How profit sharing can help you keep valuable employees (with calculations)
We’ve identified three major problems your agency can solve through profit sharing (including employee retention), and we’ve got the data to prove it!
Agencies lose an average of 30 to 40% of their talent a year, which means that valuable time, money and momentum for your team goes down the drain. Company loyalty isn’t what it used to be. The better your employees are at their jobs, the more attractive they become to other agencies, who can lure them away with more flexibility, better pay and benefits. Since burnout is a real possibility with the pace and demands of agency work, employers need to find ways to offer compensation and appreciation for high-performing team members. CEOs hesitate to offer profit sharing because they assume it’s going to take another bite out of revenue. However, many agencies who have done their research and implemented profit sharing discover that it’s is less expensive than repeatedly onboarding and training new employees. Profit sharing can help build employee loyalty and reduce turnover. While there’s no precise formula for profit sharing, it makes sense to consider billable ratio for each employee, examine how much revenue they’re bringing in directly, and factor in how long they’ve been with your agency. Offering rewards and appreciation built on these factors can empower employees and managers to keep doing great work. Here’s how you can use profit sharing to solve three common problems your agency might encounter.
Problem: Billable employees aren’t reaching their target ratio
All too often, the workload on a team isn’t evenly distributed. One member on your team of five works a ton of hours, and is consistently pulling in a 60% billable ratio, which is the recommended margin for agency work. That’s one amazing employee mixed in with four others who aren’t increasing profitability by hitting the 60% mark. You can easily discover exactly which team members are making the grade by calculating their billable ratio. Here’s how it’s done:
Billable Ratio = [Billed employee rate – Internal employee rate] / Hours spent doing all work
Let’s say each employee charges an hourly rate of $80/hour, and your agency pays them $30/hour as a base
As you can see from the chart above when your employees aren’t reaching 60%, you’re paying out salaries, but you’re not getting income in return. That directly affects your profit.
How to calculate profit for each employee: [Billed Employee Rate per hour * Number of hours] – [Employee’s base salary per hour * Number of Hours]
Here’s how performance translates to profits when you look at billable hours. All of your employees may be working really hard, but if they’re not spending enough time on billable projects, profits aren’t increasing.
When your margins are small, it may seem like the worst time to enter into profit sharing, but it’s actually the best. You want top employees to keep investing in your company, not looking around to see who’s going to offer them a better deal. If employees aren’t being rewarded for meeting or exceeding expectations, their productivity may decline, sinking your profits. And if they leave altogether, then someone else gets the benefit of their ability and work ethic.
Solution: Reward employees who reach your target billing ratio
Many agency owners who are just starting out tend to pinch pennies to conserve as much capital as possible. To many of them, sharing profit when their organization feels so vulnerable seems absurd. A profit-sharing incentive is actually an investment in your company’s foundation. For small agencies with minimal overhead, profit sharing can motivate your top employees to stay so your agency’s long-term development is stable and consistent. Start investing in your employees by setting a target billable ratio, rewarding employees who meet that goal with a small profit share, and making the results public. Too often, competent, hard-working employees are asked to shoulder a larger workload.
When other employees see that these performance leaders are making more money through a profit-sharing plan, they quickly figure out how they can increase their own billable hours. Here’s what it would look like if the other four employees on the team who weren’t pulling their weight started consistently putting in 100 hours a month: Before:
If all your employees start meeting that 60% margin, your total profit will increase by $7,000. Here’s the difference:
While there are no hard and fast rules about how to structure a profit-sharing system, agencies making a profit typically leave around 2.5 – 7.5% of annual net profits for profit sharing. Offering this carrot may mean less immediate cash in the bank, but you’re still making a profit overall-plus you’re retaining your employees. Thanks to your team working more billable hours, your agency has gained another $7,000. When you subtract the amount you lose from profit sharing from $7,000, it’s still a clear win overall. As the best employees start to reach that target ratio and receive shares, it will motivate other employees to figure out how to use their time more effectively through time tracking, making meetings more efficient, and other productivity enhancing strategies.
Problem: One team is responsible for most of the profit
Let’s say your agency made a small profit this year, but that’s because one new team whose three members have billable hours through the roof. You want to reward the entire team without disincentivizing others in the future. Of course, it would feel better to give everyone a bonus, but perhaps rewarding the standout team is a straight shot towards a long-term goal: to get everyone to think hard about their team’s progress so their team wins in the future.
Solution: Split profits among all teams
At a larger agency with more overhead and lots of teams, one way to reward your top performing teams-while incentivizing other teams to do well in the future is to reward teams proportionally to how much profit they earned. This means that the teams that generate more revenue will get a bigger piece of it. Offering a bonus like this is a way for company leaders to show their appreciation, and send a little motivation to employees who want to be part of one of the high-performance teams. Say you’re trying to initiate a profit-sharing plan and you’ve already accounted for next year’s expenses, like office rent, overhead, and salaries. Your company’s additional 10% of profit could be distributed like this:
If the teams didn’t yield the same profits across the board, you could adjust the percentages so it’s proportional to what each team earned. It could look like this:
Alternatively, if there’s 10% profit available, it should be distributed proportionally to each team’s contribution. If Team 1 contributed 40% to the profit, they should get 4% to distribute. If Team 2 contributed 10%, they should get 1% to split among the team. This rewards the team members on the most successful teams, rewards other teams for their work, and is a potent reminder that their profit-sharing check could be even larger with more billable hours next year. By rewarding everyone for their hard work and giving your best employees even more you’ll prevent turnover and conserve resources that was previously spent on hiring and training new employees.
Problem: Your managers keep leaving
A team is only as good as its leader. But if there’s no opportunity for long-term growth or an intellectual challenge, managers have little reason to stay. Replacing managers can be costly, but determining a profit-sharing structure for them can be difficult. CEOs can’t give managers profit shares based on billable hours because managers don’t have billable hours. Profit sharing can still provide a large, hierarchically-structured company with significant overhead a great incentive for growth. Here’s how to give managers a stake in your company that increases performance.
Solution: Share profit with high-value employees
When you give managers a stake in the company, it means that they’ll grow as the company does professionally and financially. Team leaders at the bottom of the totem pole could get a larger portion of whatever share comes through their team, which gives them more incentive to drive their teams towards a higher billable rate. To reward managers at different levels, executives can establish tiers for different positions and then offer managers at the top tiers of the company with higher shares. In tandem with a growing salary, managers have an additional financial incentive to stay at the company and oversee its profit growth. In this scenario, each team manager gets a slightly bigger cut of their team’s profit than their employees. This gives them more incentive to meet their targets and to drive their team towards a higher billable rate. Take this model:
Assuming each team has five members, this would normally mean that each team member gets 2 * .1 = .2 % of the company’s profit. Reducing that number slightly per each employee means that each team manager could have a slightly higher percentage without detracting from their employees’ profit share.
Having different tiers for different positions means you can stagger the reward and still compensate people at the highest echelons of the agency since they’re responsible for overseeing the professional growth of your billable employees. That gives your most talented managers a stake in the company, shows they’re valuable, and encourages them to stay.
Stay on track
Even though profit sharing is a useful tool for agency growth, it isn’t a requirement. If you’re at a small, fast-growing company, giving people equity or sharing profits is expensive, even when you’re making a profit. At the end of the day, your agency’s top talent want to do good work that’s intellectually challenging within an environment where they feel like valuable members of the organization. Giving your employees and managers a clear picture of how their hard work has improved your bottom line–by increasing theirs–is a great way to show your employees that they’re a valuable asset to your company.