Jack Stack - founder/CEO of SRC Holdings, author of The Great Game of Business and considered by many to be the father of open-book management - has this to say about discretionary profit sharing plans (from the Inc. article The Problem with Profit Sharing) (bold emphasis mine):
By profit sharing, I mean the practice of taking a percentage of a company's profits, putting it into a pool, and disbursing it to the company's employees, usually sometime after the close of the year. Understand, I'm not saying that this is a bad thing to do, just that the benefits of doing it are limited. For openers, the recipients seldom know exactly how they helped generate the profits, beyond just doing their jobs. No doubt, they enjoy getting the money. They may even be grateful for it. But they aren't likely to think or act differently because of it or to be greatly motivated by it.
What's more, if they keep getting it, they will eventually come to expect it, depend on it. If they don't know what they've done to deserve the extra money, they will begin to view it as part of their regular compensation--that is, as an entitlement program. At that point, the profit-sharing check is a bonus in name only, no matter how much the amount may vary from year to year. Meanwhile, you're getting results that are the opposite of what you're paying for. You're promoting the same attitudes you had hoped to change by moving to variable pay in the first place.
Many thanks to Mr. Stack, not only for the variable pay wisdom, but for coining a useful new term.
Has your profit sharing plan become a BINO?
Maybe the confusion is due to the name this type of defined contribution plan has been given? The purpose of a Profit Sharing plan is being missed. The purpose of a Profit Sharing plan is to offer more of a tax benefit to the plan sponsor - the employer. In order to get that tax benefit, the plan sponsor is to share taxable profits with employees who are "eligible" to receive the contribution - another benefit. Eligibility can be defined by hours of service, a vesting schedule, and/or employment status. A Profit Sharing 401(k) plan is a benefit - for both the company and the employees. It's about taxes - not performance. A performance for bonus plan is about a potential reward based on the employee's performance.
Posted by: Stephanie A. Banister, EA, ERPA | January 24, 2012 at 08:42 AM
Semantics matter. Incentive implies a carrot dangled for a specific outcome. Profit Sharing describes owners treating employees to a cut of the profits without the need for stock ownership. Bonus is simply extra money not built into the regular paycheck. Bonuses come in many flavors. Some bonuses are MBO-based, most are generally performance-related, but others are just Christmas gifts. How you define it makes a lot of difference.
Posted by: E James (Jim) Brennan | January 30, 2012 at 07:12 AM
Stephanie:
Very good point - and important to note that the term "profit sharing plan" is often used to describe two fundamentally different types of programs. On the one hand, it is the term used to describe the very specific type of tax-qualified program you mention. On the other hand, it is frequently applied to a wide range of cash-based bonus programs. Mr. Stack, like many many others, is using it in reference to the second type. But it would help if we got our terminology straight, wouldn't it?
Jim:
Per Stephanie's discussion above, semantics do matter very much - and the whole incentives/bonus/profit sharing vernacular has become pretty blurred and indistinct. Which doesn't help.
Posted by: Ann Bares | January 31, 2012 at 07:10 AM
This is an excellent article . I enjoyed reading it and am likely to reread it again soon so I can revisit some of the points that I want to consider.
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