Case Study: John Lewis Partnership
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Profit sharing is one of the most tried and tested incentive systems in existence. It is certainly one of the oldest. The first recorded scheme in England dates back to 1794 and economists were writing about the merits of profit sharing more than 150 years ago.
Old ideas that last, usually have some merit, and profit sharing remains significant. According to statistics from Incomes Data Services, around 10% of engineering firms operate such schemes, as do 20% of call centres. Profit sharing in various forms is also very widespread in major sectors such as finance and retailing, offered by firms such as Lloyds TSB, Abbey, Royal Bank of Scotland, Tesco and Argos.
In recent years a large number of employers have started to offer Share Incentive Plans (Sips), which provide financial benefits to both employer and employee, and like profit-related pay have previously been heavily promoted by government.
As a form of profit sharing, Sips however, tend to be both inflexible and fairly remote as an incentive. They can also create divisions between insiders and outsiders. Cash schemes, on the other hand, mean that each year everyone is in the same position, whether they’ve been with the company for one year or 20. With share schemes, employees build up holdings over time.
Share schemes also can’t be applied to flexible workers such as contract staff. Media company SMG, which owns Scottish and Grampian TV as well as a large advertising business, has about 800 permanent core employees in addition to large numbers of contract and freelance staff. But as HR director Peter McGrath points out: “It’s misleading to refer to non-core people in this context – many of them are core as far as the business is concerned. They ask whether they can participate in our share scheme – we have a buy-one-get-one-free arrangement – and we must explain about Revenue rules.” SMG is in the process of developing its incentive arrangements and is likely to introduce a form of profit share, or gain share, over the next couple of years. Remuneration policy at boardroom level was recently changed with a move away from individual targets to company-wide financial targets, and the performance focus further down the organisation will also shift.
“Shareholders like to see that whatever you are doing for your senior people is consistent with your policies elsewhere,” observes McGrath.
The gainsharing option is one that many companies have adopted. Gainsharing was devised by the US steel industry many years ago to describe bonuses linked to productivity, whether by group, business unit or company-wide. The classic form was based on the ratio of labour cost to total production value. A normal ratio would be set or agreed and savings distributed monthly. Management profit was derived from increased sales without a corresponding increase in costs.
A key element is a focus on joint production committees, which considered and implemented shopfloor proposals for saving costs. The same combination of profit sharing and participation can be seen at employee-owned companies such as John Lewis, and it is arguable that such an approach is necessary for profit sharing to be of most benefit to the employer. One great advantage of gainsharing is that it can be readily adapted.
Cummins’ engine plant at Daventry, for example, introduced a variable compensation scheme in 2005 which combines plant performance criteria such as quality, safety and on-time delivery with a company-wide element – profit after tax .
Store group Beatties (part of House of Fraser) meanwhile, uses profit sharing to reward staff who stay with the company. Employees with one year’s service receive about one week’s pay, which rises to four weeks’ pay for those with three years’ service or more.
And Littlewoods stores introduced a scheme in 2003 based on the achievement of budgeted operating profit, although staff are guaranteed a small payment should the target not be met. In contrast, Woolworths offers a bonus worth up to two weeks’ pay based on profit targets for individual stores.
These levels of flexibility are essential if firms are to cater to the needs of their workforce. Two final points for employers considering introducing profit sharing are payment levels and timing.
Outside the finance sector, and with exceptions such as John Lewis, payment levels tend to be limited: 5% is often considered a good target, and a 3% ceiling is not uncommon. As for timing, there are advantages in bringing in a scheme when profits are low. That may seem paradoxical, but a scheme that pays out well initially and then falters is likely to produce an adverse reaction.
Case Study: John Lewis Partnership
Partnership has become a fashionable concept of late, but the John Lewis Partnership celebrated its 75th anniversary last year. In January 1929, a notice to customers announced that henceforward: “All of the profit will go to the workers, managers and managed alike, in proportion to their pay, as the best available measure of their respective shares in the common effort.”
Today, the organisation continues to be one of Britain’s best-known employee-owned firms, where the shares are held in a trust, not by individuals.
John Lewis has a highly-developed system of employee communication and participation, including a weekly newspaper (Gazette) and partnership councils that run alongside the normal management structure and enable partners to hold management to account. A central Partnership Council is able to question executives on any aspect of the business and each main operating unit has a similar council, meeting roughly every three months.
Profit sharing is the key to the firm’s operations. Helen Megaw, corporate PR manager, says: “The annual bonus is a big event [and] seen as a fundamental benefit of working [here].”
Although the level of the bonus is a board-level decision, taking into account future investment plans and other long-term issues, the reasons behind the decision are explained and staff are kept informed of the state of the business via the Gazette.
Payments are made in March and can vary considerably, from 8% to as much as 25%. The most recent bonus was worth 14% – equal to seven weeks’ pay – compared with 12% in 2004.
This is well ahead of bonuses in other stores, as well as many firms in the finance sector, and is one of the reasons why John Lewis enjoys a much lower level of staff turnover than is usual in the retail sector.
Another business benefit is its impact on employees’ commitment to customer service. Unlike some retailers, John Lewis does not pay commission on sales, so staff are not competing against each other nor are they tempted to promote a specific product.
There has always been some debate about the extent to which employees share the company’s philosophy, but Megaw is in no doubt: “The feeling of ownership and democracy does matter. It is our business, not owned by shareholders who have nothing to do with the company.”
Profit sharing: the key issues
Companies with high levels of capital investment need to take care in framing profit sharing formulas.
Payments fixed in cash rather than a percentage can be comparably too high for low-paid staff.
Constant or continually rising payments will lead to misleading expectations. The profit share needs to fluctuate.
There can be problems when trading conditions deteriorate suddenly and payments relate to a previous period because the message sent is confused.
Any formula for profit sharing (or gain sharing) needs to be regularly revised. This is important for maintaining employee interest as well as to reflect changes in business priorities.
Change is good, but needs to be justified, otherwise employees can become cynical about the scheme.