I tend to write about repeating themes that I encounter with my business coaching clients. One of the most recurring problems with small business owners who are trying to grow their business is delegating financial responsibility to their employees.
I’d like to illustrate this challenge through the story of an owner of a small service business who we will call George. George owns ACME Business Services.
ACME Business Services – Financial Dilemma
ACME Business Services sells professional services at an hourly rate based on three different experience levels of technicians. The current technician staff is comprised of 9 technicians (2 Senior, 3 Mid-Level, and 4 Junior). The plan for the coming year is to earn an annual revenue of $2,000,000 with 10% net profit.
Unfortunately, this was the same plan last year, and ACME Business Services ended up with $1,500,000 in revenue with 1% profit.
George wants his people to help him achieve a strong financial company but doesn’t know how to motivate his folks to participate in the company’s financial success. In the past, he has run into the following problems.
When George presented the company’s financial results to his employees, they seemed indignant that George was greedy. After all, he didn’t lose money in his business. He earned 1% profit on their hard work. Why did he deserve to earn more?
Irrational Wage Increases
In the past few years, ACME Business Services has lost some of its best technicians due to them not getting pay increases that they could receive by working for a competitor. George was convinced that if he gave his technicians raises, his profit would evaporate completely.
In the meantime, many of ACME’s less-qualified technicians wanted pay raises and were already being overpaid. Several customers had complained about ACME’s junior technicians. George didn’t want to reward poor work quality with increased pay.
Throughout the year, many staff members would complain that they were too busy to complete the tasks that were outlined in their job description. They indicated to George that they needed help with their overwhelm. George believed that their financial situation was too tight to employ more people, and he believed they were not constructively using their time.
George wanted to show his employees his financial statements so that they could participate in improving ACME Business Services' performance. Unfortunately, if employees knew what he earned, and other senior staff earned, they would use this information to ask for a raise.
The financial pressure didn’t come from within his company, but also from customers. George was told several times that his prices were too high for the quality of work they were providing customers. ACME’s sales staff would complain that it was difficult for them to justify asking for higher hourly rates for technicians if the work that they provided was substandard.
If you’re a business owner, George’s dilemma is all too familiar. It feels like a trap. You want to get your people to help you grow the business. This growth is good for you, your customers, and your employees. Unfortunately, they seem too financially immature and self-serving to participate in your business.
The Wrong Approach
Many business owners try to communicate the list of problems I just described and educate their employees. They believe that if their employees better understand their financial predicament, they’d help. Unfortunately, what happens in these kinds of meetings is that most employees see the business owner as greedy. The business owner wants them to work harder to make the business owner richer.
As the business owner, you sense this adversarial tone and you get emotional about why these financial imperatives are important. A permanent divide has been established that guarantees that you will have an adversarial relationship with your employees on the profitability of your company.
In extreme cases, employees unionize and formalize this adversarial relationship because they feel like they are being taken advantage of.
The Right Approach
One or two employees will eventually be financially mature enough to see the big picture of your business; and help in the way that you want. Most of your employees will not. This means that you need to segment performance goals that are relevant to each segment of employees.
The sales staff must be rewarded for increasing your top-line revenue. This sales number drives the ability of your company to properly compensate everyone else. If your company has a $2,000,000 goal at 50% gross margin. If your sales staff meets this goal, they must be rewarded. These rewards are given in the form of sales commissions for successful sales. If they fail to meet sales goals, they must be replaced with a sales staff that will meet this crucial goal.
Operations can include a variety of different types of workers. In our example, operations is the staff of technicians. The technicians want more money, and you want more expertise, customer service, and efficiency.
Knowledge can be tested through whatever testing method is appropriate for your industry. Increased knowledge equals increased compensation. Customer service can be evaluated through customer satisfaction surveys. Technicians must be responsible for the satisfaction of their customers. This must factor into their compensation.
Efficiency is reflected in the value that is gained by your customer vs the cost you must pay for that value. On financial statements, this shows up as delivered gross margin. If the salespeople sell a job at a 50% gross margin, and the technician delivers that job at a 40% gross margin, that technician is failing to deliver value efficiently. Likewise, if that technician delivers that same job at a 60% gross margin, they are adding value to the company and the customer. When they achieve higher gross margin deliveries, they deserve a raise. When they deliver lower gross margins, they deserve a pay cut.
The operations staff doesn’t need to see the entire profit and loss statement to know if they are doing well. They only need to see their portion of the profit and loss statement that is relevant to them. It could be a project-based accounting, or a job-based accounting of their work only.
The financial performance of administrative staff is based purely on keeping the controllable overhead costs as low as possible. The leader of the administrative staff must be given a budget based on planned financial performance. If you hope to keep overhead costs at 30% of revenue, then that administrative budget should be $600,000 for a $2,000,000 plan year. If the performance of that plan is slipping, it is the job of the leader of the administrative group to reduce costs accordingly. In small businesses, the business owner is the leader of the administrative group. In larger companies, this leader can be a business manager. In larger companies, this budget can be segmented further into subgroups.
It is not customary to pay bonuses that are a percentage of overhead costs for administrative employees. Instead, it is wise to give pay increases to administrators who actively look for ways to drive overhead costs down. This increased compensation expectation must be included in the administrator's position description.
I wish this weren’t the case, but few employees understand profit. The purpose of profit is to return to investors who have taken risks. In a small business, this risk is borne by the business owner. At some point, profit will be the only money a business owner gains from their business.
Profitability varies, but most businesses must operate with a net profit margin of 10%. Mike Michalowicz published a book called "Profit First". In this book, Michalowicz encourages business owners to think of profit as the one expense that cannot be cut. Unfortunately, most business owners treat profit as the left-overs after they have subtracted out the expenses of the company from the revenue of the company.
If your company earns a greater profit than your planned profit, then you have the discretion to either reward your employees, pay down debt, reinvest profits, or reward yourself. This is a judgment call that you must make as the owner. I strongly encourage that you do not expose this number to your employees. At some point, you will identify select employees who have developed the financial maturity to understand the purpose of profit. These are the folks who can run your business.
The simpler and more focused you can create compensation reward for your individual departments, the better your people will respond to deliver the performance that is within their control.
ACME Business Services' Happy Ending
George looked at his $1.5M year with his 1% profit. He realized that if he increased the pay of his technicians and maintained the same gross margin with the same expenses, ACME Business Services could achieve a $2.0M year with a healthy net profit margin.
To give his technicians raises, they would need to meet certain skill requirements. The sales goals would be increased to $2.0M at the same commission pay they received the prior year. He believed the salespeople would accept this objective if they had higher quality services to sell with an improved technician staff. George would be responsible for controlling overhead costs to remain the same as with the $1.5M year.
Everyone would be happy. The technicians would be making more money, the sales staff would be selling a high-quality service, and ACME’s profitability would rise from 1% to 13%.
With the individual financial and customer service accountability in place, ACME Business Services couldn’t lose.
About the Author
Jeff Schuster has been actively engaged in the energy efficiency, renewable energy, and energy conservation industry since 1987. Jeff was a licensed Professional Engineer in six states and a Certified Energy Manager (CEM). He worked as a sales executive, energy engineer, sales manager, and entrepreneur. Jeff started, grew, and sold his Energy Service Company (ESCo) called Ennovate Corporation (1997 to 2013). Jeff is now a certified professional business coach for business owners, engineers, and business development executives. The name of his coaching practice is Mechanics & Mindset Business Coaching.