Is Gainsharing for You?

by Ronald J. Recardo and Diane Pricone

The basic premise behind gainsharing is to improve the ratio of inputs to outputs.

Most organizations today struggle to implement multiple operational initiatives. Many of these organizations have discovered that one main reason why their initiatives have achieved insufficient results is because their current compensation systems don't reward employees for modeling appropriate behaviors or achieving desired results.

Productivity gainsharing plans have existed for nearly 50 years. They're all based on a mathematical formula that compares a baseline of performance with actual productivity during a given period. When the actual productivity is greater than the baseline, a percentage of savings is shared with employees.

As its name suggests, productivity gainsharing plans reward improvements in productivity. Although productivity can be measured in different ways, it's usually calculated as a ratio of outputs to inputs. Common output measures include: pieces/units/pounds; net sales; sales; inventory changes; value added; total standard costs; orders; total direct labor dollars earned; and total standard hours earned. Inputs commonly used include: materials; energy; inventory; labor; purchased goods/services; and total costs.

One key to success is selecting the most strategic inputs/outputs to track. A measurable increase in productivity is usually due to one of the following scenarios:
Greater production output with equal or less input.
Equal production output with less input.

Types of productivity gainsharing systems
There are four types of gainsharing programs: the Scanlon Plan, the Rucker Plan, Improshare and custom plans. The plans are similar except for the way the bonus is calculated and the level of employee involvement required to support the plan.

The Scanlon Plan is the oldest and most widely used type of gainsharing plan. It's based on the historical ratio of labor cost to sales value of production. And, because it rewards labor savings, it is most appropriate for companies that have a "high touch labor" content.

The Rucker Plan is based on the premise that the ratio of labor costs to production value (actual net sales plus or minus inventory changes, minus outside purchased materials and services) is historically stable in the manufacturing industry. This principle became the underlying precept of the Rucker Plan, which tracks the value added to a product as a measure of productivity. Because this plan utilizes a multicost formula, it's most appropriate for organizations that want to improve other variables, such as scrap reduction or energy consumption, in addition to labor.

Improshare measures changes in the relationship between outputs and the time (input) required to produce them. This plan is minimally affected by changes in sales volume, technology and capital equipment, product mix, or price and wage increases. It's the easiest of the gainsharing plans to understand and install.

Custom plans are used to customize components of a gainsharing plan to support a unique aspect of an organization's environment. Typically, these plans modify either the "textbook descriptions" of the bonus formula or the employee- involvement system. Since the Scanlon and Rucker plans were developed about 60 years ago, the employee-involvement vehicles associated with the textbook implementations of these plans are extremely dated. Instead, many organizations utilize self-directed work teams or cross-functional teams in lieu of the structured, multitiered employee-involvement approaches that plans were designed to use.

Our experience in designing and studying many gainsharing plans suggest six factors must be addressed in creating an effective gainsharing program.
Utilization of an easy-to-understand formula that tracks those variables which directly affect an organization's strategic performance. Employees must have an impact on formula's elements.
Regular program evaluation (at least annually). This can include developing metrics to assess program performance, creating procedures for revising the bonus formula and using a process for communicating the program's changes.
Employee involvement during design, implementation and periodic evaluation. Organizations that solicit employee input regarding program design tend to have programs that outperform systems designed without such contributions.
A base reward system that pays at the current market level. Gainsharing is not a substitute for paying salaries below the market level. It is designed for and works best when augmenting a base salary system that reflects market conditions.
A subject-matter expert to guide the design process. Gainsharing systems are not do-it-yourself programs. Success requires an expert who has successfully designed these types of reward systems. Organizations that think the process is as simple as reading a book usually encounter significant problems.
Stable product/service lines. Organizations that have relatively stable product/service lines or an ability to develop a stable formula tend to have the highest success rate. Rapidly changing product/service lines and unstable baselines will result in wide payout variations, which tends to undermine employee confidence in the program.

Features of each gainsharing plan include:
Strategic objectives-Most successful gainsharing programs utilize clearly communicated objectives. Common objectives include: improving safety, reducing operating costs, enhancing productivity and quality, and reducing materials and/or energy usage.
Employee involvement-Involving employees should be an important consideration in gainsharing plans. The Scanlon and Rucker plans utilize a multitiered employee-involvement program that consists of a suggestion system and one or more committees to identify and solve operational problems. Although Improshare doesn't require an involvement program, plans having an involvement vehicle tend to be more successful than those that do not.
Employees covered by gainsharing plans-There is wide variability in the employee groups covered by gainsharing plans. Some organizations have established plans that cover all employees, while other plans have focused on production and indirect labor. One of the most difficult decisions to make is designating which employee groups should be included in gainsharing. In the decision process, organizations must consider the tradeoffs between including those groups of employees who can impact the measurement formula the most, and including all employees to develop esprit de corps.

Types of measurement formulas
There are two distinct types of gainsharing measurement formulas: physical and financial. Physical formulas reward employees for improving the relationship between physical units of output and input (e.g., Improshare). This type of formula affords many advantages because it's based on easily understood variables within the employee's direct control. The downside of using this type of formula is that it can pay bonuses during periods of shrinking or nonexistent profit.

The Improshare formula can best be understood by examining the Dowe Cheatum & Howe company-the world's premiere kite manufacturer. The company was founded by Ben Franklin's brother more than 200 years ago. It employs 100 people-80 employees comprise the direct-labor work force, and 20 comprise management and technical support. DC&H makes two different kites-a starter kite that retails for $500 and the U.S.S. Enterprise kite that sells for $2,500.

DC&H bases their formula on engineering work standards, which are calculated by dividing the total production work hours by the number of units produced. For the starter kite, the work standard is 40 direct labor employees x 40 hours/50 kites, or 32 hours per kite.

The total standard value hours in the base period is 4,800. Improshare plans use a based productivity factor to factor in all production and nonproduction hours within the base period. Once these hours are added together, they are divided by the total standard hours (4,800), or 0.833. The bonus calculation for the month is shown in Figure 1.
Financial formulas are based on an organization's overall profitability. Employees become eligible to receive a bonus only when the organization makes a profit. The Rucker and Scanlon plans use this type of formula. Since financial formulas are affected by factors beyond an employee's direct control (e.g., inflation, government regulations, taxation, pricing decisions), they are distorted by the relationship between effort and reward. This can have a deleterious effect on employees' motivation (see figures 2 and 3).

In some organizations, the three textbook formulas don't track and reward the variables required for competitive advantage. In these instances, it may be appropriate to develop a customized formula that meets an organization's special needs. When developing a formula, you should consider the following guidelines:
Create a formula that can be administered easily.
Develop a formula that adapts to changing environmental conditions.
Before installing a formula, do simulations or modeling to identify how the bonus is affected by changes in volume, selling price, market share, etc.

The baseline
Baselines are used as a starting point for calculating improvements. Organizations use either permanent, dynamic, rolling or targeted baselines. Permanent baselines remain constant during the plan's lifetime. This provides employees with an added advantage because their bonuses reflect improvements made during previous periods. Dynamic baselines are revised on an intermittent basis (usually early) according to the performance level achieved in the previous measurement period. Plans that utilize dynamic baselines have problems maintaining bonus levels because employees must generate new improvements constantly.

Rolling baselines calculate the average performance for a specific number of periods. The length of time typically varies from four to six weeks. For example, if a company utilizes a four-week rolling average as it begins the first week of month two, the first week of month one is dropped. Targeted baselines are used when no appropriate baselines are available. This can occur when a new product or technology is introduced or when work processes are significantly changed, making the existing baseline invalid.

The employee bonus
The percentage of savings shared with employees varies depending on the gainsharing plan utilized. Generally, plants that only measure labor productivity share the greatest percentage of savings with employees. Traditionally, the Scanlon plan (labor-only formula) returns 75 percent of the gain to employees. Improshare usually returns 50 percent of the gain to employees, while the Rucker Plan varies greatly.

When determining the bonus share, management should consider the capital intensity of the business, frequency of baseline changes and expected motivational impact. Capital-intensive industries usually pay out smaller shares to employees. Plans that frequently change the baseline require larger productivity improvements for employees to receive a bonus. Typically, these types of plans provide employees with a larger share.

In most plans, organizations pay out bonuses either weekly, monthly, quarterly or annually. Most organizations reward employees monthly. When deciding on payout frequency, consider the availability of data, motivational intent desired, administrative costs and environmental uncertainty (uncertainty in the environment can cause considerable payout variations).

Organizations can divide employees' share of gains as follows:
Percent of income-The bonus pool translates into a percentage of salaries, with each employee receiving an equal percentage of compensation. This method is used in about 75 percent of the plans.
Equal shares-Every employee receives the same dollar amount.
Hours worked-The bonus is paid in terms of dollars per hour worked and applied to employees accordingly.

Deficit reserve
Deficit-reserve accounts are frequently used in Scanlon and Rucker gainsharing plans. They protect a company from profitability and inventory fluctuations. Employees covered by the plan usually fund the account by contributing between 15 percent and 40 percent of their bonus share. This, in effect, defrays risk. When employees perform in excess of the baseline, both stakeholders share the gain. Conversely, when employees perform below the baseline, both the organization and employees share in the loss.

Any money left in the account by year's end is paid out to employees. Organizations that don't utilize deficit-reserve accounts base their bonus shares on the average of several performance periods.

Advantages of productivity gainsharing
Organizations that have successfully implemented productivity-gainsharing plans report a number of benefits. Many of these organizations believe it has significantly improved organizational communications, especially between labor and management, and between different interdependent functional units. Since gainsharing supports a true pay-for-performance culture, employees tend to see their prosperity linked directly to the organizations. This tends to increase their commitment to the organization.

Since gainsharing plans measure changes in critical relationships between inputs and outputs, employees must understand the variables-that they can control-which affect organizational performance. Many gainsharing plans create an esprit de corps between interdependent work groups, and between labor and management, which usually reduces conflict, improves cooperation between related work units and benefits labor-management relations.

It's not uncommon for these quality-of-worklife benefits to have a positive effect on absenteeism, turnover and tardiness. Also, most companies report considerable reductions in their cost drivers (e.g., labor costs, product/service quality, purchased goods or services). Lastly, gainsharing plans motivate employees to improve the performance of key success factors within an organization.

Is gainsharing right for you?
Listed below are seven variables that should be considered when assessing the feasibility of gainsharing.
Fit with strategy and ongoing operational initiatives-An organization's strategy is the vehicle of change. Gainsharing is viable only when it supports the business strategy and is integrated with ongoing operational initiatives.
Alignment with existing culture-Gainsharing is not an overlay. It must be consistent with the organization's existing beliefs and values.
Commonality with the prevalent leadership style of management-Gainsharing requires a participatory leadership style. Supervisors and managers must not be threatened by increased employee empowerment. Management must be receptive to suggestions for improvement and be willing to act on those suggestions.
Capabilities of the information-reporting system-Gainsharing plans can tax an organization's information system. Successful plans require accurate, timely and appropriate information to calculate the bonus and track the plan's performance.
Type of product/service mix-Plan complexity increases exponentially as the product/service mix becomes greater. It is, therefore, more difficult to implement gainsharing principles in an organization with a wide range of product/service lines.
Interdependence of the work force-Gainsharing works best in organizations that have highly interdependent processes.
Potential to absorb additional output-The basic premise behind gainsharing is to improve the ratio of inputs to outputs. Typically, organizations focus on increasing outputs. If your organization competes in a market that cannot utilize additional output of products/services, productivity gains can become personnel displacements.

Implementation issues
Since no two organizations are alike, there is no map that can be used to design and implement gainsharing in all environments. Listed below are several broad steps that should be considered when designing and implementing a gainsharing program.
Conduct a readiness assessment-A readiness assessment answers two important questions: Is gainsharing a fit within my organization, and what are the requirements for a successful transition to gainsharing?

In most instances, the readiness assessment should start with a review of your operations.

This can include an analysis of the current physical layout and process flows, existing productivity measures, historical information on resources used, key cost drivers, input/output variables that measure productivity, capital investment plans and assessment of the degree employees can impact profitability.

It is not advisable to install gainshar-ing in an environment where large capital investments are planned, which can affect the capital-labor ratio and makes the baseline unreliable.

In addition to the operations review, you should conduct an assessment that identifies how a gainsharing program will affect your organization's architecture. We believe architecture is composed of three elements: technology (i.e., the equipment, data and applications used); organization (i.e., administrative control systems, structure, human resource systems, culture and employee competencies); and process (i.e., work processes and physical layout).
Design gainsharing program-Typically, this begins with the formation of a design team. Our experience suggests a cross-functional design team-represented by human resources, training, finance, operations and the union, if applicable-with significant employee representation a must for success.

Unless the design team has considerable gainsharing experience, we recommend you conduct education on gainsharing principles, including: the history of gainsharing; successful case studies/plant visits; benefits/risks; features of each gainsharing plan; and a blueprint for design/implementation.

After completing the training, the design team should get down to the nuts and bolts, and develop the objectives of the gainsharing program, identify which groups will be covered by the plan and design the plan's key features (e.g., employee-involvement vehicles, productivity baseline, bonus formula, bonus payout). Before selecting which plan to implement, we recommend highly that the design team simulate the Scanlon, Rucker and Improshare plan formulas based on historical data while using a variety of input/output measures.

One of the most critical components that organizations frequently ignore is the evaluation strategy of the gainsharing plan. This should include metrics to measure the plan's effectiveness, timetables for ongoing measurement and the establishment of a committee or team that has the authority to review and modify the plan.

After the plan has been designed fully, decide the scope of initial introduction. Specifically, will the plan be introduced on a pilot basis, or will full implementation take place? The optimal time to implement gainsharing is when demand for the organization's products or services exceeds current production levels. Avoid new product introductions or implementing technology with long learning curves. Also, avoid introduction during peak times or labor negotiations.
Maintenance-Gainsharing plans must be flexible enough to respond to changing market conditions. The last key task that the design team should tackle is clarifying maintenance roles and responsibilities.

This is a ticklish issue. For a plan to succeed, employees must understand and have confidence in the plan. Whenever a plan is modified, employees tend to be skeptical. They assume that management has a hidden agenda. Plan modifications usually occur because of changes in the product/service mix or capital investments (i.e., new technologies).

One way to mitigate the perception of tampering is to include a section in the gainsharing policy on plan evaluation and modification. The policy should describe who will review the plan, circumstances under which the plan can be modified and a process for modifying the plan.

Always include employees in the review process. The utilization of a gainsharing policy should reduce employee mistrust. And some organizations document how and why decisions to modify the plan were made, what assumptions were made and what conditions existed that necessitated the change, reporting the results to em-ployees.

About the authors
Ronald J. Recardo is managing partner of The Catalyst Consulting Group, which specializes in operations improvement and change management. Recardo works with Fortune 500 organizations to assist them in strategic business transformation. He is a certified Baldrige Examiner, certified in just-in-time and a certified management consultant. His research and consulting have enabled him to work with organizations in North America, Asia and Europe. Recardo has written two books and several articles on change management, reengineering, quality management and organizational effectiveness.

Diane Pricone is a consultant with The Catalyst Consulting Group. She has more than 10 years of experience working in the insurance and health-care industries. She has co-written articles on teams, reward systems and change management.