Profit sharing is an incentive plan which awards employees with a certain percentage of company’s profits. Under this variable pay plan, the management of the company sets out a percentage of yearly profits as a pool for sharing with employees. The amount to be distributed is decided on the basis of a formula which is devised for profit distribution. Often, profit sharing results in more money shared with employees with higher salary and lesser amount to the employees whose compensation is lower. Profit sharing works best in organisations which have relatively stable earnings, or if the earnings are gradually increasing.
There are several advantages of implementing profit sharing mechanism which have been discussed below:
• Cordial employee-employer relations: In settings like factories, implementation of profit sharing will ensure that workers understand that their actions have impact on company’s profits, and hence on their final pay. Thus, they will take their tasks seriously and there will be lower chances of strikes and untoward incidents.
• Reduced turnover: Usually, the payment is directly related to the length of service of an employee in the organisation. Hence, employees will hesitate to move to new jobs if they want to earn higher bonuses, thus reducing the labour turnover.
• Less supervision: Employees realise that their higher efficiency will result in higher earnings for them, hence they are better motivated to work efficiently and thus, do not require constant supervision to enable them to work.
Like any other scheme, profit sharing has its share of pitfalls as well. These include:
• No bonus if the company incurs loss: the worker only gets his share of profit if the organisation earns a yearly profit. Hence, there is always an element of uncertainty associated with this scheme, even if the workers perform to the best of their abilities. In many situations, the company cannot earn profits due to external factors too, like recession, fluctuating demand or unfavourable business conditions.
• Measured reduction or profits: Sometimes, cunning members of the management manipulate the reports to showcase lesser profits, so that they can take away the share of the workers illegally.
• Not an effective means of measuring performance: Under profit sharing, no clear distinction can be made between workers. Thus, the high performing employees are not sufficiently motivated to work to the best of their capabilities.