Profit-Sharing: Features, Types and Problems | Wage System | Economics

In this article we will discuss about:- 1. Definition of Profit-Sharing 2. Features of Profit-Sharing 3. Types 4. Profit-Sharing’s Relation to Wages 5. Merits 6. Limitations 7. Profit-Sharing in India 8. Problems 9. Unions’ Attitude.

Definition of Profit-Sharing:

The International Co-operative Congress, Paris, France, in 1889 defined profit-sharing as:

“An agreement freely entered into, by which the employees receive a share, fixed in advance, of profits. In the discussions of this Co-operative Congress, profits were further defined as being the actual net balance or gain realized by the final operations of the undertaking in relation to which the scheme existed, and the sums paid to the employees out of the profits were directly dependent upon the profits.”

This conception further stipulated that an appreciable fraction of employees must be profit shares not less than 75%.

Profit-sharing is the payment to employees in cash, stock, or future credits of some amount over and above the normal remuneration that would otherwise be paid to these employees in the given situation. The payments do not have to be derived from the current period involved but may be taken from an earned surplus from prior periods of operation. This definition does not require an agreement fixing the percentage in advance.

Payments could be made from current profits without any prior agreement, although it is believed that the morale-building effect would be greater if these payments were made in conformity with a well-organized plan.

Certain bonus payments made to employees, particularly executives, would be according to our concept, partly wages and partly a share in profits. For instance, it is not uncommon to pay an executive a base salary sufficient to care for his normal living costs and to pay him a bonus depending in part upon the volume of business or profits.

Profit-sharing is an attractive supplement of a wage system. Under profit sharing an employer undertakes to pay his employees a share in the annual net profits of the enterprise. This share is in addition to regular wages and is neither based on time nor on output. Profit-sharing is an agreement entered into between the employer and the employees under which the employer agrees to pay to the employees the share in the profit fixed in advance.

Profit-sharing is different from wage incentives which are directly connected with the output of workers. But profit-sharing is related to the profits of the enterprise which depend on productivity and several other factors. It is a major departure from the traditional concept of profit where it is treated as the exclusive monopoly of the employer. The workers are treated as co-partners in the productive process and profit is treated as the outcome of the joint efforts of employer and workers.

According to I.L.O. “Profit-sharing is a method of industrial remuneration under which an employer undertakes to pay to his employees, a share in the net profits of the enterprise in addition to their regular wages”. Profit-sharing arrangement enhances social justice, strengthens the common interest of capital and labour and increases the productive efficiency of the workers. It would be highly successful if the parties’ viz., labour and employers take each other into mutual confidence.

The concept of profit-sharing is now accepted in the industrial world and also at the government level. In western countries, profit- sharing is very popular among the industrial workers. However, this concept is not popular in India. We have a system of bonus payment which is compulsory even when there is no profit to a company.

In India, workers and trade unions are interested in bonus payment and they are not interested in profit-sharing agreement. This is because bonus payment is compulsory even when the workers are not co­operative and there is no profit to the industrial unit. However, profit- sharing is possible only when workers give full co-operation to raise the profits over and above a particular limit.

Features of Profit-Sharing:

(1) The payment to workers under profit-sharing is generally made on cash basis, but it is also possible to make such payment in shares or transfer of money to provident fund account of the employees.

(2) Workers share the profits only. They do not contribute to the losses incurred by the firm.

(3) Profit-sharing denotes the extra payment given to workers in addition to annual wages and allowances.

(4) It is paid out of the net profits and as per the agreement between the two parties, i.e., employers and employees.

(5) The sharing of profits in a particular proportion is decided by an agreement between the employer and the employees.

(6) The profit-sharing agreement is possible at the unit level or even at the industry level. It is also possible to have such agreement on locality basis or industry-cum-locality basis.

Types of Profit-Sharing:

In general there are two basic types of profit-sharing programmes:

(a) The current-distribution plan, in which the full amount of the employees profit share is given him at the time of allocation, and

(b) The referred-distribution plan, in which the employee’s share of profits is given to him at some future date such as at the end of 5 years, at retirement, disability, death, or termination of employment.

Of course there could be a combination of these two methods on practically any basis, such as 30 per cent of the employee’s share to be distributed currently and the 70 per cent to be distributed on a deferred basis. The deferred profit-sharing plans may or may not have an employee’s participating savings feature.

Plans calling for the employee’s saving in order to be eligible for his full share in profits may have almost any ratio if allocation of profits in terms of participation. For instance, if the plan be a combination of current payments in cash or stock and a deferred payment, the deferred part may depend entirely upon the employee’s participation in the savings plan. The combined current and deferred distribution of profits seems to be gaining in popularity.

There is no doubt that such a plan has a stronger pull on the employee, particularly the newer employee, to increase his efforts to add to the profit available for distribution. Since the deferred plan builds up an estate for the employee more rapidly than any form of current distribution, this deferred distribution is likely to be preferred by the longer-service employees.

Profit-Sharing’s Relation to Wages:

Profit-sharing is that part of the employee’s remuneration over and above what he would otherwise receive if he were paid the going rate in the community for the services rendered. By this definition a man’s wage will not be lower because he shares in profits.

His share of profits may be in proportion to his wages, since this is a common method of allocating profits. It is not unusual to consider length of service in the total allotment, but, even when this is considered, it is usually tied to the employee’s wage as a basis of computation.

In the case of ordinary workers, it is highly improbable that the regular wage is materially lower under normal conditions than it would be if profits were not being shared. The situation may be somewhat different in the case of some of the higher executives. Since executives are usually in a better position to influence profits, it may be reasonable to remunerate them in a greater degree through profit-sharing than the regular workers.

Merits of Profit-Sharing:

(i) The workers are motivated and have a sense of belongingness to the firm. They cooperate voluntarily because their prosperity depends upon the prosperity of the firm. If the firm earns higher profit, the workers will get higher amount of bonus.

(ii) Profit-sharing brings about stability in the working of the enterprise. The rate of labour turnover is reduced because the workers are connected with the management.

(iii) Profit-sharing results in equitable distribution of profit among the employer and the employees of the enterprise.

(iv) Profit-sharing is a step towards industrial democracy as employees are treated not only as wage earners but also as partners in the progress of the company.

(v) There is industrial peace in the enterprise. The workers are satisfied as they get an additional amount over and above their wages. A healthy atmosphere prevails in the enterprise. There is co-operation between labour and management as the objectives of both are common, i.e., to increase productivity.

(vi) Profit-sharing acts as a driving force for higher production and productivity. The workers take more interest and initiative leading to higher production.

(vii) The share of workers in the profits depends upon the efforts, initiative and hard work of the employer and employees. This brings about a team spirit among the workers and employers. The chances of conflict are reduced.

Limitations of Profit-Sharing:

(i) Profit-sharing gives equal benefit to all workers. Distinction is not made between good and bad workers. As a result, sincere and efficient workers get less than what they deserve while bad or inefficient workers get more than what they deserve.

(ii) Profit-sharing as a method of extra remuneration to workers is used during the period of prosperity when profits are high. Profit sharing is not possible during the lean years of depression.

(iii) Unscrupulous management may manipulate the accounts to the detriment of the workers. The workers may, therefore, get nothing due to dishonesty of the management. This will dampen the enthusiasm of the workers.

(iv) There is a high degree of uncertainty in profit-sharing. The share of profit will be paid only when the profit exceeds a particular limit. The profit may not cross a particular limit due to market forces and the workers will suffer. Thus, profit-sharing does not give full guarantee of extra-payment to the workers.

(v) As the amount of profit is to be distributed after a specified period, there is no real incentive to produce more. The incentive effect of the scheme is completely lost due to remoteness of the reward.

(vi) The scheme of profit-sharing does not eliminate the need for negotiations between the management and the labour regarding distribution of profits to the labour.

Sometimes, relations between labour and management are adversely affected on profit-sharing agreement. This defeats the very purpose of profit-sharing.

Profit-Sharing in India:

In 1948, the Central Government appointed a committee to study the problem of profit-sharing in industry. The committee suggested the introduction of profit-sharing as an incentive to production as a method of securing industrial peace and as a step of labour participation in management.

It however, did not give any exact formula of profit-sharing, but suggested that the share of labour should be 50%. This scheme was not favoured by the employers and workers, and so the progress of this scheme was limited. The trade unions preferred minimum bonus to profit-sharing.

The progress of profit-sharing in India has been insignificant. This is partly due to statutory provision of payment of minimum 8.33% bonus to workers under the Payment of Bonus Act. However, in many industries, the concept of productivity linked bonus has been introduced under which higher bonus is payable to workers where their productivity is higher. The Government has also given encouragement to this scheme in the recent years.

The reasons of failure of profit-sharing in India have been summed up as follows:

Some employers in India introduced profit-sharing schemes with a view to stimulating interest among their workers in increasing production. There was, however, no change in the outlook of these employers.

They did not treat the workers with justice and fairness and refused either to consult or to inform them on matters of common interest in the working of the industry. Requests for facilities for looking into the balance sheets of the companies were resented as unwarranted interference in the sphere of management.

Problems in Profit-Sharing:

Profit-sharing may result in negative morale as well as positive attitudes. If there are no profits to be distributed and the workers have been expecting them after having received them for a period of years in cash, morale is certain to be lowered. The objective of building up an estate for the worker is achieved more readily by giving him his share of profits in annuities, to which he may or may not contribute in part.

When this is done, it probably serves as a weaker incentive to the worker in the beginning of his career than the profit-sharing programme in which the distribution is in cash; however, the motivating effect of annuities, etc. tends to increase with the passage of time and the accumulation of an estate.

The plan of requiring an employee to contribute some of his own earnings to a profit-sharing programme should be carefully worked out so that the employee’s contribution is safeguarded and earns a reasonable return. A failure to do this may readily defeat the fundamental purpose of profit sharing when depressions cause the employee’s contribution to be worth less than he originally invested.

In view of the uncertainty of profits and the fact that their sharing involves considerable waiting, if their major objectives are to be achieved, profit sharing seems to offer a stronger incentive to executives and supervisors than to the rank-and-file workers.

The basis for distributing of profits also presents certain problems illustrated by the following questions and comments:

(1) Will the shared profits be computed before or after taxes? The profits shared with employees up to 15 per cent of the employee earnings are a deductions to the company as an expense.

(2) Will the profits to be shared be computed after allocating a certain amount to the owners of the company’s stock?

(i) Should this allocation to the owners be in relation to the book value of the stock to its market value, or on what basis?

(ii) What percent allocation should be made to owners before sharing profits with employees? Should this percent be related to general interest rates for risks similar to that borne by the company? One thing is relatively certain: there will be no profit sharing in the absence of satisfactory return to the owners unless it is forced on management by a strong union.

(3) Having determined the basis of computing (1) and (2) above, how will the amount of profits to be shared is computed? Will it be on a 50-50 basis between owners and employees, 40 per cent to employees and 60 per cent to owners, or on what basis?

(4) Having determined the amount to be distributed to employees as a share in profits, shall it be allocated on the basis of earnings for the period, earnings plus length of service, or what basis to those eligible to participate? No formula may be used, but the allocations may be on the basis of estimated contribution of the employee to earning the profits.

(5) Who should participate in the profit-sharing programme? Shall it include all regular employees regardless of length of service or only persons with 1.2, or 5 years of service? The programme will have a stronger incentive to produce if it applies to all employees after a reasonable short period of service. If the plan is a deferred type to be paid only at retirement or some reasonably long period such as 5 years, some companies do not include employees under the age of twenty-five or even thirty. Such plans are frequently related to the pension programme.

(6) If the profit-sharing plan includes a deferred feature, who will operate the fund created? Will it be operated by trustees made up largely by management’s representatives, by a bank or trust company, or by what agency? May the funds be invested in the company’s own stock on some percentage basis or entirely?

The foregoing questions and comments are illustrative of the decisions to be made in a profit-sharing programme. Profit-sharing does not take the place of collective bargaining or other personnel procedures.

Unions’ Attitude toward Profit-Sharing:

Some unions support profit sharing, and in the past other unions opposed it. In 1958 Walter Reuther of the United Auto Workers tried to include a profit-sharing clause in their contract. His programme was not simple one but a complicated one involving economic philosophy. It was rejected by the automobile companies.

It is conceivable that unions and management may include a workable profit-sharing plan in future contracts just as they have pension plans. As a matter of fact a carefully planned profit-sharing programme may well become a part of a pension plan. Organized labours former opposition is based essentially on distrust of the motives of management.

In part, it may be due to a fear that, if the employees in fact embrace the partnership idea, there will be less class consciousness and possibly less feeling on the part of the workers that they need the protection of the union. Management would be unwise if it originated a profit-sharing programme for the purpose of preventing the organization of its employees or to weaken the existing organization of its employees’ choice.

The Senate Committee reported the opinion of the president of a prominent American labour union as follows:

We are emphatically opposed to any form of so-called profit sharing because it creates the mistaken idea in the minds of employees that such plans make them “partners” in industry and divert their attention from unionism. It seems to become a substitute for collective bargaining. These plans are used to keep salaries and wages at status quo and even lower levels. Such minor returns as employees have received have been unimportant in comparison to increase, dignity, and independence gained through organized unionism.

In the same report, William Green, the late president of the AFL, is quoted as saying, “Labour is not opposed to principles involved in profit sharing, but it is opposed to the way in which it has been developed and operated—recognition of real partnership and frank acceptance of the privileges and rights derived therefrom would be the greatest incentive to sustain efficiency in work that industry could devise—If the earnings of the industry would justify an equitable distribution of the profits of industry between investors, management, and employees, let it be done with a full understanding and in full cooperation with the representatives of the workers. The one trouble about profit sharing as practiced by a number of corporations is that it has created suspicion and distrust, because the workers know nothing about the basis upon which the profits were distributed… there is a great need of frankness and open dealing between the management and the workers today. Let the worker- know the truth.”