs. If materials were a big issue, the procurement guy had to sign off as well, not only for costing but for timing… some materials had long lead times from the vendors, and sales people tend to be optimistic on delivery schedules. And any job bid at less than 15% Net HAD to be signed off by the company President.

      It’s all about process.

  2. I would suggest a change to the way you disburse the incentive pool.

    As we have seen, sometimes a “money-saving initiative” backfires. Like the office manager getting a great deal on 4000 toner cartridges for a printer that dies before you have used 1000 cartridges. Sometimes this backfire is not evident in the same calendar year.

    Put a portion of this year’s incentive pool towards next year. That way if something happens to backfire, it is, at least partially, covered by the pool. It works the same way as profits, part is put back into the company and part is disbursed to stake-holders (which is different than shareholders).

    • PocketWatch says:

      2nd -- You have touched on a subject that I really didn’t cover because of time, length, and the fact that every business is different.

      The unspoken but very necessary issue you touch on is “process.”

      In most small companies, no one is allowed to actually spend money except the owner. In your example, the Office Manager would not be able to do that without the knowledge of the owner who signs all checks, and, unless the owner was a total deadhead, it would not go forward.

      Each of the groups needs to have a process established for either adding to the pool or removing value from the pool.

      You also want to make it transparent and understandable. It is my experience that quarterly is a good interval, since it is long enough to accumulate rewards and wash out any mistakes. Yearly is too long, since peoples’ attention will wane.

      There must be a clear and visible process to establish what is put in the pool and how it is shared out. Again, in your example, the Admin team comes up with an idea and in the weekly staff meeting presents it. If everyone agrees, it moves forward. The idea may be modified or added to in some way. By having weekly staff meetings that present ideas, update the pool amounts, and discuss issues with operations or sales, etc., people become involved and continually interested in the process as well as the results.

      This now gets the pressure off the owner, which is the whole point, going back to Part 1 and how micromanagement is not a best model for running a business.

      • By the way, that was not a criticism of your article, just a suggestion. I’m the kind of guy who likes to hedge his bets, because I do not have a lot of money to waste on a bad gamble.

        • PocketWatch says:

          2nd -- I hear ya. I don’t take anything personally. This is all about adapting this stuff to your own business. There is no such thing as “one size fits all.” That’s why I am avoiding specifics and keeping to general principles.

          Just develop a process to make sure that such things can’t happen.

      • PW, I have seen way too many “great ideas” get passed by committee. Everybody is eager to agree to something they can take credit for, but discussions of possible consequences (if they happen at all) is poo-poo’d as “too negative”.

        I saw my boss at a non-profit okay the purchase of a new printer that a friend had recommended, ignoring the fact that it was a plotter and the friend was an architect. There was no reason for us to have one. I tried to explain the difference to her, and was treated as if I was trying to re-crucify Christ and the state’s population of kittens.

        When the plotter sat for seven months without being used, it was my fault, because I was considered the “computer guy” (not my actual position and not in my job description at all, but hey, who cares about that?).

        • PocketWatch says:

          2nd -- Ahhhhhhhhhhh…. that’s the beauty of my suggested system. If that happened, guess what? The cost of that printer comes right out of the bonus pool! Oooops!

          (BTW, NEVER ‘buy’ office equipment… lease it. Technology changes too fast, and you end up with obsolete equipment. It’s about the same costs, and if you have a junker, all it takes is a phone call to rectify! Just a piece of advice from your Uncle Pocket…)

          When people are financially invested in the process, they will respond in a smarter way than if it wasn’t “their” money.

          It takes a little training and experience, but no one gets their project approved in that staff meeting without a cost/benefit analysis and argument.

          People start to become ‘internal entrepreneurs’ within the company.

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