Summary
What It Is
Compensation varies according to the business’ success. It includes basic compensation, profit sharing, and optionally, stock.
What Problem It Solves
Variable compensation aligns the interests of the workers with those of the owners and thereby, persuades the owners to share governance with the workers.
How It Works
Workers’ compensation is a percentage of the revenue left after obligations to the owners are met and business costs paid.
Benefit: Why It Is Better
Variable compensation reinforces in the worker that their income depends on success in the market place. This and the profit sharing incentivize the workers to obtain results that matter.
Discussion
This article discusses that part of compensation which is the dividing of the economic fruits of enterprise with the workers. There are other kinds of compensation to workers that are also important such as the intrinsic reward of the work itself, opportunities to perform other work more valued by the worker, recognition, and awards. This article only discusses the kind of compensation which concerns accountants and the tax collector, i.e., compensation with monetary value.
Compensation is Variable (at risk)
One of the central concepts of Liberty Workforce is that the worker’s entire compensation is variable or at risk. This means that their compensation rises and falls proportional to the rise and fall of their firm’s profits. There are no fixed components in their salaries and wages. In a typical business today, a worker receives a salary that is constant regardless of how the business is doing. Only the amount of profit sharing usually depends on the success of the business. In Liberty Workforce, all compensation, not just profit sharing, tracks the fortunes of the enterprise.
Variable compensation accomplishes two important objectives. First and foremost, it brings the workers more in harmony with natural law: compensation now depends on results in the marketplace. This will help eliminate labor aberrations such as just putting in time at work, appearing busy, and impressing the boss. This closer exposure to the law of the harvest will encourage workers to judge every activity by how it will increase profits and delight the customer. The result will be greater productivity for the business and higher compensation for the worker.
Second, variable compensation is a principle part of the incentive that influences owners to want to share governance with the workers. To begin with, it is key to helping the workers think and act like owners. When the desires and goals of the workers are aligned with those of the owners, it increases the likelihood that the owners will agree to share power with the workers. Equally important, the variable worker compensation makes possible the main financial motive for the owner to agree to the power sharing. This motive is that the workers will allow the owners to have a fixed, average profit before they (the workers) pay themselves compensation. This assures the owners a cash flow profit every year from operations. Of course, this does not preclude the owner having a loss for the year due to events like natural disasters and accounting write-downs, but it is as close to a guarantee to a profit every year as can be imagined. Variable compensation is part of what the workers offer the owner in exchange for the owner agreeing to share governance of the business with the workers.
Some workers will think that sharing governance is not worth the risk of their paycheck being short. Or stated another way, they do not believe they could succeed in the marketplace. Liberty Workforce is not for everyone. It may not be appropriate for workers who don’t believe in themselves or who aren’t willing to take risks. Notwithstanding, if the company where these workers are employed now is making a profit and payroll, then these workers would be able to succeed in this same company as a Liberty Workforce. The security they get from a fixed paycheck is somewhat of an illusion. Yes, some owners will sacrifice a little profit or tolerate a little loss in order to make payroll. But, before long, if it continues, they will be laying off workers to stop the flow of red ink. Liberty Workforce removes the illusion of a secure paycheck from the workers’ mind and gives them power to deal with the reality of market forces. These workers may not be the early adopters of Liberty Workforce, but as they see it succeed in other companies, they may grow to prefer this power over the illusion of a stable paycheck.
Publishing a history of the business’ compensation payout ratio will help potential workers feel more comfortable with the concept of variable compensation. The payout ratio is the percent of compensation paid vs. the workers’ stated compensation (i.e., the compensation he would have received if compensation were fixed).
Bases for Dividing Up Compensation
It is useful to discuss various possible bases for dividing up the compensation among the workers before discussing the compensation recommendation for Liberty Workforce. While the next section will contain this recommendation, it should be understood that in implementing Liberty Workforce, a business can adopt any bases it thinks best. The only firm requirement is the variable compensation previously discussed. For example, while many businesses will find themselves at a competitive disadvantage in hiring the best workers if their compensation system is based on something that does not allow them to pay market value salaries, other businesses whose mission is more social, for example, might more easily attract the best social entrepreneurial talent if their compensation system had a decidedly social justice bent to it (e.g., based on personal need as discussed below).
Per Capita
A basis other than the individual is almost inconceivable now. In times past, there were probably other bases such as compensating the master for work done by his slaves, the head of household for all work done by children, etc. Today, we probably do not need to consider any other basis besides the individual worker. In a per capita basis, an individual worker is compensated for the work he or she performs.
Yet, there is another way of looking at per capita as a basis: every worker receives the same compensation. Some might think this is the ideal, but given the human condition, it is unviable for total compensation. As such, a discussion of it as an ideal is moot. However, as a basis for the distribution of profits, it can be considered.
Personal Need
Some might also suggest that society would be better served by compensating workers according to their needs. This concept is certainly mirrored in the regressive tax policies of some governments. Even some employers argue for secrecy of the amounts of an individual worker’s compensation because it allows them to adjust compensation for factors such as need. To effect compensation based on need, workers would likely have to share their personal affairs, engage in debates about what needs are justifiable, and so forth.
A compromise or partial implementation of this basis would be a minimum salary for a career position. A career position is a job that the business desires workers to remain in for years (i.e., desires low turnover). This is in contrast to starting jobs requiring little skill and training where high turnover is normal and acceptable. Starting jobs are for high and college students and for those seeking additional income, but are not providing for a family. The minimum salary is what would be required to support a standard family at a minimum level.
Market Value of the Worker’s Services and Qualifications
In developed economies, the basis is usually the market value of similar services. Employers compete for workers with other employers. Employees usually accept employment with the employer who agrees to pay the most compensation. Thus, the worker’s compensation is based on the market value for the kind of services for which he is hired. It is not based on the value of the services he actually performs for the employer. The services of an engineer are worth less in the marketplace than those of a CEO even though both might be essential to the success of the business. Under the market basis, an employer would pay the engineer less than the CEO.
Equal Pay for Equal Work
A market basis sometimes results in situations where workers performing the same work receive different compensation. This could be because of biases favoring gender, race, etc. Or it could be perceived value of worker qualifications. An example of the latter is a worker with an accredited engineering bachelor degree being paid more than a worker doing the same work who only has a non-engineering associate degree. Compensation on the basis of equal pay for equal work is usually still loosely based on market value, but is modified to remove variations correlating to race, gender, ethnicity, and socio-economic factors.
Impact on Profits
It is said that there are certain positions in a business where the performance of workers in those positions have a much greater effect on the profitability of the business than most other workers. For example, the profitability of an architectural firm is more closely aligned with the performance of the principal architect than a production architect. Obtaining projects in the first place depends on the principal’s client relationship skills. Principals with better negotiating skills receive higher fees for the same work. On the other hand, the difference between acceptable work and excellent work by the production architect makes little difference in obtaining work or in client satisfaction. The only difference the production architect can make in profitability is how fast he can produce the required drawings. Under the idea that rewards should be proportional to results, one could legitimately reason that workers in these high impact positions who perform well should be rewarded much more than most workers.
Yet, to some degree, it is the position that makes them high impact rather than their personal excellence. Or, in other words, the position amplifies the impact of the worker’s performance. So, when it comes to distributing profits, some would argue that it is not fair to give profit sharing bonuses to workers in direct proportion to their impact on profits when that impact results only from their position. Using the architectural example again, let us illustrate this problem. Assume that that the principal architect was able to negotiate a 7% fee because of her excellence whereas an average principal would only have received 6.5%. Assume also that it takes a 6% fee to cover costs normally, but that the 10 production architects on the project were able to reduce costs by 10%. Using these numbers, the principal architect’s excellence is responsible for a 31% increase in profits, while the production architects’ excellence is only responsible for a 4% increase per architect. Again assuming there are just these 11 workers and that the “normal” part of the profit is divided equally and the “due to impact” part is distributed proportionally, then the principal architect would receive 34% of the profits and each production architect would only receive 7%. It is hard to justify that the excellence of the principal architect is worth five times the excellence of the production architects. This seems especially true when it was the efforts of the production architects who produced the actual work (high impact workers typically do not produce any deliverables). Work is produced by a team. It is somewhat de-moralizing to team members who actually do the deliverable work when the high impact workers are paid so much more without actually producing anything a customer will pay for. Some would argue that profits should be shared more “equally” among all workers and not exactly proportional to their impact on profits.
Individual Performance
Another rationale is to base compensation on how well the worker performs. Those that perform excellent would receive a greater share than those that performed average. The theory is that rewards proportional to results will motivate the worker to produce higher results. There are workers who will not put in extra effort or hours if they don’t receive more money as a result. Giving out the same compensation to every worker, regardless of their performance, does not take advantage of this motivational opportunity. However, there are some serious, insurmountable challenges with performance based compensation.
First is the message it communicates to the workers. The owners are rewarded based on the overall business performance. One of the goals of Liberty Workforce is for the workers to feel and act like owners. Dividing up the compensation based on individual or Unit performance will have the tendency to reinforce the attitude that the worker is an employee. It communicates that they really are not owners. It says that the all-knowing and powerful management benefactors need to create motivational schemes to guide their inferior minions because they are incapable of making proper choices on their own and will not work unless a carrot is dangled in front of them. Performance reward systems can have this demeaning effect.
Next is the problem that performance based compensation works against the unity necessary for high performance. Work is produced by teams. When individuals are compensated according to their performance, then individual will do things that increase their individual performance. They tend not to do things that adversely impact their performance. These individualistic pursuits can have serious negative impacts on the performance of the business. Tasks necessary for the good of the business that don’t affect the individual’s performance tend not to be done. The individual is focused on his bottom line rather than the company’s bottom line. For example, an experienced worker will not want to mentor a new worker because time spent mentoring negatively impacts the experienced worker’s performance. As a result of this self-centered focus, the new worker does not perform as well and the business as a whole suffers. It is the team that succeeds. Rewarding individual performance weakens team performance.
Another problem with compensation based on individual performance is who is to be the judge of this. If a person (a manager) is the judge, then this gives that person power over the worker. The Liberty Workforce concept is to free workers to govern themselves. Having such a judge puts them in bondage to the judge. Furthermore, the focus of the worker is distorted to pleasing the judge rather than pleasing the customer. This has negative impacts on the success of the business.
Yet, another problem is that performance measurement can result in anomalies adverse to the business. Take for example a company that produces all sizes of armored military vehicles. Management wants to have a simple metric they can use to measure and reward the worker’s productivity. With all the various sizes of vehicles, a metric based on count would not reflect the difference in man-hours required to produce the various vehicles. But, they realize that larger vehicles which require more man-hours to produce also weigh more. So, they determine to use the metric of weight to normalize the differences between the vehicles. They set up a pay for performance plan for the workers based on the weight of the vehicles produced per week. This all seems very reasonable. But, it resulted in the workers incorporating more steel than necessary in the construction of the vehicles so that they would receive more pay. This not only increased production costs, it resulted in greater fuel consumption in the battle field. It often is best to base performance rewards on the natural metrics in the market system (e.g., profits, sales, etc.) rather than create artificial ones. To reward most workers (except some like salesman) based on individual performance requires artificial metrics which could have deleterious effects on the business.
Unit or Group Performance
Another factor to consider is whether to base compensation on Unit performance. This would bring the control of the profits more within the reach of the workers; and thus, it would have a greater motivational effect on the workers. This could possibly be useful if there were naturally occurring metrics and each Unit is like a separate business for all practical purposes. Examples of this would be individual retail stores and architectural offices. However, some of the same challenges exist for rewarding individual Units as for individual workers. Some stores are in low profit and/or high theft areas. Workers in these stores would receive less compensation than others simply because of where they worked. This is neither fair nor motivational. Also, individual units need to cooperate with each other. They work as a team. Rewarding them individually breaks up the team and can result in adverse results for the overall company’s success. Furthermore, in a business, there might be some Units that meet the separate business with natural metrics criteria, but not all. The Units or workers that don’t meet those criteria will then present a problem of how to fairly divide up their compensation.
Nevertheless, it might be useful to have a small portion of the profit sharing based on Unit performance where Units are separate businesses and natural metrics exist and then have the rest of the profit sharing be based on overall business performance .
Components of Monetary Compensation
There are two components of monetary compensation that are integral to the Liberty Workforce. One is basic compensation which is the worker’s wages and salary. The other is profit sharing. There is a third type that is optional, but is often used with good results: stock and stock options.
See the article “Financial Topics” in the Finance and Legal Structure category to learn how basic compensation and profit sharing are calculated.
Basic Compensation
The basic compensation component is similar to traditional business except for its “at risk” nature described above. A job applicant would negotiate a salary with a Liberty Workforce business as with any traditional business. In normal times, the worker will receive that amount of salary in his or her paycheck. In lean times though, it will be something less. That is the “at risk” difference.
Considering all the bases for compensation previously discussed, it is recommended that basic compensation be based on the market value for the worker’s services and qualifications, adjusted to remove the effects of gender, race, and other biases (i.e., equal pay for equal work) and to provide a minimum salary for career positions (i.e., personal needs).
Bases of individual performance and impact on profits should not be used. Individual performance is too difficult to implement without negative side effects. Similarly, impact on profits is almost impossible to determine precisely. Regardless, it is generally reflected in the market value, so there is less a need to consider this basis.
Hourly Wages for Part-time Workers Only
As has been stated many times, the purpose of Liberty Workforce is to create a work situation where the worker feels and thinks like an owner. Punching a time clock is one of the most employee-like things a worker could do. It is difficult to conceive of how the goal of Liberty Workforce could be accomplish without eliminating this artifact. Few owners, if any, keep track of hours worked. They are (or should be) focused on results. Tracking hours sends the message that it doesn’t matter what you accomplish, but only how long you work. Shift work, and office work to a lesser degree, require the worker to be certain places at certain times. But, no time clock or hourly wage is required to accomplish this.
One of the advantages of hourly work is the flexibility it gives management to increase the rate of production without hiring more workers by asking workers to put in more hours per week. Giving workers a salary who typically do this kind of work would appear to remove this flexibility. However, salaried office workers regularly put in longer hours as needed without additional compensation. What is different about Liberty Workforce is that the workers are their own managers. They can decide to work longer if they feel it is needed. Furthermore, in Liberty Workforce longer hours can mean more compensation and profits because the workers share all the results of their efforts. In the typical salaried position of a traditional business, longer hours have little or no effect on the compensation of the worker. The flexibility in hours worked to increase production will be present in a Liberty Workforce business even though all workers are salaried.
Nevertheless, workers will need to be considerate of their own and fellow workers’ situations when working longer hours. They will want to spread the load as fairly and evenly as possible across all the workers. While workers will be compensated for results accomplished through longer work hours, the effect can be diluted if the work is not spread evenly. To illustrate, assume there are ten workers, but only one worker puts in extra time. If he puts in ten extra hours, he will only receive the benefit of one hour of those ten hours. This is because everyone shares in the results. The results of the other nine hours are shared with the other nine workers even though they didn’t do any extra work. Liberty Workforce gives more to the workers, but it also requires more. Consideration and fair sharing of the work are some of those requirements.
The discussion about hourly wages so far has been based on full-time positions. In some situations, a business may find it beneficial to have part-time workers. A salary could be an option for them as well. They might work a few full days per week. They could be eight hour work days, expanding to as many hours per day as possible and necessary, but never to more days per week. This would give the flexibility required to meet the demands of business. However, due to the variable hours and days of most part-time work, an hourly wage is probably the only way to accommodate it. Thus, in Liberty Workforce, hourly wages should only be used for part-time workers.
Pay Raises
The Congress of the business determines general cost of living raises.
Individual worker raises are determined by a committee in the Unit organized by the Unit Legislature. The goal is to keep each worker’s basic compensation at his or her market value. The Federal will conduct market research and make this information available to the Units. The Unit compensation committee will review the workers’ performance, abilities, and experience. The workers, their co-workers, and leaders can all provide input to this process. After reviewing each worker, the committee will make any needed adjustments to the salary.
Worker compensation does not affect the cost structure of the business due to its variable nature. Thus, giving out raises will not affect the business’ competitive advantage. The purpose of the salary is to mark how the fruits of enterprise are to be divided with the workers. While initial salaries and raises do not affect the cost structure, they do affect how these fruits are divided. Therefore, normal due diligence should be used to keep individual worker salaries at parity with the market.
If there is no parity, certain unfair anomalies can occur. If existing worker salaries are higher than market value, this wage inflation will have two unfair results. First, if basic compensation cannot be met, then those with market value salaries will receive less than their fair share. To illustrate, suppose there are two workers in a business. The first’s salary is $100,000 which is at market value. The second’s salary is $200,000 which is double his market value of $100,000. Assume that revenue available for compensation is $180,000. Calculating with the inflated salary, the first worker would receive 1/3 of the available monies or $60,000 in basic compensation and the second would receive 2/3 or $120,000. Whereas, if there were only market valued salaries, each worker would receive ½ of the monies or $90,000. Second, wage inflation will cause the owners to receive less than their fair share of the profits. If salaries were allowed to inflate, it would reduce the profits, and therefore, the amount of profit sharing money paid to the owners. Processes should be created and followed to maintain salaries at their market value.
Profit Sharing
Profit sharing is the second component of Liberty Workforce compensation. Profits happen when revenue exceeds the costs, the Workerle’s lease payment to the Ownerle, and the workers’ basic compensation. A portion of the profits is shared with the owners. See the article “Financial Topics” in the Finance and Legal Structure category about the Ownerle-Workerle split of profits. The rest of the profits are distributed to the workers. The discussion above about bases of dividing up compensation also applies to the profit sharing component of worker compensation.
It is recommended that profits be distributed among workers as a percentage of their basic compensation, with the same percent for every worker. This is a compromise among various bases. The high impact and higher performing workers usually have a higher basic compensation than most workers. If the same percentage of basic compensation is used to distribute profit sharing for all workers, then the high impact and higher performing workers will still receive more money than most workers. This provides more reward for those with more impact and the higher performers, yet preserves the egalitarian feel through using the same percentage for every worker.
As described above in the Bases section, basing a portion of the profit sharing on Unit performance may be useful to link the workers to performance over which they have greater control. This is only advisable where each Unit is like a separate business and natural performance metrics exist.
Stock and Stock Options for Workers
Worker stock options are another way to help the worker think and act like an owner. These are often associated with senior executives. Some find them particularly useful in startups where funds for basic compensation are limited and channeling the creative and “do or die” forces of the workers is so vital to success. Established companies also give stock and stock options to their workers.
Not all types of stock options can be used in Liberty Workforce. Non-qualified stock options can be given to the workers. However, incentive stock options cannot be used in Liberty Workforce because workers are not employees. They are members of a limited liability company.