One of the biggest benefits of value-added accounting and focussing on value added or wealth creation as the common fate measurement for all stakeholders in a company is that it lays a solid foundation for flexible or variable pay. The latter is undoubtedly the most effective, if not the only real way of counteracting growing unemployment.

A well-founded variable pay policy has to have a clear strategic intent. In my view there really are only two: Involvement or incentive. As I mentioned before, the former will most likely encourage the latter. The latter will probably discourage the former. The former needs a common fate trigger. The latter can be based on any measurement or family of measures. The downfall of incentives mostly lies in the need to guarantee a payout should the individual concerned achieve a present target.

Value-added through its formal accounting convention, the value-added statement, is an ideal way of setting up the essential communication and understanding of drivers that affect the worker’s variable pay. Its simplicity and comprehensiveness eliminate one of the biggest problems that companies face in aligning a common fate variable pay scheme to line of sight by all. (Loss of line of sight has resulted in a plethora of “bonus schemes” in which different layers of the workforce are rewarded on completely different criteria).

In the value-added approach sub-scores that cascade out of the main company measurements reflected in the value-added statement are mundane to tasks at operational level. These can be linked very clearly to your main company measurements that in turn impact on your statutory accounts. (Examples of sub-score designs and definitions will be dealt with in future). A “profit” or “earnings” trigger including derivatives such as Rona, Rota, and Eva etc can still be put completely in line of sight by filtering it through the value-added statement.

Remember that in value-added accounting the prerequisites of sensible wealth distribution are meeting legitimate expectations of all of the stakeholders and encouraging continued contribution. Profits as reflected in retained income (part of “savings” on the standard value-added statement) plus “dividend”, are really the only relevant measurements in terms of meeting expectations. After all one assumes that employee expectations are clearly defined through market conditions and Union activity, and that government’s expectations are met through company tax.

The standard profit formulae therefore establish shareholder expectations that can be converted into a figure. This figure may be the finely tuned trigger of a gain share payout that becomes easily explainable on the value-added statement. This way one obviates the need to explain to employees how some of these highly complex formulae are arrived at. The trigger level of Rona, Rota, Eva etc can be related simply to either the size of wealth needed to achieve those targets, or a different distribution of wealth that will increase the shareholder returns. In this way, line of sight is not lost, and there is a golden thread that links task measurements such as quality, deliveries, customer complaints, volumes, safety etc to your profit driven gain share trigger - at least qualitatively if not always quantitatively.

Preoccupation with shareholder value has favoured shareholder measurements as a common fate trigger to most bonus schemes and incentives at top management level. The lack of empathy and understanding of these measurements at a lower level has led to production type incentives at lower levels. This schizophrenia ion remuneration is obviously not desirable.

While value-added accounting and communication will largely eliminate this problem I question the need for a profit driven trigger at all. Gain share should be an intermediate step to full fortune sharing that implies sharing in the losses as well as the gains. This is simply not possible if the trigger is a profit number, because only the shareholder is affected. Moving the trigger a level higher to value-added or wealth created does create the foundation for fortune sharing because value-added measures the reward for employees and shareholders. So if the cake is bigger everyone has more to share. If it is smaller, everyone has less.

Lets examine how this would be calculated in practice. In the example below, let us assume that this statement reflects wealth distribution that does meet the two requirements of meeting expectations and encouraging continued contribution.

FIRST STEP:
ESTABLISH EQUITABLE DISTRIBUTION

This should not be as difficult as it may appear. In the first instance market forces guide one on individual expectations. In the second, as we said, employee and government expectations are normally quite well defined. Shareholder expectations can be based on any formula or reasonable figure that again has to be linked to market realities.

What is important in the above is to use the percentage distribution as the yard-stick given the current size of value-added. Once these are established, they can be adjusted by consensus in terms of a change in company capital structure. Obviously the serious pressure on each stakeholder when value-added is smaller should act as an incentive for enhanced pay flexibility and increased effort to counter the adverse conditions.

PREPARING FOR A PAY OUT

The two pillars of a gain share payout are an improvement in wealth distribution and a bigger cake.

In the above, there has been no change in value-added. However, through say staff rationalisation etc the employee actual pay amount was R44 million against an expected or previous of R50 million. This gives a gain of R6 million without disturbing sensible distribution. The R6 million could then be Asplit@ in such a way to either restore distribution or enhance profits. The shareholders get R3 million; R1 million is put into a contingency fund and the remaining R2 million is split between say 3000 employees: i.e. each gets R666.

In the next example we are looking at a fully-grown Gain share programme:

Here we have experienced both an increase in wealth and containment of the employee share. Note that a 5% increase in sales accompanied by say a 5% fall in outside costs (difficult but not impossible!!!) gives a 15% increase in wealth. This entitles the employees to R57 million, but in reality they have only again claimed R44 million. The gain is thus R13 million. At this level, the gain share becomes truly dynamic and affords one to allocate proportional merit rewards more effectively, as well as accommodate higher profits and a bigger contribution to the community.

To recap, variable pay demands a clear-cut strategy in terms of defining its intention. Value-added and its distribution become the ideal common fate calculating mechanism once expectations have been clarified. There is n nothing to stop a company from implementing such a gain share programme without recourse to extended negotiation. The simple fact is that if the cake exceeds the expectations of all of the stakeholders, then no one would argue that some of these discretionary surpluses could go to labour instead of automatically to employees.

I would suspect, however, that for most South African companies in the current climate the priority would be to restore a balance in distribution that sees the bulk of any gains go to them. Once this is done then let the games begin!