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I am trying to get some insights regarding potential gross margin sharing approach for a hardware company. Company sells hardware to consumers, it is already profitable.

Engineers are scarce and management wants to optimize performance. One of the ideas they are considering is gross margin (Revenue minus COGS) sharing for the company.

They devised a system that is semi democratic. People and managers collectively allocate percent for each member out of a total pool. Pool doesn’t get large, new members reduce everyone’s share. They will make twice a year payments to people who has this right.

Their thinking is

  1. This doesn’t dilute ownership of the company and existing stock holders,
  2. This creates incentive for people to be more motivated (participation in company success, better pay)
  3. Other side benefits (better retention, more productivity and less hiring since the sharing pool gets larger, individual shares get smaller, likely better alignment because people will crowd out non performers and will force people to play nicer)

I am trying to think about counter points about their approach and one of them is that it will possibly create a bit more hostile environment if the share allocation is not managed well. Otherwise it is a well devised system.

What do you think ? How it can/will break and fail ?

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  • 3
    "people will crowd out non performers" - what is the mechanism for this?
    – svgrafov
    Sep 22 at 12:33
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    Of the company is profitable, it can just pay people more, no?
    – Pete W
    Sep 22 at 12:42
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    If you have underperforming employees, why not just let them go? Just sitting back and hoping the problem will resolve itself never works.
    – jwh20
    Sep 22 at 13:12
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    @MichaelJ. The same reason why nobody in movies will take a piece of the net anymore and insist on the gross. Too many games you can play with accounting on net. Gross can also be manipulated, but a bit less so. Look up Hollywood Accounting if you've never heard of this. Sep 23 at 5:30
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    You're letting engineers, the people whose career is to tinker and find shortcuts and find out how to manipulate systems to their benefit, decide who is getting paid? This is disasterous idea. Just pay people that you want to keep more money.
    – Issel
    Sep 24 at 14:00
69

I've seen a similar thing done with platforms like Bonusly, where staff get to "give" a certain amount of money out of a pool to each other to reward their colleagues. There are several problems with this kind of system (and with your suggestion):

  • It can reward people who are popular, rather than who are good.
  • It can reward people who staff think are more productive, rather than people who actually are more productive.
  • It encourages people to do things that make them appear more productive, rather than less glamorous or obvious things are are just as important.
  • It will cause resentment when people feel like they work "just as hard" or even "harder" than other members of staff, but get less.
  • It could potentially open you up to challenges about discrimination (for example, if all your male engineers are the ones who get bigger bonuses).

If you're going to give individual bonuses to staff, they should be based on clearly defined metrics (KPIs), or on the basis of the manager's evaluation of who is the most productive/useful - not based on who is most popular among the staff. Both of these approaches also have difficulties (particularly KPIs), but they're less likely to cause problems.

Alternatively, you could just share the bonus pool equally between staff - that way no one can complain about it being unfair. And if some of your staff are more or less productive than others, you can give them actual pay rises (or get rid of them).

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    Good points! Reading this response I wonder how allocating percent for each member is supposed to work. I have a vague idea about what close colleagues do and no idea for most others and I have really no clue at all how good or fast most of them are. How would I rate percents for them? Yes by popularity - aren't the popular ones those who don't work so much but are seen talking everywhere? Or by my personal plan - would I vote for someone who is really good (assuming I could evaluate that) but who could have more points than myself?
    – puck
    Sep 22 at 17:16
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    Excellent answer overall. I do recommend that OP does a bit of research into "the cobra effect" and its parent perverse incentive Sep 23 at 8:53
  • Thing is with having a "well devised" and also "self regulating" system: it needs control measures (your answer is on point: how do pool percentages get allocated, popularity or KPI's?). This reminds me of Strathern's (an anthropoligist!) generalization of Goodhart's law: When a measure becomes a target, it ceases to be a good measure. (Although, to be realistic, KPIs are measures too that can and have been gamed to benefit the gamer - this is just human nature.) (The "See Also" section in the Wikipedia article is interesting too...)
    – frIT
    Sep 23 at 10:12
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    I've never seen a single KPI that measured programmer performance that wasn't utterly idiotic. I'd much rather have my colleagues give me "x out of 5" ratings with no explanation.
    – Davor
    Sep 23 at 16:53
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    A true Meritocracy is like true Communism. It sounds good on paper, but is likely to be perverted by human nature. The premise of distributing a bonus pool is a flawed concept from the beginning. The only fair thing is equal distribution of equity in the company, and not insignificant amounts of equity. Your directly incentivized for the company to do as well as possible so as a partial owner, YOU will perform as well as possible. Regardless of what equity your peers hold, your motivation for the company to do well is still there. Sep 23 at 18:29
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The most important thing about any compensation plan is that people understand how their performance and results impact the rewards. The more direct the connection is the more effective bonus or profit sharing programs are.

It's not at all clear from what you've described how an individual's performance translates into money. It sounds more like a popularity contest which is likely to be counter-productive.

Take a hard look at what you are trying to incentivize, come up with as objective a way to measure that as you can, and tie revenue sharing to that measure.

Keep things a simple as possible. The more removed the compensation is from the desired outcomes the less effective it becomes.

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If you're lucky, it will turn into a popularity contest - see the answer by Gh0stFish.

If you're unlucky, it will descend into a very nasty power game. Those with the most power and influence get the most money.

If I am your supervisor, you'd better vote me a good bonus, or you're getting "requires improvement" on your next appraisal.

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  • Yes. Far better to just give everyone a profit-sharing amount based on salary.
    – jamesqf
    Sep 23 at 16:41
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    @jamesqf Far better to just set aside an employee stock program. Profit sharing is already complicated enough without ownership, and having a bit of a valuable company makes most people want the company to be more valuable. Of course, this doesn't fix performance directly, but these two areas aren't directly connected no matter what plan one devises.
    – Edwin Buck
    Sep 23 at 17:51
  • @Edwin Buck: Either one solves the basic problem with the OP's plan, that the "sharing" turns into a popularity contest.
    – jamesqf
    Sep 24 at 20:36
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I'm a highly paid, high performing engineer (software rather than hardware, but the example holds true). I have two options for my next job- your company with this pool, or PublicCo which is going to give me RSUs. Why would I ever pick yours? Let's look at the problems:

  • With RSUs, I know about how much they're worth by looking at the ticket price. I have no idea what the size of the pool is, what percentage of it I get, etc.|
  • RSUs are more stable. In general, companies don't hugely dive or grow in a given year. But profits change drastically.
  • RSUs are priced by the market. Your pool is priced by trust. You say it's accurate- but we all know the kind of Hollywood accounting companies can do. (You are using gross not net which is less gameable, but can still be played with easily). In a public company, that kind of game playing with RSUs is difficult and would be very public.
  • If I believe in my company, I can hold onto RSUs. A profit pool is terminal each year.
  • With an RSU grant, I know up front what I'm getting. With a pool system and allocated shares- its a popularity context with management. There is 0 chance it will be fair or equitable. I'd rather just have my payment negotiated up front, thanks.

Quite frankly the fact that you go profit sharing rather than equity is a giant turn off. It makes me trust you less. Especially if you're public company.

If you're a private company- I'd still rather have options and equity and get my lottery ticket for when you go public/get acquired. Going with a profit sharing pool means you're not willing to let me get at the real money and makes your offer less attractive.

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    Perfect answer. The best most productive employee is a partial owner, and not by an insignificant amount. The early Silicon Valley success stories operated mostly like this, with early startup employees being offered significant equity that gave them motivation and a potential huge payoff if the company was acquired. This is why these employees worked such insane hours. Fast forward today, VC firms "incubate" startups and game it so founders and VC have all meaningful equity and employees are given tiny amounts, yet still expected to work insane hours for a fake carrot on a stick. Sep 23 at 18:36
  • The problem, though, is that you have a pretty limited pool of stock. That is, issuing new stock to give to employees dilutes the value for current shareholders. So you can effectively run out of new stock, but with any luck, profits will keep coming in every year.
    – jamesqf
    Sep 24 at 20:39
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    @jamesqf Yes, that's what equity is. Its giving a part of ownership from existing owners to the employees who do the actual work. You can always issue new stock, it just dilutes existing ownership. So no, it never runs out. Which is part of the problem with the proposal- they're trying to throw crumbs at their employees in hopes they don't see the loaves the owners are unwilling to share. Sep 24 at 21:33
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First of all I have no experience in real-life with this kind of experiment. But I try to feel like someone working under these conditions.

new members reduce everyone’s share

Would people be happy if someone new is coming? Probably not. New employees would have a bad time.
Probably employees would try to play the need of new manpower down until projects are delayed beyond reasonable limits.

If you need more people to do more work, then you should have more bonuses available.

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    It is very often that if new people are being hired, then company revenues are up. And therefore the overall pot for bonuses should get bigger.
    – bfris
    Sep 23 at 23:47
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I'm not an HR person, but I've worked for large companies with complex compensation schemes.

What you are talking about is normally just called a bonus. There's a pool of bonus money calculated at the end of a bonus period, and each employee gets a slice of it based on some magic calculation.

One place I worked, you were assigned a "target bonus". If you met expectations, you got the target. If you came close, but no cigar, you got half. It was also possible to get no bonus (in which case, it was a strong hint to polish up your resume). A small subset of folks would get 150% of target and folks who hit the ball completely out of the park could get 200% of target. There was no guarantee of anyone hitting the 200% number, but there were quotas for the 0, 50, 100 and 150% buckets.

In at least one place I worked, the target bonus was expressed as a percentage of the "bonus pool" number that would be announced at the end of the period. That's sort of what you are describing. When the bonus pool number was announced, everyone would get their calculator out and start multiplying.

In some places I've worked, different aspects of compensation reflected different measures of worth. Consider:

  • Salary: what you get for showing up and doing your job every day
  • Promotions: how your worth to the company has increased over time
  • Bonus: your relative worth (relative to your pool of peers) over the past year
  • Stock grants/options: at two places I worked at, these were awarded based on management's impression of your future worth to the company. Since they generally have a vesting period associated with them, they tend to be very future oriented.

The semi-democratic mechanism you describe can be problematic. These are often called 360 Reviews; your review is based not only on what your manager thinks, but also on what your peers and your direct reports (if applicable) think. Whenever I've seen this, the feedback from the reviews is often close to useless. Most people are only going to give somewhat positive feedback; no one wants to be the slimeball, and you don't really want to be too glowing in your review of a peer (since you get paid from the same bucket). But, look up "360 Review" to read about it.

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This is a terrible idea on many levels.

First, it creates resentment and competition between coworkers. Under this system, bonuses are fundamentally a zero-sum game; if I give you $100, there's $100 less for me. This will likely create resentment, manipulation, competition, and possibly even outright sabotage between coworkers, given that other people are effectively obstacles to me getting my bonus.

Secondly, this will tend to result in people being motivated to get the money, not to do the work. Additional pay beyond what people perceive as fair and adequate has a rapidly diminishing marginal return as far as motivation goes. You may want to read the book Punished by Rewards to understand why this is.

Third, many people don't have a clear connection to revenue, in which case it would not motivate them (because it's out of their control). For example, as a software engineer working on several high-visibility projects, I understand why my role is important to the company; however, it's hard to quantify exactly how much I contribute to the company's revenue.

Fourth, even if I do have a clear connection to revenue, it becomes so diluted by the time it gets to me that it's hardly worth it. Suppose that 10% of revenue goes into a pot for bonuses, and it's split 50 ways. If I'm a salesman that generates $1 million in sales, that means that $100,000 goes into the pot; divide that by 50 and it's $2000. By way of contrast, if I have a $500,000 year, I still get $1000. If I have a base salary of $100,000, that's only an extra 1% of my salary. The question then becomes: how hard do you work for $1000? Would you work twice as hard to get a one-time 1% bonus?

Finally, this would not directly reward cost savings. If I save the company $100,000, how much does my bonus increase as a result? Well, it doesn't because a cost saving is not revenue.

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People and managers collectively allocate percent for each member out of a total pool. Pool doesn’t get large, new members reduce everyone’s share. They will make twice a year payments to people who has this right.

That means NO measurables to be accounted to.

"Vote" can be rigged as every vote can , and IMHO it will be

This looks like a great system for management to curb intake of new employees and distribute work between existing ones without additional expenses for overtime or bonuses.

Short term solution, but i can see work for about a year

Perhaps there is a plan to sell / merge company in that period of time

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