Let’s first set a definition of recognition: It is creating a business structure where your key employees are given authority and responsibility, which is tied to profit and accountability. This becomes a “profit center” that the key employee manages. Each profit center has separate profit and loss accountability, which is determined frequently. (Many fast food stores operate on weekly profit and loss statements!) The idea is to create an atmosphere where your key people feel they have entrepreneurial decision-making authority and are paid incentive compensation based on their own center profits. But, they are not given authority in two non-delegated roles, which remain your sole responsibility:
- Capital expenditures
- Signing checks
This suggests that your key people will be given enough latitude in operating their profit centers that they might make some mistakes.
By the two restrictions stated above, plus frequent financial reporting, you can recruit well-motivated managers and at the same time limit your exposure to big losses.
Obviously, the incentive plan must be tailored to each business situation and be based on the profit and loss report of the individual’s separate responsibility.
By rewarding managers through profit participation, you create the engine that will drive your managers to success. And, the greater their success (and reward), the more your overall business will benefit.
Here are three types of plans (there are many) that have been used to structure a manager’s incentive:
Leveraged profit sharing plan
Managers receive all, or a large part of, unit earnings over a fixed target. This has been used successfully by fast food chains that are company owned and operated (rather than franchised units). Here is an example of a simplified weekly income statement of a donut shop that is operated by a company employee-manager. This plan is “leveraged” because every penny saved becomes a penny going into the manager’s bonus check.
| Sales | $5,000 | |
| Wages | $1,500 | |
| Purchases | $1,500 | |
| All other expenses (including co. profit) | $1,500 | |
| Total expenses | $4,500 | $4,500 |
| Weekly profit and manager bonus: | $500 | |
Unleveraged profit sharing plan
In this case, your manager receives a percentage of earnings of his or her profit center. Here is an example:
| Sales | $5,000 | |
| Wages | $1,500 | |
| Purchases | $1,500 | |
| All other (actual) expenses | $500 | |
| Total expenses | $3,500 | $3,500 |
| Net profit | $1,500 | |
| Manager bonus @ 10%: | $150 | |
Commission plan
In this plan, the manager receives a percentage of sales for the accounting period. Assuming, as above, that sales for the period are $5,000 and the commission is 5%, the compensation would be $250. In many instances, commission incentive is not appropriate because it does not include provisions for expenses. Your manager could get rich while you go broke. But commission incentive can work well when the manager does not control pricing. Salespersons in a retail-clothing store would be a good example of a commission structure.
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