10 Profit Sharing Plans Advantages and Disadvantages

One method of employee compensation that goes above and beyond the salary is a profit-sharing plan. In this type of plan, the leadership of an organization will designate a specific percentage of the annual profits (or all of the profits) as a pool of cash that is shared with workers.

Profit-sharing plans may include specific groups of workers instead, such as managers and above, instead of including the entire employee base.

Then the money pool is divided across the employees who are covered by the plan using a distribution formula, which varies by company. Straight cash, stocks, or bonds can all be part of a modern profit-sharing plan.

Here are the advantages and disadvantages of a profit-sharing plan to consider.

List of the Advantages of Profit-Sharing Plans

1. These plans offer companies a competitive advantage.

Whether unemployment rates are high or low, the companies which offer profit-sharing plans hold an advantage over the rest of their industry. With better benefits and an improved compensation package, it is easier to recruit and retain highly-qualified workers to stay within the organization. By bringing in the best people, there is more creativity within the workforce, which leads to more innovation.

2. It can save the company money.

Although the cost of a profit-sharing plan must be budgeted (and it is a cost companies without profit sharing won’t have), the retention of employees will save a company more over time. For every employee that must be trained, a company faces a potential one-time charge that is 50% of the salary of that worker. That means the training costs for just 10 workers at the U.S. median salary would be over $250,000 in one-time charges. With higher retention rates, profit-sharing can save money for some agencies right away. This structure also lowers recruiting costs.

3. People are encouraged to buy into the company vision.

People who are motivated by their salary will buy into the vision and mission of their employer more often when there is compensation on the line. If personal benefits, like profit-sharing, are higher when the company does better, then workers have an incentive to maintain productivity and engagement levels. This helps the company establish a greater market share of their industry, provides job security for the workers, and everyone makes more money. It’s a true win/win/win situation when everything works as it should.

4. It provides an atmosphere of accountability.

When individuals are leasing or renting space instead of owning it, then they are less likely to take care of it. Rental management agencies see this issue all the time with the properties they manage for landlords, which is why quarterly inspections are conducted. Without accountability, there is no reason to achieve specific standards if you’re comfortable with where you’re at. With a profit-sharing plan, accountability comes back into the organization. Teams keep each other accountable to encourage better results within the profit-sharing distribution. It really does create a reward for those who are willing to put in their best effort when they go to work each day.

5. Efficiency rates can improve with profit-sharing plans.

When a portion of the profits are shared with employees, it can give your internal efficiency rates a boost. It can also improve productivity, motivation, and employee loyalty. That is because profit-sharing creates a vested interest in the mutual success of everyone. There is a goal to ensure that metrics are met to boost profits, so everyone sees a boost in their paycheck.

List of the Disadvantages of Profit-Sharing Plans

1. The added costs of profit-sharing plans can be high.

The average worker is not going to complain if their employer wants to pay them more money. It must be remembered, however, that the pool of money that is used for sharing profits is finite. Sending more money to workers means there is less money for research and development, market outreach, product enhancement, or company growth. Companies with profit-sharing plans are investing into their workers instead of reinvesting into their structures.

2. A profit-sharing plan is only effective when it is equal.

This is the disadvantage which will grind many profit-sharing plans to a halt. When one worker gets a bigger share of the pie than others, then dissent is created within the workplace. Greater profit shares are usually handed out at the manager level or executive level. Some plans may not even reward entry-level workers for the work that they’ve done. When such a structure exists, it changes the pattern of incentive. Employees don’t want to work hard to fund the bonus of someone else. They’ll work hard to fund their own bonuses.

3. It changes the purpose of the work that is being done.

The issues seen at Wells Fargo since 2015 are a good example of what can happen when profit-sharing plans, bonuses, and incentives are not properly supervised. Wells Fargo charged customers for items they didn’t want or need, created fake accounts in customer names, and even refused to refinance loans for some customers, which caused them to go into foreclosure. Why did all of this happen? Because of the employee payment incentives that were in place without proper supervision. Placing the focus of an employee on profits takes away their focus from productivity and innovation. When that happens, the reputation of the company goes under.

4. There is no guarantee of value.

McLeodUSA was once one of the larges competitive local exchange carriers in the United States. At one point, its stock was above $100 per share. Then the markets began to change. As part of a profit-sharing plan, stock options were issued to employees that were based on value projections that were too high. With the stock trading below $10, employees had options to buy at $30. Even though it was a benefit, it was worthless. If there are no profits, there is no profit-sharing plan.

5. It may create issues of entitlement.

Some workers will put their all into a profit-sharing plan to reap the rewards. Others will do the bare minimum because they feel entitled to what they see as part of their salary. If all workers are compensated equally, but there are some who don’t put in the same level of work, then it may reduce the motivation of your hardest workers to remain productive. People who feel like they are undervalued will not sacrifice much for the good of everyone else. They’ll look out for themselves first.

These profit-sharing plan advantages and disadvantages show us that when it is structured correctly and has accountability built into its structure, it can be a beneficial addition to an employee benefits package. If it is not properly supervised or is built on false assumptions of profit, then it will drive people away.