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I was talking to a client
about incentive plans a while back. He
said, "I pay my empoyees pretty well.
Why should I give them more?" I
explained to him that a well designed incentive plan doesn't cost him a thing. In fact, it makes him money.
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They are designed to improve
performance and to get his staff to "think like the owner". That is to make good business decisions out
in the field. A good incentive plan is
always based on increased profit.
As we talked, he saw that an
incentive plan could be developed to reward his top performers. Unfortunately, the types of things that he
was looking at either were untenable given the circumstances of the company or produced
relatively little impact on the bottom line.
Like so many businesses, the
owner had started it from scratch and built it organically. He was a great technician but a "seat of the
pants" owner. He instinctively knew what
a good decision looked like but because he had no grasp of the costs of
specific processes in his business, he could not quantify the difference in
profit between a "good decision" and a bad one.
Unfortunately, if you don't know
the cost impact you can't design an effective incentive plan because any incentive plan not based on increased
profit is a gift.
So, the first thing that we
had to do was to cost out his jobs. He
had never done job costing before. This
job costing process provides the baseline for a good incentive plan. But costing requires additional drill
down. When analyzing a project, you have
to take into account labor, materials, outside contractors, equipment costs,
consumables, and of course, let's not forget overhead.
Unfortunately, these numbers
are not always what they seem. Take
labor for instance. If you pay someone
$15 per hour, is that what they really cost you? After FICA, UI, Workers Comp, health
insurance, vacation and sick time, and all of the other stuff, you are lucky
that it is only $25 per hour. But that presumes
that your staff is producing revenue on all of those hours. You have to index their total cost per year
by their productive hours to find out what they are actually costing you.
One previous client had just this problem. One of his staff did nothing but repair work. He could spend an hour on the road getting to
the job where he might spend a half hour in productive work. Taking into account operating costs of the
pickup truck, the REAL cost of this $15 per hour employee was just shy of $50 per hour.
We need to dig into all of the
areas of cost to make sure that we know what a project is actually
costing. You have to know how much it
costs to run machinery taking into account consumables, maintenance expense,
and setup and clean up time. And don't
forget interest expense and depreciation.
Again this must be indexed by the number of hour the machine is used in
a year. Job materials may have freight
costs and require time unloading and inspecting the cargo. Remember your waste factor.
Once you have a handle on
your costs, you can begin the process of designing a profit based incentive
plan.
This step requires setting a cost baseline for each job. Early on, it may
be your best estimate on what it should be simply because you have no prior historical
data to refer to. But by tracking
performance going forward, you refine that baseline to recognize what good
performance actually looks like. Now you
determine what the incremental profit impact is on better than average
performance. If you have good cost data,
this is relatively easy.
Then you
identify what activities are most costly. The 80/20 rule kicks in here. 80%
of the profit impact will be realized by attacking 20% of the problems. Don't
waste your time on the small stuff.
Conversely, start small. Until you have a
good historical baseline for performance, you are really only guessing the
basis for the program. It is better to
start small than to promise big payouts only to discover that you are not
getting the improvement to justify it. You can always increase the payout as you get better data to work
from.
Also be careful that you don't give away more
profit than you generate by double and triple dipping. That is, don't increase
the salesman's commission for selling a profitable project and then create incentives
for the delivery staff on that same project.
One previous client was notorious for promising ½ of the profit to
multiple people. When he was done, he may have promised 200-300% of the
profit. He subsequently only paid out a
very small percentage of what he had promised.
This obviously resulted in disgruntled staff. Rather than improving morale and performance,
it had the exact opposite effect.
Finally, "Keep It Simple Stupid". Don't make the
plan complicated. But, Simple doesn't
mean Simplistic. Make sure the process can't be gamed. That is, you have to make sure that the plan doesn't
pay out without producing increased profit.
Sales staff can generate an infinite amount of revenue if they sell at a
loss. Shop floor productivity can go
through the roof if you don't care about defects. All good systems have controls that make sure
that you don't produce dysfunctional behavior. One client wanted to get his staff to save fuel. But I pointed out that the easiest way to
save fuel is to never start the equipment. The measurement needed to be fuel consumption per unit of work
accomplished.
Next issue, I will describe
a plan that I designed for a roofing contractor that captures of the essence of
these guidelines.
What do you think?
Let me know at jbharter@sigmapiconsulting.com.
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