Master's Thesis, 2010
140 Pages, Grade: 1,8
List of Figures
List of Appendices
1.1 About DIS AG
1.2 Research Aims and Objectives
1.3 Why is this an Issue for DIS AG?
2. Literature Review
2.1 Motive, Incentives and Motivation
2.1.4 Content and Process Theory
2.1.5 Intrinsic versus Extrinsic Motivation
2.1.6 Money and Motivation
2.1.7 Working Motives
2.1.8 Employee Motivation, Model of Nitin Nohria
2.2.1 Forms of Centre Organisations
2.2.2 Accounting, Controlling and Key Figures in Profit-Centres
2.3 Incentive Systems
2.3.1 Incentive Systems in Profit-Centres
2.3.2 Problems with Incentive Systems
2.4 Economic Value Added (EVA)
2.4.1 Potential Uses and Problems within Companies with Profit-Centre Structure
2.4.2 Advantages & Disadvantages of EVA
2.5 Literature Review - Summery
3. An Practical Example - The EVA System at DIS AG
3.1 Why did the Company choose EVA?
3.2 Calculation of EVA and Payouts of Bonuses
4. Research Design and Methodology
4.1 Research Philosophy
4.2 Resources, Access to Information and Data Collection
4.3 Research Approach and Technique
4.4 Research Strategy and Time Horizons
4.5 Analysis of Data: Quantitative and qualitative Methods
5. The Evaluation of the EVA-based Incentive System of DIS AG
5.1 Questionnaire Analysis
5.2.3 Transparency of the Incentive System
5.2.4 General Statistics
5.2.5 Analysis of Suggestions for Improvements and Comments
6. Data Interpretation and Discussion
6.4 General Comments
11. Management Summary
Ashcroft International Business School
MASTER OF BUSINESS ADMINISTRATION
EVA-based bonus systems and the influence on motivation of employees in companies with branch or profit-centre structure
By Tobias Bandt
Since the beginning of the Industrial Revolution in the early the 20th century, companies have tried to find ways to motivate their staff and, through that, increase performance and productivity. Despite several theories that consider monetary incentives as not being a motivator it is still very common practice for companies to motivate their employees using profit participation schemes. Companies and organisational structures have significantly changed in the last 50 years. Is it still possible to measure and influence the performance of the individual? And what is the assessment based on? Is the approach of profit participation sustainable and contemporary?
Even in times of globalisation, companies try to delegate responsibility to their business units and branches in order to measure performance and make them comparable. Therefore, they organise them as profit-centres, small organisational units which act like a company within a company. Economic Value Added (EVA) promises to measure more than the profit of a unit; it considers the added value of a branch to the company, shareholders and customers.
This Master thesis aims to provide an overview of EVA, how it works and how it influences the motivation of people who work in branches that are organised as a profit-centre. It also analyses the influence of EVA-based incentive systems on the cooperation between branches and regions and, further, assesses the influence of fairness and transparency on the motivation. The research project is supported by a survey, conducted among branches of DIS AG, a company that has been using EVA for eight years as a basis for the calculation of monetary incentives. The survey covers three areas of EVA’s impact on employees: the influence on motivation in general, on cooperation between branches and the influence of transparency and fairness.
The results of this survey are used to develop recommendations for adapting the system in order to maximise the impact on employee motivation.
Figure 1: Maslow’s Pyramid of Needs
Figure 2: Hertzberg Theory of Motivation, Factors
Figure 3: Vrooms Expectancy Model of Motivation
Figure 4: The Porter/Lawler Model
Figure 5: Motivation: Driver and Lever
Figure 6: Influenced Areas within Companies
Figure 7: Forms of Centre Organisation
Figure 8: An Example for Step-by-Step Contribution Margin Calculation
Figure 9: Key Figures of Profit-Centres
Figure 10: Material Incentives
Figure 11: EVA Calculation
Figure 12: EVA-influenced Sectors
Figure 13: Reasons for EVA Implementation
Figure 14: Calculation of EVA
Figure 15: Bonus Calculation
Figure 16: Issues addressed by the Questionnaire
Figure 17: How do you assess the Motivation within your Branch Office?
Figure 18: Motivation by financial Incentives
Figure 19: Satisfaction with the EVA-based Incentive Model in the Branch Office
Figure 20: Perception of EVA depending on Position
Figure 21: EVA Influence on short-term Motivation
Figure 22: EVA Influence on long-term Motivation
Figure 23: Influence on Sales Motivation
Figure 24: Influence on Workload
Figure 25: EVA Effect on general Actions
Figure 26: Effect of annual Adjustment on Motivation
Figure 27: Lost Business due to Discrepancies between Branches
Figure 28: Influence of EVA on Competition
Figure 29: Dealt with Orders of other Branches (I)
Figure 30: Dealt with Orders of other Branches (II)
Figure 31: Impact of Branch Outcome on Cooperation Level
Figure 32: Level of Complexity
Figure 33: Kendall's tau-b Correlation of Position and Level of Understanding
Figure 34: Position and Level of Understanding
Figure 35: Age
Figure 36: Position
Figure 37: Consultants - Percentage of EVA Payouts
Figure 38: Branch Managers - Percentage of EVA Payouts
Figure 39: Analysis qualitative Questions
Figure 40: Influence of annual Adaptions on Team Spirit
Figure 41: Impact of Economic Situation
Figure 42: Comparison of Nohria’s Model and DIS AG - Lever Reward System
Figure 43: Nohria’s Model of Employee Motivation - Drivers, Levers and Actions
Figure 44: Possible Actions to improve the Impact of EVA on Motivation
Figure 45: Possible Matrix Organisation
Appendix I: Regional Allocation of Branches
Appendix II: Areas of Business
Appendix III: “What, Why and How” Framework of Crafting Research
Appendix IV: Research Onion
Appendix V: The Process of quantitative Research
Appendix VI: An Outline of the main Steps of qualitative Research
Appendix VII: How do you assess the motivation within your branch office?
Appendix VIII: How satisfied are you with the EVA-based incentive model within your branch office?
Appendix IX: Cross-tabulation Item 2 * Item 45
Appendix X: How do you assess the influence of EVA-based incentives on your short-term motivation to work?
Appendix XI: How do you assess the influence of EVA-based incentives on your long-term motivation to work?
Appendix XII: How strongly do personal monetary incentives motivate you?
Appendix XIII: How does the existent incentive model motivate you personally in aspects of sales? ..96
Appendix XIV: How does the existent EVA-based incentive model motivate you personally, regarding to your daily volume of work?
Appendix XV: Cross-tabulation: Item 34 * Item 45
Appendix XVI: Correlation Analysis Item 34 * Item 45
Appendix XVII: How frequently is the distribution of the bonus in your branch office determined afresh?
Appendix XVIII: What effect would have an annual adjustment of the distribution on your motivation to work?
Appendix XIX: Statistics Motivation
Appendix XX: Lost Business due to Discrepancies between Branches
Appendix XXI: How do you assess the direct cooperation with other Office & Management branch offices in your surrounding area?
Appendix XXII: How do you assess cooperation with branch offices dealing with other business in your area?
Appendix XXIII: How do you assess the influence of the EVA-based incentive system on the pressure of competition between the branch offices in your area?
Appendix XXIV: Have there ever been situations in which your branch office has dealt with orders which technically should have been allocated to another department?
Appendix XXV: Have you ever forwarded orders to other branch offices only after your branch office was not able to fill the vacant position?
Appendix XXVI: How do you assess the impact of the outcome of your branch office on the cooperation level with other branch offices?
Appendix XXVII: Statistics Cooperation
Appendix XXVIII: How do you assess the level of complexity of the existing EVA-based incentive model?
Appendix XXIX: Cross-tabulation Item 31 * Item 45
Appendix XXX: How detailed did your manager explained the model?
Appendix XXXI: Statistics Transparency of the System
Appendix XXXII: Age
Appendix XXXIII: Gender
Appendix XXXIV: Which position do you represent within your branch office?
Appendix XXXV: Seniority in Years
Appendix XXXVI: Share of variable salary
Appendix XXXVII: How high is your percentage of the monthly royalty regarding to the total distribution of the branch office?
Appendix XXXVIII: What effect would an annual adjustment of the distribution have on the collaboration in your team?
Appendix XXXIX: What impact has the current economic climate in answer to the questions?
Appendix XL: Questionnaire - English Version
Appendix XLI: Questionnaire - German Version
The shareholder value approach is a very common approach and has worked well for the last four decades (Hostettler, 2002) . Economic Value Added (EVA) is directly derived from this approach. Since the beginning of the Industrial Revolution in the beginning of the 20th century, companies have tried to find ways to motivate their staff and, through that, increase performance and productivity (Hostettler, 2002) . A very common approach is monetary motivation. Companies and especially organisational structure have significantly changed in the last 50 years (Stern, 2001). New models like EVA have been developed and introduced. Monetary incentive systems have been adapted to the new aims and new organisational forms. How do these systems work in day-to-day business? Do they motivate people? What influence do these systems have on teams and on the cooperation between different departments or branches? This Master thesis aims to provide an overview of EVA, how it works and how it influences the motivation of people who work in branches that are organised as profit-centres.
Founded in 1967, DIS AG is one of the six largest HR Consulting companies in Germany. It is the market leader for high-qualified temporary employees and recruitment solutions. More than 9,800 people work in Germany for DIS AG, both internally and externally. DIS AG has a branch structure: 174 branches are located all over Germany (Appendix I , Appendix II) , most of which are in the western part. The business is divided into 4 divisions:
- Information Technology
- Office & Management
Each branch is organised as a profit-centre with a focus on one of the above-listed specialisations. Furthermore, there are several subsidiary companies, which have a focus on consulting or engineering issues.
In 2006 the company was taken over by ADECCO and is now part of the ADECCO GROUP. In 2008 DIS AG had a turnover of 479.6 million Euros and an EBT of 74.7 million Euros (source: company presentation 2009). Aside from 2009, the revenues have continuously grown in the last few years.
According to the literature at least two criteria are needed to define responsibilities and avoid conflicts in profit-centres (Jost, 2000):
- Regional differentiation
- Functional differentiation
The company has defined its sales areas according to postcode; sometimes conflicts occur due to the lack of a clear definition of which division is responsible for which order. Only the rough framework is given by headquarters.
According to the company’s values as described on its website, the success of DIS AG is based on a high degree of self-dependence and self-motivation. Even if the principle of self-dependence works well in practice, the ill-defined responsibilities have led to arguments between branches.
Unlike other comparable service providers, DIS AG usually has only one specialised branch per city. Each branch is organised as a profit-centre and is, depending on the region, responsible for approximately 30-150 employees.
There are only flat hierarchical levels within the company and its branches. Each branch has one branch manager plus several consultants, assistants and wage clerks depending on the number of employed external staff.
This Thesis will concentrate on the influence of “Economic Value Added” -based incentive systems on the motivation of employees, especially in companies with a branch or profit-centre structure. Therefore, the existing system of DIS AG – a very successful company in the field of HR Consulting – has been evaluated. The specific research focuses on the following questions:
- What motivates people in companies with a profit-centre structure?
- How transparent does an EVA system have to be?
- How much influence does this system have on the motivation of employees (long term and short term)?
- Does a system like this have influence on the level of cooperation between different branches (regional and functional)?
- Does the current economic crisis affect these topics?
- How can a system be changed to increase the level of motivation?
The result of the final project is an evaluation of the existing system. Resulting from this, recommendations on how to improve the level of cooperation between branches in order to maximise employees’ level of satisfaction, fairness regarding distribution of bonuses, and company revenues will be made evident. The project is structured according to the “What, Why and How-Framework of Crafting Research” (Bryman, 2007; Appendix III) .
This thesis aims to provide an overview of existing models of employee motivation, especially with a focus on incentive models. Therefore, it will concentrate on the model of “Economic Value Added”, developed and published by the consulting company Stern Steward & Co (Stern, J. M., 2001) .
Finally, the Master thesis should give concrete information about EVA in the praxis of de-central-organised companies, the influence on motivation and the level of cooperation between different branches. Furthermore, it should give information about the EVA system, profit-centre structures and a general overview of current motivation models that are described in the literature.
At the end, the reader should be able to appraise the value and sustainability of EVA for a company like DIS AG. This includes:
- The effect on team cooperation (branch- and regional-wise)
- The effect on motivation
- The influence of economic crisis on the bonus system and motivation
Regional distance and different professional focusing in a holding structure can cause problems in the cooperation. (Becker, 2008) (Details about DIS AG’s structure are described in Appendix I , Appendix II.)
In 2003 the company introduced EVA as the foundation of the bonus system in its branches and for all hierarchical levels. In the last few years of economic growth the system worked well, even if there were discussions about the allocation of funds.
Since the beginning of the recession in 2009 the system has increasingly come under question. People who have earned large bonuses in the past have been moved back to their basic salary structure. There have also been arguments about responsibilities and the lack of cooperation in several regions. The aim of the thesis is to find out what level of responsibility EVA has for the current situation and how it can be improved to increase the level of cooperation and motivation.
Besides the fact that DIS AG is currently in a post-merger phase and is facing a lot of organisational changes, the results of the study can be transferred to other companies with similar business models. It has to be mentioned that the calculation of EVA might be different in other companies.
The aim of the literature review is to provide an overview of the theoretical framework behind (employee) motivation and to describe the EVA system and the functionality of profit-centres. Because of the limited word count in this thesis, it will not describe the controlling aspects of a profit-centre, but rather focus on organisational and motivational aspects.
To understand the functionality of EVA-based incentive models it is necessary to give a short overview of existing models of motivation.
In everyday language usage, the words motives and motivations are more or less interchangeable; in a psychological context, however, there are fundamental differences between them.
“A motive is an inner state that energizes, activates or moves and directs or channels behaviour toward goals.” (Jeff Harris, 2001)
Motives refer to a class or cluster of affectively tinged goals (Hogan, 1997). They are the reasons why people act, and they influence their behaviour. Each individual has different motives, and also forces that drive them to react to these motives. The literature describes three categories of motives, known as the BIG THREE:
Other models also exist, like Moslow’s pyramid of needs, which explains a hierarchy of motives. As shown in Figure 1 this pyramid, developed by A. Maslow in 1947, divides needs of individuals into 5 accumulative levels.
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Figure 1: Maslow’s Pyramid of Needs (Source: Alan Chapman 2001-4)
The first four layers of this pyramid (biological, safety, social and esteem needs) are called deficiency needs. The higher layers of the pyramid only come into focus when the lower needs have been satisfied. If they have not, then there is no physical compulsion to reach the next level. Once the basic needs have been satisfied, people then begin concentrating on individual needs like personnel fulfilment and growth, cognitive and aesthetical needs and self-actualisation.
In developed countries, levels one and two are almost guaranteed, especially in the group of employees who receive EVA-incentives. Compensation systems of companies target levels four and five. Particularly status and some individual needs like aesthetical needs can be improved with financial resources.
Incentives are the second stage in the process of motivation. J. Herris et al. compared the relationship of motive and incentive with the relationship between a magnet and a metallic object. The magnet as incentive can only be received with appropriate action or effort of an attractive (metallic) object. Incentives encourage people to act in order to achieve an aim. Like a magnet, incentives must be adjusted so that they appeal to the individual motive.
The aim of a company should be to find out what the right incentives for a specific motive are. Therefore, motives should be defined first. The next chapters will provide an overview of common classifications of motives.
Depending on the context, different definitions of motivation exist.
Motivation can be defined as “the direction and intensity of one’s effort, where direction refers to whether an individual seeks out, approaches or is attracted to situations and intensity of effort to how much effort a person puts forth in a particular situation.” (Weinberg, 2007, p. 52)
The majority of the definitions describe motivation as the interaction of motive and incentive, witch activates human behaviour.
This definition is very general and fits all areas of life. To focus on an economic context it is necessary to add a few characteristics to this definition (Mullins, L., 2007; Mitchell T., 2004). These characteristics are:
- Motivation is typified as an individual phenomenon.
- Motivation is intentional (controlled by the individual, who has a choice of actions).
- Motivation is multifaceted (influenced by two major factors: 1. What gets people activated, 2. The force of an individual to engage desired behaviour).
- Motivation is not the behaviour itself and not the performance. Motivation concerns actions, and internal and external forces which influence a person’s choice of action.
- The performance itself is the result of ability and motivation. The aim of motivation research is to determine the forces that cause people to use the full potential of their abilities.
The process of motivation is typically divided into different levels. Depending on the motivation theory, the levels might differ. Typical steps are (Rosenstiel, 2003):
- Perception of a deficit
- Expectation of deficit removal through specific behaviour
- Behaviour that is expected to remove the deficit
- Final act of removal
- Status of satisfaction
Models of motivation are separated into two different groups of theories (Schuler, 2006):
- Content theory
- Process theory
A very common example for content theories is Maslow’s pyramid of needs, described in Chapter 2.1.1. Content theories explain the change of human needs over time. In order to do this, they try to describe which incentive activates which motive. Even if content theories are the basis of motivation research, they are often criticised, especially because of the lack of validity and the high degree of abstraction (Kanfer, 1990; Schuler, 2006). Because of this, it is very difficult to explain a correlation of concrete behaviour and a level of motivation.
A typical example of content theories is Hertzberg’s theory of motivation. As shown in Figure 2, Hertzberg defines two different kinds of factors. According to Hertzberg, the hygiene factors do not give positive satisfaction – they only avoid dissatisfaction from their absence. Typical hygiene factors are: Working conditions, salary and status. Hygiene factors are more extrinsic in nature.
The second factors described by Hertzberg in his model are satisfiers. These motivators give employees positive satisfaction. Coming from intrinsic conditions of the job itself, Hertzberg assumes that the motivation is sustainable. Typical satisfiers are: Achievement, the job itself and growth (Hertzberg, 1968; Weightman, 2004).
illustration not visible in this excerpt
Figure 2: Hertzberg Theory of Motivation, Factors (Source: Hertzberg, 1968)
Like Maslow, Hertzberg differentiated between physiological and psychological needs. Physiological needs can be fulfilled with money (flat, food, etc.). Psychological needs, like growth and appreciation, have to be fulfilled by activities that cause the individual to grow.
These models have often been criticised because of inadequacies. Especially the assumption that satisfied employees produce more is often questioned. Another critical point concerns content theories trying to explain average behaviour.
To avoid the weaknesses of content theories, psychological research has concentrated on process theories which take a deeper look at the dynamics of motivations. The theories try to predict how and why people make decisions in certain situations if they
have different options open to them. From a process perspective the observer appraises the intensity and persistence of the activity.
Heckhausen (2006) defined four phases of the process:
- Purpose setting
One example of a process theory is the extension of the expectancy theory. The basic model of the expectancy theory was developed by Vroom and assumes that behaviour is influenced by a combination of personal and environmental forces. Vroom suggested that motivation leads to effort that results in performance, which leads to various outcomes that have individual value (valence) for the employee. (Griffin, 2007)
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Figure 3: Vrooms Expectancy Model of Motivation (Source: Griffin, 2007)
Porter and Lawler modified this model. The central determinants of their extended expectancy model of motivation are:
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Figure 4: The Porter/Lawler Model (Source: Porter L;, Lawler E., 1968)
The difference in this advanced model is that satisfaction depends on the performance and not vice versa.
The literature describes two basic kinds of motivations. Intrinsic motivation has a psychological base. This kind of motivation contains all motives that come from inside. Typically they are not tangible. Intrinsic motives are: self-fulfilment, a sense of a challenge and receiving appreciation. The psychological rewards can usually be determined by the actions and behaviour of individual managers (Mullins, 2007, p. 251).
Extrinsic motivation is related to tangible awards such as salary, benefits, position, conditions of work and status. Such rewards are often determined on the organisational level. Even if Mullins (2007) mentioned that these factors are typically beyond the control of the manager, managers often have possibilities to influence these factors. EVA- or performance-based salary are two of them. Extrinsically motivated employees do not get satisfaction from the work itself, but from external circumstances like salary and status. While intrinsic motivation is more sustainable, external motivation constantly needs new attractions and has a short-term nature.
The idea to use money as a motivator is based on the idea of the rational-economic concept of motivation, analysed by F.W. Taylor at the beginning of the 20th century. He believed that factory workers would show the highest motivation and performance if they had the highest possible salary. Today this theory is heavily criticised (Mullins, 2007). As shown in Hertzberg’s theory, salary is a hygienic factor. The power of the extrinsic motivation factor money is very limited and short-term-orientated. The literature shows that there is a correlation between the complexity of work and the sensitivity for money-based motivation. The lower the degree of complexity, the higher the possibility to motivate people with money. An example of this is a laundry worker. The possibilities for growth within the job, changing jobs and gaining acceptance are very limited. Because of the low wages for this position people are motivated by money, which is usually connected to the number of finished articles they have worked on. The problem with motivation by money alone is that it usually creates no loyalty or connection to the company. As soon as another company offers more money, the employee will move (Mullins, 2007).
For the majority of people money is clearly important and a motivator. The degree of importance they place on it depends on the personality of the person, their circumstances and any other satisfaction they get from the job. On the basis of the mentioned theories of motivation it is important for companies to understand that motivation is a complex construct of several factors, of which money is only one. The working environment, the possibility of self-fulfilment and growth on the job have significantly more influence on motivation than salary.
Working motives are those, which are significant for the working process (Becker, 2008).
In his study of work habits in the public service sector conducted in 2008, H. Jung defined 6 relevant groups of motives that influence the working process:
- Performance motive: satisfaction by achievement of individual goals
- Competence motive: need for professional self-fulfilment, possibility to influence the future
- Social (contact) motive: need for belonging to social groups, personal appreciation and companionability
- Monetary motive: status-definition via salary, power, safety
- Safety motive: need to defend external threats like unemployment, illness etc.
- Prestige (status) motive: wish to differ from other people, to be respected
Depending on the person, different motives cause different actions. Every individual needs different stimuli, depending on his individual motives (Jung, 2008, p. 373).
Performance, competence and social motives have an intrinsic background (Chapter 2.1.4/2.1.5); this means people find satisfaction in the work itself. Incentive models clearly have an extrinsic focus, which correlates with monetary, safety and prestige motives.
Individual working motives change over time. Typically professional entrants react more sensibly to extrinsic motives; young people are naturally more career and money focused. Once they have achieved an adequate position, other motives like self-fulfilment and social acceptance come into focus (Jung, 2008).
Maslow’s pyramid of needs and Hertzberg’s theory of motivation represent a very general approach to motivation. A model that fits closely to the addressed research issue has been developed by Nitin Nohria. An article about her model of employee motivation was published in the Harvard Business Review in July 2008. It also represents a contemporary approach to employee motivation.
The article gives an overview of a leadership system based on the experience of the authors and their work with Fortune 500 companies. The authors identified the organisational needs and levers that companies and frontline managers have at their disposal as they try to meet workers’ fundamental needs (Nohria, 2008). The article also concentrates on branch-business organisations, which is an excellent fit with the business model of DIS AG.
Nohria’s definition of motivation is also strongly related to the working environment and also offers an approach to measuring motivation. To define motivation, she used four commonly measured workplace indicators (Nohria, N. et al, 2008, p. 80):
- Engagement: “represents the energy, effort and initiative employees bring to their jobs”
- Satisfaction: “reflects the extent to which they feel that the company meets their expectations “
- Commitment: “captures the extent to which employees engage in corporate citizenship”
- Intention to quit: “is the best proxy for employee turnover”
The study found that 4 drivers that underlie motivation exist which are hardwired into the human brain:
- The drive to acquire: In order to increase well-being, people want to acquire material and immaterial goods as clothes, promotions and experiences. This driver is relative; people compare what they have to the possessions of others.
- The drive to bond: Humans have a need for social affiliation. The need to belong to social organisations, groups and collectives is the second driver of Nohria’s model. Employees’ motivation gets an enormous boost when they identify with the company and feel proud to work for it.
- The drive to comprehend: People want to understand the world around them. They become motivated when they find answers and feel that their work delivers a meaningful contribution. On the other side, people become demoralised when their job is monotonous or leads to a dead end.
- The drive to defend: People tend to defend their achievements. A fulfilled drive to defend gives them a feeling of security and confidence; not fulfilling produces strong negative emotions like fear and uncertainness which have negative influence on motivation.
It has to be mentioned that there exists no ranking of the levers. “Each of the four drives we have described is independent; they cannot be [...] substituted one for another” (Nohria, 2008, p.81).
Besides the drivers of motivation, Nohria describes also levers that influence the drivers. These levers are (see also Figure 5):
- The reward system
- Company’s culture
- Job design
- Performance management and resource allocation processes
Even for the levers it is essential to use all of them to create a motivating working environment. The lever “reward system” is directly linked to the research issue.
Nohria describes the following requirements for the reward system:
- Performance orientated
- Clear separation between high and low performers
- Performance related incentives
- Promotion perspectives for the best people
- Pay at least as good as the competitors
Critically it has to be mentioned that focusing only on the reward system might have negative effects. It is very likely that a motivation system that is based only on rewards increases competition and has negative influence on team spirit or cooperation between units. This might negatively affect the other indicators for motivation such as commitment to the company and intention to quit. It is important to concentrate on all levers with sufficient intensity.
To measure the performance of people or organisational units, a system is required that evaluates transparently and sustainably the performance of the individual or a business unit. EVA could be the basis for this system. As described in Chapter 2.4, it measures the added value that a unit delivers to the company.
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Figure 5: Motivation: Driver and Lever
“A business unit or department which is treated as a distinct entity enabling revenues and expenses to be determined so that profitability can be measured” (www.investorwords.com) .
Companies are in a continuous change. The bigger they get, the more intransparent and stolid they become. What can the management do to offer the structure a higher flexibility, transparency and adaptability? How can people be motivated to be open for the environment and act intrapreneurially? These attitudes of small and medium-sized enterprises are the basic idea behind profit-centres. Management concepts can be changed quickly. Different to management concepts, the idea of profit-centres has a structural approach, is sustainable and long-term orientated (Preißner, 2002, p. 3).
Besides profit-centres, there exist many other forms of centre organisation. A well-working profit-centre structure has various requirements, not only in regards to organisational issues, but also in accounting and planning. It is essential to build up structures and key performance indicators (KPI’s) as EVA that are able to measure the
success and performance of every single centre and make it comparable to internal units and external competitors.
Definitions for profit-centres might differ, depending on the point of view. Typical focuses are:
- For the management and the organisation: Profit centres are a system of motivation.
- For the controlling: A profit-centre is a system of profit and loss statements divided in fields of responsibilities. In literature this field is described as “Responsibility Accounting”. (Preißner, 2002)
- For strategic planning: Profit centres are a system for improving the exactness of planning and forecasting.
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Figure 6: Influenced Areas within Companies
In practise, there exist different forms of centre organisations. Sometimes it is not possible to establish pure profit-centres. The following table provides an overview of existing models:
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Figure 7: Forms of Centre Organisation
Practical experience shows that centres are structured with the following focuses:
- Sales regions
- Distribution or sales channels
- Customer groups
- Supplier (groups)
Depending on the source, different environmental requirements are mentioned that a company has to fulfil in order to set up a successful profit-centre structure. Preißner (2002) defined the following basic conditions:
- Market orientation: Besides the internal market, there must also be access to external markets. A profit-centre has to offer and to demand services and products on this market.
- Responsibility orientation: Paired with the possibility to influence costs by the decision regarding product quality, amount and marketing, there must be a high level of influence on creation of value and performance.
- Controlling support: The controlling system must be able to support the profit-centre management. This includes a differentiated targeting system, with clearly definable and realistic targets that support the centre management. Furthermore, there must be a clear cost category calculation that defines costs and revenues exactly for each centre.
Frey (2002) defines further requirements for profit-centres:
- Transfer autonomy: Can the profit-centre decide autonomously where to purchase and where to sell their product, especially to internal or external customers? Does a competition between profit-centres exist which is comparable to the external market?
- Standardised and substitutable products: combined with the possibility to find objective prices
All sources underline the high importance of independency and comparability of the profit-centres. To ensure a comparable structure a corporate framework for accounting and controlling is necessary. In the chapter below important criteria for this will be described.
This thesis has a focus on the motivation inside centre organisations. To keep focussed on the main issue only the basics of accounting and controlling that are necessary to understand the correlation between accounting and EVA will be explained.
The accounting within the structure is primarily necessary to cover five points (Preißner, 2002):
- Assessment of bonus payments
- Legal requirements
- Performance measurement
Like in other organisational forms, companies differentiate between internal and external accounting.
External accounting is strongly regulated by laws and international standards like US GAAP and IFRS. It is the basis for earnings statements, balance sheets and the taxable base.
The internal accounting does not have to follow legal regulations and is individual for every company. The aim is to support management decisions. The main constituents are the controlling and the profit-and-loss statements.
For the calculation of EVA, the internal accounting provides the necessary figures, mostly based on the internal profit/loss statement. The result of the internal controlling might be significantly different to the result of external accounting.
Several options exist for evaluating the performance of a profit-centre. One common approach is the contribution-margin-based calculation. Depending on the model, the calculation occurs in 3-5 steps. In organisations like DIS AG, usually 3 steps are used.
Based on the sales revenues different kinds of variable and fixed costs were subtracted in several steps to calculate the operational income. The three relevant margins for a contribution-margin-based calculation are:
- Contribution Margin I = Revenue - variable costs
- Contribution Margin II = Contribution Margin I - direct fixed costs
- Contribution Margin III = Contribution Margin II - any other fixed costs
Depending on the internal organisation, further steps are possible. At the end, the calculation shows the individual operational result of the profit-centre. The figure below shows an example of a step-by-step contribution calculation. These figures are important because the calculation of EVA is based partly on the results of this analysis.
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Figure 8: An Example for Step-by-Step Contribution Margin Calculation (Source: Meier, 2005)
The table below shows the most important financial key figures in profit-centres:
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Figure 9: Key Figures of Profit-Centres (Source: Preißner, 2002)
Depending on the point of view, different key figures may influence the day-to-day business in profit-centres. HR-related key figures are, e.g.:
- Staff retention (average time of employment)
- Employee satisfaction
- Employee performance
- Sick rate
Most of the mentioned HR key figures are directly or indirectly related to motivation. Only if people are satisfied their work, are they motivated. A high fluctuation and a short time of staff retention combined with a low employee-satisfaction index are very good indicators for low motivation. The employee performance is also a good instrument to measure motivation. Even if other factors like qualification and ability have an influence on the performance, with increasing motivation, the performance per employee should improve as well.
According to Maslow’s and Hertzberg’s theories, responsibility and personnel growth are significant motivators. The literature describes various kinds of requirements for incentive systems, which are not only monetary in nature, but also all kinds of working conditions that have a positive influence on defined behaviour. Typical requirements are (Lichtenstein, 2004):
- Long-term orientation
- Performance orientation
To ensure a long-term effect, the incentive system should contain different forms of incentives. Each of the contents should fulfil the requirements above.
Preißner divided incentives into material and immaterial groups. As you can see in Figure 10, he also separated material incentives into financial and non-financial groups.
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Figure 10: Material Incentives (Source: Preißner, 2002)
According to Hertzberg, material incentives are more a hygienic factor, which means they are not, or using Maslow’s pyramid of needs, just a short-term motivator for the basic needs. Long-term and sustainable motives are more of an immaterial nature which is described in the theory of intrinsic motivation.
Preißner gave concrete examples for this kind of motivator:
- Working contents
- Job-promotion perspective
- Job title
In summary, most authors came to the conclusion that incentive systems have to contain several forms of incentives that are adjusted to the individual environment and people. Therefore, a manager should have different options for individual motivation. Ideally the company offers him a kind of toolbox, which he can use to choose the best incentive or motivation program for each of his employees. Therefore, targets should be clear and realistic and employees must be able to understand the calculation method for bonuses.
The idea of centre structures is to break down tasks from central to a decentral level in order to improve local responsibility. This is a special form of organisation that demands a high degree of responsibility and intrapreneurial thinking, which also requires adapted forms of incentive systems. The current financial crisis has also shown the importance of another point with a high relevance for this type of organisation. If profit-centres and bonus models are extremely focussed on earnings and revenues, do they also consider the risk? A good example of incentive systems, which failed to work, is those used by banks in the past. Because they did not have a share in the risks, especially traders were motivated to accept high risks or losses for the company. The personal disadvantage to the trader was only the loss of their bonus.
There also exist other special requirements for incentive systems in profit-centres. As mentioned in the previous chapters, profit-centres tend to act self- and not company-focussed. The system should support cooperate goals and reduce centre egoism. It should reduce risks. There should be a relation between the achieved incentives and the risks the person has accepted, i.e. for branch managers.
A mix between standard programs and individual incentives adapted to the individual competences and priorities/personality of the employee is the best way to support personnel improvement. A good foundation for this could be Hertzerg’s or Maslow’s model. Different tools (personality tests) also exist to identify individual motivators.
A broad range of goals should be defined. These goals must be long- and short-term oriented and contain qualitative and quantitative goals which should be realistic and dynamic. Only realistic goals motivate people.
Even though bonuses are currently attracting a great deal of criticism, they should be not limited. Only the chance for an extraordinary valuation will motivate extraordinary performance. To avoid excessive bonuses it might be useful to design models with different levels of payments. Another possibility is to combine this with the risk-avoiding factor and pay out the bonuses in a time-shifted manner.
All goals must be transparent and should be revisable by an independent department. It might be useful to establish an independent channel for complaints and use the MbO approach to define individual goals.
Incentive systems can also cause several problems or conflicts in profit-centres. As part of a critical evaluation of one of these systems it is necessary to take a closer look at their problematic effects. The literature describes 3 different forms of problems (Hoffmann, 2001; Preißner, 2002).
Discrepancies in character of goals According to the point of view, goals can be very different. Especially in profit-centres a high degree of autonomous thinking is demanded. People have to act as if they are an entrepreneur within a company. This also goes along with a high identification with the centre and colleagues. Even if this creates an environment with high performance and motivation standards it can also lead to conflicts between different departments. The ideal goal of the centre might not be ideal for the whole company. In companies with regional- and professional-focussed sub-divisions there are also often arguments about responsibilities. Here it is absolutely necessary to define a clear policy of responsibility.
An incentive system should stimulate staff to cooperate with other branches, in order to avoid losing any business. Another example for different goals is often found in transfer pricing. Every centre aims to achieve the maximum price for its product or service, even if it sells the product to another internal department. If there is a possibility to choose, they will sell the product to an external customer if they can get a higher price. The consequences might be that the other department can no longer continue its production and the company loses business. Even if there clear rules exist for this, they can have a very demotivating effect.
Other conflicts of goals also exist within a profit-centre. A manager who is focussed on gaining a quick promotion might be concentrated on short-term key figures and have limited interest in the sustainable growth of his unit.
One reason why companies decide on a profit-centre structure is that they are trying to reduce complexity. This can have two very different effects on the risk behaviour of the managers.
Depending on the situation and delegated power, they can take very high or very low risks. High risks are possible because of the strong relation between the profit-centre revenues and the performance (and salary) of the branch managers. He will do as much as possible to maximize the revenues, especially if he doesn’t participate in the losses of the centre.
The other option is that managers try to avoid risks. Due to the reduced complexity, managers have only limited possibilities for diversification. This phenomenon is often found in high-integrated centres, with a high degree of specialisation and a lack of external customers.
The incentive system should create a compensation of different risk dependencies within company and employees (Preißner, 2002).
The third category is time-related discrepancies. The bigger a company is, the stronger the requirements to plan for the future. Small companies are more short-term focussed. The reason for this is often the capital structure. Profit centres often act like companies within companies and are also affected by this problem.
Huge decreases in sales and revenues quickly affect the incentives of employees, which creates a kind of uncertainty. Because of this, they are often short-term focussed.
An incentive system should be able to connect the long-term orientation of the company with the short-term orientation of the profit-centre.
The American management consulting company Stern Stewards & Co. developed the Economic Value Added method in 1989.
The basic problem is the existing divergence between shareholders and management interests. Stern’s intention was to find a system that got managers to act in the interest of shareholders (Stern, 2001, p. 3-5). Usually managers have more information than shareholders. To solve this problem, shareholders concentrate on some presumable objective criteria to measure companies’ performances. These are i.e. the Earnings per Share (EPS) and the Price Earnings Ratio (P/E). If a company grows, the share price rises and the P/E remains constant. This might be a good indicator for the current situation of a company, but doesn’t show the true value. “These indicators do not measure the value of R&D, training, advertising and the brand” (Stern, 2001). Also EPS is easy to manipulate. It is easy to increase earnings by cutting costs for R&D and advertising if the situation, e.g., at the end of a bonus period, requires this. This increases the earnings for the moment but doesn’t create any kind of sustainable economic value for the company.
In 2000, 12 of the 30 German DAX companies used EVA as a controlling instrument (www.kpmg.de). According to the literature this model is very shareholder-value oriented (Stern, 2001). But it can also have a negative influence on cooperation
(Stern, 2001) and, especially in times of economic crisis, on motivation (Stern/Herrmann, 2008).
The idea of EVA is that companies should focus on maximizing their value (Rapport, A., 2000). This principle is very close to the shareholder value approach. The easiest way to identify the value of a company is to make a calculation based on its share price. The problem with this method is that the share price almost never represents the real value of the company. It is always influenced by speculations, over- or undervaluation. To identify the true value through the share price would only be possible under perfect market conditions (Stern, 2001). EVA offers an interesting alternative for measuring the value of a company.
The key indicators that influence EVA are: earnings, invested capital, and weighted average cost of capital (WACC). “Simplified, EVA is the difference of the profit after taxes and the cost of financing the firm‘s capital” (Hostettler, 2002). EVA is calculated by the formula below:
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Figure 11: EVA Calculation (Source: Hostettler, 2002)
In practice, EVA is used to measure the increase in the value of a company, or in a sub-unit of a company, in a clearly defined period. While traditionally incentives are based on a direct participation of sales, profit or turnover, EVA concentrates on the increase in value.
Typical EVA-based incentive programs also address the problems of incentive systems in profit-centres mentioned in Chapter 2.3.2. To avoid risk- and time-related discrepancies they contain a bonus bank. Parts of the bonuses are paid into this account, which is used as a buffer for times of negative EVA.
A profit-centre acts like an independent company within a company. Each centre has its own structure, planning and controlling instruments (Biermann, 1998). This creates competition within internal business units and with external companies. The business units have a kind of customer relationship with each other. The idea behind this concept is that this kind of structure should increase the ability to compete on the external market (Füser, 1997), but this also increases competition between the profit-centres.
The manager of each unit acts as an intrapreneur. His personnel success is measured by the contribution margin. EVA supports this system; it is the key figure for measuring the value creation in a profit-centre. It offers the possibility to compare different business units with clearly defined numbers.
On the other side, EVA might also cause problems in profit-centres. In companies with different branches like DIS AG, the tasks of the single branches are very similar. Even if the business is divided into four sections (Office & Management, Finance, Industry and IT), it is sometimes not very clear which branch is responsible for what. If one of the new orders is in a grey zone regarding branch jurisdiction, it is very likely that the branch will try to do the business alone without the help of other branches. There will be little intention to involve other branches because if the turnover is achieved with the help of another branch, the contribution margin, and the resulting EVA participation, for this project has to be shared.
Another very critical point is a lack of synergy effects in matters of customer care. If there is no motivation for branches to work together, it is possible that every single branch in a region will roll-out different sales promotions or customer care actions with the same customer. This is not only ineffective but also creates unnecessary high costs. In some cases companies lose business because of rivalry and the lack of communication between the branches.
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