Thoughts on Employment Compensation and Profit Sharing

I am going to present my thoughts on business and how employees should be compensated. If I had my own company this is how I would run it, in terms of profit sharing and compensation.

I have spent many years working in corporate America as a "system administrator" (IT/computer field) and once or twice as a manager of engineering staff. I continue in these endeavors on a part time consulting basis. In my experiences, particularly most recently in Silicon Valley, I've had opportunity to see what people (and companies) do with money as far as rewards, compensations, and salaries. I have to say, I'm not impressed. It could, and should, be structured in a manner that is more equitable, which ultimately would take some money out of the hands of the exec team and put it in the employees hands, which would have a positive effect on the long-term health of the company (if anybody cares about that, these days.)

I came up with the things that I would do if I were in charge. I'm probably one of the few people in the world who would actually implement these things if I were in the position to do so.

It's really simple.

Salaries

There would be no negotiation of salaries when hiring an employee. For a particular job title we know the local "market rate" for cash compensation (salary + bonus) and as an incentive we would start every employee at a percentage higher than the average. This encourages competition of candidates who want to work here. As the cost of living is different from one place to the next, the rate would be based on the commuting area where the employee lives. For positions where the employee is allowed to work remotely, their salary would be adjusted accordingly.

There would be no "undercutting" in the salary negotiation process. In fact there would be no salary negotiation at all. No trying to get "cheap candidates" by asking them what salary they are looking for and hoping it's lower than others with the same qualifications. I believe that this is a self-defeating strategy because when the employee finds out they are being underpaid (which they always do) they become bitter and hostile and usually try to renogiate or they jump ship in search of a higher salary. Either way it hurts the company.

All the candidates know what their compensation will be if they join. A midlevel software programmer with a bachelor's degree will earn a predetermined amount above the average of what every midlevel software programmer with a bachelor's degree makes in the area. One of the responsibilities of HR will be to stay on top of changes in market rates. When market rates go up, the company will automatically increase the salary compensation for its employees. Perhaps this is done once a year or once every six months. This incentivizes employees to stay with the company. High turn over and discontent among employees is bad for employee morale which is ulimately bad for the company.

When market rates go down, the company will NOT decrease or make any changes to the salary compensation for its employees. This provides great incentive for existing employees to stay with the company and to work hard because they don't want to lose their job. It also attracts a greater number of candidates for open positions, allowing us to greater choice. Profit sharing

Every single employee contributes equally to the success of a business. There is no such thing as a single person whose talent and brilliance means they make a greater contribution. The business owner may have the vision and insight, but they won't be able to acheive anything without their employees. The janitor who makes sure the bathrooms are clean presents a good image to visitors, including clients, customers, business partners. This has just as much of a direct, tangible effect on the business as a marketing campaign.

Therefore, when the business turns profitable, the profit pool at any given time is divided among all employees (including the owners) into equal proportions based on length of time of service (and whether they are full time or part time.) An employee's piece is related to another employee's piece by a proportion based on length of service and the value of the profit pool at the date of joining. The date of hire is a threshhold or "0 value" for that employee. The size of the profit pool is 0 from the perspective of the employee and will rise or fall going forward depending on whether the company continues to be profitable. This means the new employee will benefit from future success but does not benefit from the labors of previous employees. At a given point in time, the entire profit pool is divided among the active employees with different threshold levels for the different dates of hire. When someone leaves, their portion is cashed out. When a new person joins, the clock starts ticking from the date of hire and the profit pool for any amount higher than the threshold is divided among employees based on length of servcie . The profit pool is dynamic, it is adjusted whenever there is a change of personnel and it always reflects the most current profit of the business.

By way of example, let's say the company has 10 employees when it turns profitable. Over the next six months, the business shows a profit of $100,000. The company hires an 11th employee half way through the year. Let's say at the end of the year the business shows a total profit of $150,000 for the year. So, value of profit pool was $100,000 at the end of 6 months. Value of profit pool is $150,000 at the end of one year.

Now we do an exercise to calculate the portion of profit pool that belongs to each employee at the end of that year:

$100,000 is divided equally among the original 10 employees. Each owns $10,000 based on this piece. $50,000 is divided among the 11 employees based on length of service. Employee #11 has 1x length of service; each of the others has 2x. The total is 10*2x + 1x = 21x. $50,000/21 = $2,381. Therefore, from this piece employee #11 is entitled to $2,381 and each of the original 10 is entitled to $4,762.

Therefore, at the end of the year: each of the original 10 employees owns $14,762 and the 11th owns $2,381.

Notice that the $50,000 profit in the second half of the year is not divided equally among the 11 employees. It is divided proportionally according to length of time of service.This reflects the fact that the profit at any time stands on the cumulative shoulders of all past efforts. The $50,000 gain in the second half of the year is not based just on efforts made in the second half of the year. The business does not "begin fresh" when a new employee joins. It still owes a debt to previous efforts. The reputation of the company does not begin anew when a new employee joins. Neither do the business relationships or anything else that affects the ability of the business to grow. The person who has been with the company the longest is entitled to the proportionally largest piece of the "new profits", in addition to their piece of the"old" profits.For example, let's say a salesman spent the better part of the first sixth months building a relationship with an opportunity (potential customer). A contact was signed on month 7 producing the $50,000 additional profit. The new employee does not have the right to an equal percentage of that. Only the employees who have been around as long as the salesman are entitled to an equal percentage of that profit as the salesman is entitled to.

At this point, you may argue that this type of profit sharing is not fair for people who have more brains or education. Why should the janitor who started on day 0 be entitled to exactly the same portion of the profit pool as the Ph.D engineer who started on day 0? The answer is obvious by way of a simple analogy. Consider what happens if the janitor fails to clean the bathrooms for three weeks. The bathrooms are a disgusting mess. Employee morale goes down. Visiting clients get a bad impression of how the business is run. Visiting potential customers are turned off. You get the idea. The supposedly "simple" job that a janitor does actually has a much greater impact on business than you might be willing to admit. Same thing goes for every other job title in the company. Each employee's role is key to the success or failure of the business. If the janitor does not clean the bathrooms for three weeks, the business suffers as much as if the Ph.D software engineer makes mistakes in his code.

By the way, the PhD's brains and education are already rewarded in their higher salary. His salary reflects his years of education, his skills, his knowledge, and abilities. This is why we salaries based on the market rate for equivalent job title and experience.

You may argue that if everybody's entitlement to the profit is based simply on length of service, what is to prevent people from slacking off? The answer is simple: "Slacking off" is a personnel issue, not a compensation issue. Personnel issues are handled in the usual fashion by HR. If someone is not doing their job, they go through the normal castigation process. If they are unable to correct the problem, the employee is laid off and a check for their portion of the profit is given to them.

You may argue that, does the business owner not deserve a greater portion of the profit pool? After all, was it not his or her money on the line, their risk, their vision, etc? The answer is that they deserve no more and no less than the proportion based on their length of service, just as with all employees. Keep in mind that:

The owner's investment was recuperated at the moment the business became profitable. From that point forward there is no "risk" Everybody's contribution to the success of the business is equal. The owner cannot do it without the employees Presumably the owner is one of the original employees and therefore their length of time is longest.

Employees always know what their portion of the profit pool looks like. At any time hey can ask Finance or HR for a statement showing the cash value.

I truly feel the above is a way to run a business, even in the "real world", even in the middle of Silicon Valley where things are definitely not done this way. I feel that it would create a work environment that all employees would be content with, would get up every day looking forward to going to work, would work diligently if so inclined (would get fired otherwise) and to the best of their capability. This is the type of place that other people would want to get into.

If I were starting a business, this is exactly how i would structure it. It makes for a workplace of people working together towards a common goal, rather than each person greedily looking out for themselves. It makes for a stable long -term company, rather than a fly-by-night smash and grab operation.

Socialism? Not at all. If you run a smart business, you are entitled to all the profit you can get. You just need to fairly reward the employees who help you get it. The procedure I've given above seems, to me, as the fairest way to do it.

I welcome any and all comments. If you see flaws in my thinking, by all means let me know. I would like to chance to address them. You might even concvince me that I'm wrong, but I doubt it.