Gainsharing and Profit Sharing

Gainsharing (GS) and profit sharing (PS) are two pay-for-performance systems used by organizations to reward workers for increased performance at the group, unit, or organization level (Rynes, Gerhart, & Parks, 2005). The ultimate goals of GS and PS plans are improving specific aspects of organizational productivity and improving employee attitudes relating to justice, collaboration, and teamwork. Successful group-, unit-, and organizational-level pay-for-performance plans incorporate the concept of common fate. Common fate is integral to the management of performance at the group, unit, and organizational level (Werther, Ruch, & McClure, 1986). The performance of an organization is seen as a direct function of the combined efforts of all its members. The margin of success for an organization, then, comes from replacing the adversarial relationship between management and employees with cooperation and collaboration. Workers who feel they have a stake in the company make contributions to the success of the company.

Gainsharing rewards employees for increases in efficiency on some important organizational criteria such as decreasing wastefulness and increasing productivity (Lawler, 1981). The typical GS plan is designed, using one of a number of formula variants, to be implemented within one facility such as one factory. Higher levels of performance are achieved through the involvement and participation of employees in some form of suggestion system (Lawler, 1981, 1988; Masternak, 1997). The two components, monetary reward for improved efficiency and the use of participative management, are the defining components of a GS plan.

Profit sharing rewards employees for increases in organizational profits (Kruse, 1993). All PS plans have a formula specifying how a fixed percentage of organizational profits are divided among employees. Employee compensation is based substantially on the profitability of the company during some fixed time period. The typical PS plan is designed, using a number of formula variants, to be implemented within an entire corporation.

Both GS and PS plans have been shown to be effective. GS plans have been shown to result in labor cost savings of approximately 29% (Lawler, 1988). Rynes et al. (2005) write that PS plans, with a payout based on meeting a profitability target—such as return on assets (ROA) or return on investment (ROI)—have been shown to have a median effect of +4.4% and a mean effect of +7.4% on the criteria being used in the PS plan.

The most important difference between GS and PS plans is that the two types of pay-for-performance plans use different types of criteria to evaluate changes in performance for reward purposes. GS uses criteria that are focused on the internal efficiency of the organizational unit in which the plan is being implemented. For example, a GS plan may determine that the historical labor cost to produce one widget in the plant is $5.00. Employees receive a bonus for lowering the cost of production of that widget. If the employees, through their suggestions and changes in work behavior, lower the labor cost to produce to $4.50 per widget, the employees are rewarded for this decrease in labor cost through the established GS formula. The criteria chosen for use in GS plans should be those which the employees of the organization may directly influence through changes in their behavior, or suggestions made, in the workplace. GS plans work only in situations where the inputs of employees are actually influential, and also in labor systems as opposed to capital-intense systems (Kim, 1999).

Lawler (1988) wrote that the mechanism by which GS plans increase organizational performance is proposed to be that GS plans

  • establish the belief that rewards are based on improvement in performance on the organizational criteria being measured;
  • establish ways for employees to influence organizational performance as measured by the reward system;
  • provide feedback about organizational performance to employees; and
  • create opportunities for employees to learn how to contribute to organizational performance.

Profit sharing plans use criteria that are focused on the external effectiveness of the corporation. The additional compensation received by employees is based on criteria (such as change in stock price, ROA, or ROI, which may be more related to factors outside the control of the organization than to the efforts of the employees of a company. For example, widget production may be linked to the cost of a raw material, X, which is required to produce the widget. If the price of X rises, the company may not be able to pass all the cost of this rise to its customers and profits will fall. If the price of X decreases, the company may be able to keep the widget price for consumers at the same level, and more profit is generated. In each case, however, the efforts and inputs of the company’s employees are irrelevant to the amount of profit generated. The mechanism through which PS plans improve performance is, therefore, less clear than for GS plans. In fact, PS plans may not be appealing to some employees because they do not know how their behavior contributed to the profits of the company (Stack, 1996; Kraizberg, Tziner, & Weisberg, 2002).

This leads to a second important difference between GS and PS plans. Gainsharing programs always are implemented in conjunction with some form of participative management (e.g., a suggestion system), whereas PS plans usually do not have a participative system associated with them (Lawler, 1988). This may be the result of the way PS plans allocate additional compensation. Employees have less input in PS plans because they are being rewarded for changes in externally focused criteria that are not under their control.

One decision that must be made during the planning and implementation process is related to choice of the variant to be used whether a GS or PS plans is being considered. Variants differ on both the degree of participation by employees and the formula to be used in GS plans (Bazerman & Graham-Moore, 1983; Welbourne, Balkin, & Gomez-Mejia, 1995). There is no clear distinction among the GS variants such as Scanlon, Rucker, or Improshare plans for effectiveness. Similar problems exist for choice of appropriate variant in the implementation of PS plans (Kruse, 1993). For PS plans, however, the variants deal more with the way employees are compensated. There are three basic forms of PS plans. First, PS plans may provide cash (employees have their share of profits added directly to their paychecks at quarterly or annual intervals). Second, PS plan profits may be deferred (the profit share amount is put into a pension trust for the employee and received by the employee on retirement). Finally, PS plans may provide both cash and deferred benefits in some combination. Kruse (1993) wrote that the variant of PS chosen is related to the effectiveness of the program. Cash plans are more effective than the other forms of plans in improving employee perceptions of teamwork and collaboration in a company.

One key variable in the development of perceptions of common fate critical to the success of a pay-for-performance program at the group, unit, or organizational level is the size of the organizational unit in which the plan is implemented. The size of the facility covered by a GS plan is usually small (Lawler, 1981). According to White (1979), GS plans such as the Scanlon Plan can be implemented without size limiting possible success for companies of up to 600 employees. In a review of the Shultz study, Schuster (1983) found that only 3 out of 21 companies using GS plans had 1,000 or more employees and the median number of employees per company was 201 to 500. Kruse (1993) wrote that these numbers are similar to those found for PS plans. Average productivity increases are larger for smaller companies: The highest improvements in PS plans are found for companies smaller than 775 employees (Rynes et al., 2005).

An interesting paradox exists in the study of the effects of both GS and PS programs on organizational performance. Lawler (1988) wrote that moderators of the success of GS plans include a climate of trust between labor and management; and Kim (1999) noted that success dependes on whether or not the company is financially sound and able to make reward payments. Similarly, PS plans work better in companies that have shown an increase in stock price over the preceding two years (i.e., are generating a profit) (Kruse, 1993).

Lawler (1988) suggested that if companies are high on the two moderators listed for GS, they will not stand to gain a lot from implementing a GS plan. It is likely that this proposal holds for PS plans as well. Therefore, one key issue that remains to be resolved for both GS and PS plans is whether the GS or PS plan is a cause of organizational performance or an effect of organizational performance (Lawler, 1988; Kruse, 1993).

References:

  1. Bazerman, M., & Graham-Moore, B. E. (1983). PG formulas: Developing a reward structure to achieve organizational goals. In B. E. Graham-Moore & T. L. Ross (Eds.), Productivity gainsharing: How employee incentive programs can improve business performance (pp. 40-61). Englewood Cliffs, NJ: Prentice Hall.
  2. Kim, D.-O. (1999). Determinants of the survival of gain-sharing programs. Industrial and Labor Relations Review, 55(1), 21-42.
  3. Kraizberg, E., Tziner, A., & Weisberg, J. (2002). Employee stock options: Are they indeed superior to other incentive compensation schemes? Journal of Business and Psychology, 16(3), 383-390.
  4. Kruse, D. L. (1993). Profit sharing: Does it make a difference? Kalamazoo, MI: W. E. Upjohn Institute for Employment Research.
  5. Lawler, E. E. (1981). Pay and organization development. Reading, MA: Addison-Wesley.
  6. Lawler, E. E. (1988). Gainsharing theory and research: Findings and future directions. Research in Organizational Change and Development, 2, 323-344.
  7. Masternak, R. (1997). How to make gainsharing successful: The collective experience of 17 facilities. Compensation and Benefits Review, 29, 43-52.
  8. Rynes, S. L., Gerhart, B., & Parks, L. (2005). Personnel psychology: Performance evaluation and pay for performance. Annual Review of Psychology, 56, 571-600.
  9. Schuster, M. (1983). Forty years of Scanlon Plan research: A review of the descriptive and empirical literature. International Yearbook of Organizational Democracy, 53-71.
  10. Stack, J. (1996). The problem with profit sharing. Inc., 96(18), 67-69.
  11. Welbourne, T. M., Balkin, D. B., & Gomez-Mejia, L. R. (1995). Gainsharing and mutual monitoring: A combined agency-organizational justice interpretation. Academy of Management Journal, 38, 881-899.
  12. Werther, W. B., Ruch, W. A., & McClure, L. (1986). Productivity through people. St. Paul, MN: West.
  13. White, J. K. (1979). The Scanlon Plan: Causes and correlates of success. Academy of Management Journal, 22, 292-312.

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