Monthly Musings

July 2010


Jim Harter
Sigma Pi Consulting, LLC

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Volume 1 Number 5



Incentive Plans That Increase Your Profit


Virtual COO - a Cost Effective Alternative to Traditional Consulting


Incentive Plans That Increase Your Profit

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.  

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

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Virtual COO - a Cost Effective Alternative

The concept of a "virtual CFO" has been around for a number of years.  A company needs a CFO because the business has grown more complex that a staff accountant can address.  

But there simply isn't enough money to justify a full time CFO.  So you hire a virtual CFO who works part time (one or two days a week) to bring order to you financial world.  You financial affairs are addressed but at a much lower cost than hiring a full time CFO. 

Similarly, Sigma Pi Consulting is addressing the cost factor on the operations side of the house.  When we do a business assessment, we normally find a number of areas that are lacking.  The standard consulting approach involves creating a project plan and one or more consultants attach the problem with a SWAT team approach.  The problems get solved quickly but it involves a big hit on cash flow.  A second issue with the SWAT team approach is the concern about the cultural impact of abrupt change.  Finally, the SWAT team approach usually addresses multiple problems simultaneously. But most problems follow the 80/20 rule.  That is 80% of the effect is realized by attaching 20% of the problems. 

The Virtual COO model works well to address all of these issues.  By working one to two days a week, your cost is spread out over a much longer time.  It is a lot easier to pay for the services through day-to-day operations.  Additionally, there is not the cultural upheaval as old approaches are replaced by new systems.  It also gives your staff more time to become acclimated to the new systems and to understand how they are better than the old approach.  They also participate more in the implementation.  So they have more skin in the game and a vested interest to see it succeed.  With the 80/20 rule, you pick your areas to attack one at a time, choosing the tasks with the most bang for the buck.  The returns from early projects will literally fund the later efforts.

While there are distinct advantages to the SWAT team approach, the Virtual COO may be the best way to get it done in your company.  Contact us to discuss which way will work for you at:

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I am always interested in your feedback.  Please email me at

Sigma Pi Consulting, LLC
1248 Rolling Meadow Rd.
Pittsburgh, PA 15241
Phone: 412-576-2685
Fax: 954-206-1184

(c) 2010 Sigma Pi Consulting, LLC