Creating a Variable Pay Plan

Profit Sharing

A further attempt to tie employees to the economic success of the organization is to grant them a share of the organization's profits. Obviously, this type of incentive is useful only in a for-profit organization.

In profit sharing, the organization puts a portion of pre-tax profits into a pool that is split among eligible employees.

Usually, employees with higher base salaries receive a larger percentage of the profits. The money is usually paid out on an annual basis.

Advantage

Profit sharing plans assist in gaining employee focus on the bottom line. Employees become more aware of the profit margin since they receive a piece of the pie. Management often feels that having the employee focus on profits is useful and will lead to organizational success. This type of plan provides for higher labor costs when the organization performs well and lower labor costs when the organization faces an economic downturn.

Disadvantages

Unfortunately, there are disadvantages to using profit sharing plans.

Employee perception. Employees do not receive rewards based on their individual efforts and so may feel that their individual performance does not matter.

Quality control. Profitability may be achieved at the expense of quality.

Taxes. The Fair Labor Standards Act (FLSA) requires employers to recalculate each employee’s regular rate of pay, based upon their total compensation. Some profit-sharing programs may have components that will require a re-calculation of 'regular pay.'

Growth of profit sharing plans

The growth of profit sharing plans has been blunted by:

• The Employee Retirement Income Security Act (ERISA): Deferred profit-sharing plans are subject to the participation, vesting, reporting, and disclosure fiduciary rules of ERISA. A profit-sharing plan, though, can successfully be designed to meet U.S. 401(k) requirements.
• Variations in profits: Profit sharing plans operate best when company earnings are stable or steadily increasing. In these situations, employees are less likely to face large swings in earnings.