Unethical behavior continues to be a major problem in all industries. A recent survey indicates that, as a result of inventory shrink alone, a group composed of many of America’s biggest retailers lost $34.5 billion in 2011, 44% of which came from employee theft!
You probably are aware that some workers steal. But you may not be aware that your pay programs and incentives may in effect encourage good employees to behave badly by failing to pair those incentives with strong internal controls as well as ethics policy and training. The result is that behavioral problems are unintentionally encouraged, from simple interpretation issues to minor or major losses that can damage the financial viability of the business.
Recently, a Florida woman was indicted for embezzling from a building materials store over four years. The initial loss estimate of $3,700 grew to $30,779, creating a pattern similar to the stages of grief: shock (a trusted employee did this?), followed by a minimalist view (it can’t be that bad), followed by reality (it really is that bad).
This is an example of direct theft in which small problems grow over time, often because of nonexistent or ineffective internal control systems. We really don’t know how bad a problem this is at construction supply companies, because I believe most violations go undetected.
For decades, the management truism has been “you need to inspect what you expect to gain respect.” In the case of employees behaving badly because of pay and incentive programs, the key rule is this: Someone other than the affected party must control the situation. Not even a manager should be entrusted with controlling his or her own actions.
Pay and incentive programs in our industry typically range from full salary to full commission. Each comes with its own set of control issues; there’s no totally safe plan. So all owners must establish a control system to ensure that pay programs aren’t abused. Otherwise, incentive plans become inventive plans.
At one end of the spectrum is the full salaried plan. Easy to compute and administer, it ostensibly allows the manager and sales associate to perform at their best via the comfort of predictable earnings. In actuality, this type of plan causes the employee to operate within his or her comfort zone. If this coincides with business objectives, fine. But in general, you can’t count on that being the case.
Comfort zones are stress-free and anxiety-neutral. Comfortable environments are rarely the breeding ground for optimization. For a full-salaried plan to work, owners must manage and control most activities of the employees’ workday or simply overpay or underpay. Overpayment causes additional cost, and underpayment tends to lead to turnover.
Dealers typically seek to negate those potential problems by creating incentive-based plans. That’s fine, but keep in mind that each component of the pay plan requires consideration of risk and some sort of internal control to make sure that the component is working as expected. And anyone on a variable pay program must be trained to understand how the plan works.
Let’s look first at incentives based on shipped sales and/or gross margin. These bonuses often are sent out monthly or by pay period. As a result, this plan creates pressure for short-term results, and the shorter the time period for assessment, the greater the number of problems.
The problem compounds if there is a tiered incentive, such as a lower incentive on lower sales or margin and a higher percentage as sales or margin grow. This can cause employees to move sales from one accounting period to the next.
I personally eliminated sales dollars and gross profit percentage as goals long ago. Instead, I prefer to pay based on a percentage of gross profit dollars (collected, if possible). This way, the trade-off argument of sales volume vs. price is minimized.
Now compare incentives based on sales or margin with incentives based on how working capital is treated. This system does encourage the employee to avoid extending credit and/or keep inventories low. But some will do so by manipulating the numbers—and never think they did wrong. Decades ago, a manager floated an entire barge with $300,000 worth of lumber down the Chicago River until after inventory, just to make sure he didn’t lose a bonus.
When these types of incentives are in play, you must ensure that the employee knows the rules, so that they can follow them. In many cases, our employees think they can simply manage working capital in any creative way they choose, but there are rules that must be followed.
Paying managers for controlling payroll cost can lead to potential negative outcomes: understaffing and poor customer satisfaction.
If owners and managers create an environment of consistency and ethical behavior and lead by example, employees tend to follow. Weak systems beget weak compliance. Sadly, many owners and some managers are the first to break the rules.
We all want to trust our employees and fellow associates. But we must realize that sometimes we set up systems that have too many incentives to cheat. When this happens, we are encouraging employees to behave badly. is a consultant based in Atlanta.