Profit sharing vs. Incentives

So I was in a meeting. A colleague spoke up and said that she felt that incentives weren’t a good thing, that they caused much damage and that it would be better to remove their use and replace them with something better.

This was followed by the usual conversation that ‘bad’ objective setting is clearly the actual problem…and implied that the (obvious and only) answer was to continually strive to set ‘good’ objectives (incl. targets and linked incentives).

Finally, it led to a discussion as to how different organisations handle the issue of pay. Two particular comments made of interest to me were that:

• “most organisations have incentive schemes”, with the implication that therefore this must be right; and
• some organisations use a ‘profit sharing’ concept and, “really, this is incentives just by a different name… isn’t it?”.

Now, there are (what I believe to be) some important points that I’d like to put out there regarding each of these two comments. Here goes…

Part 1 – The problem being the quality of the objectives

To run a ‘performance related’ incentive scheme, an organisation needs to do four things:

• set out meaningful (?) personal objectives (which are ‘cascaded’ down from above, hopefully derived from some customer related purpose);
• set criteria from which to measure a person’s performance against these objectives (i.e. targets);
• judge a person’s performance against these criteria; and
• lay out a financial methodology to convert this judgement of performance into a (contingent) monetary reward.

I have already written posts that are highly relevant to each of these points. In particular:

• I’ve explained why cascaded personal objectives are not a good idea, such as in my post titled D.U.M.B;
• I’ve explained the major problems with using targets in a few posts, such as The trouble with targets, The spice of life and Falling into that trap!;
• I wrote the post An exercise in futility to cover the huge problems with judging someone’s performance. I had earlier written about Anointing heroes;

and perhaps most importantly:

• I have written about the science showing the harm caused by using extrinsic motivators in The chasm and Money as pay. I used the analogy of Don’t feed the animals.
• …and on the related matter of purpose (from which those cascaded personal objectives theoretically originate), I have written about why this shouldn’t be seen simply as ‘to make profit’. I wrote about this in Oxygen isn’t what life is about

I hope that this gives you plenty of thought to explain my contention that, in Ackoff’s words, we shouldn’t be “trying to make a wrong thing righter”.

The issue is NOT with poorly set personal objectives, criteria, judgements and financials methodology. You can fiddle with these all day long but you won’t remove the fundamental flaw within.

Part 2 – Is Profit sharing the same as incentives?

Firstly, what do I mean by profit sharing as opposed to incentives? Here are definitions for each:

Definition of Profit sharing: All employees share in the success of the organisation.

“Employees receive a variable amount each year (or some other increment of time) where this variable reflects the pre-tax prosperity of the company.” (Scholtes)

Note that such profit sharing can be carried out in a myriad of ways. Some of these are:

• Same percentage of salary per employee (this is probably the most common method)

• Same absolute amount per employee i.e. shared equally, from the Contact Centre Agent through to the General Manager. Promoters of this method argue that:
  • People’s salary already caters for the market rate of their skills and experience;
  • We shouldn’t be implying that some people contribute more to a company’s prosperity than others…indeed some would argue that the most important people are the front line staff and they spend much of their time protecting the customer from the decisions made by command and control managers!

• The use of some seniority factor: i.e. profit share based around tenure – promoters of this method suggest it encourage long-term thinking*

• some hybrid of the above

* Note: A key consideration for anyone designing a profit share method is to avoid short-termism. Alternative thinking on how to achieve this might be to consider payment in shares that can’t be sold for a certain period, or payments into a person’s pension scheme, or [some other way of thinking outside the box]

Definition of Incentives: Extrinsic motivators – the offering of something (usually money) on a contingent basis in order to control how someone acts. ‘Do this to get that’.

At work, such incentives link to the idea of ‘paying for performance/ merit’ i.e. the setting of a challenge and then the judgement as to whether/ how well it has been met and the subsequent release of the contingent reward.

A comparison:

So, with these two definitions, I can now explain, via the following table, why profit sharing (however done) and incentives are very different:

Comparison:	Incentives:	Profit Sharing:
Purpose	Optimising the parts of the system, at the expense of the whole: ‘Meet personal objectives’ usurps overall purpose, with departments, and people within, pulling in competing directions. Personal objectives create: silo’d thinking and competition; barriers to collaboration Effort: massive time and effort spent in cascading, wording and ‘agreeing’ objectives Static: Once ‘locked in’ each year, people are constrained by this thinking.	Optimising the system: Encourages collaboration since everyone (horizontally and vertically) is joined together towards the same purpose. Encourage people to think about the ‘customer’ and their horizontal flow of value. Effort: Little effort required. The purpose remains as ‘True North’ Dynamic: People can continually move in new innovative directions towards the one purpose, liberated from personal objectives.
Targets	Required as ‘criteria’ for the objectives. People are only truly interested in their own targets.	Not required. People are now interested in measures (NOT targets) in how the system works and whether it is improving.
Judgement	Required to ‘score’ people against. Much time and emotional effort to run the judgement process, and deal with the de-motivating fall out… …which occurs due to the impossibility of making a fair judgement.	Not required.  Can now move to coaching conversations that are divorced from judgements and rewards…likely leading to open-ness, learning and self-development
Motivation	Extrinsic	People collaborating towards a combined purpose which they now believe in, leading to/ enabling intrinsic motivation

…and for anyone who holds that incentives must be right because everyone else seems to be doing it, you might be interested in my earlier post on Benchmarking.

To end with some thoughts for the way forward:

After very skilfully dealing with the subject of pay and performance in his book ‘The Leaders Handbook’, Scholtes puts forward (what I consider to be) some very useful guidelines when it comes to pay:

• Employee compensation should be a completely separate process from the employee feedback system;
• performance issues are one thing. Pay issues are another. Keep them separate. Don’t try to solve performance problems with pay solutions;
• There should be no merit pay, because it is virtually impossible to differentiate on the basis of merit; (Note: My post titled Outstanding discusses this)
• All employees should benefit from the success of the company through profit sharing;
• The greatest sources of motivation are intrinsic. Pay cannot motivate, but pay that is perceived to be unfair can de-motivate.