Why automakers are adopting pay for performance

October 7, 2011: 11:33 AM ET

While performance bonuses do not make sense for every industry, there are a host of reasons why it adds up for manufacturers like Detroit's Big Three.

By Shelley DuBois, writer-reporter

FORTUNE -- The genius of Ford's first Model-T was that it optimized a highly complex process: workers could make each of the parts in isolation. Then, a specific group of workers would put those parts together to make a car.

Over a century later, that assembly-line mentality is moot. Car making, like other modern manufacturing processes, has become an integrated process where many different departments work together, much earlier than the final phase, to form a product. Car companies that want to provide an incentive for employees to produce more high-quality cars faster need to frame the work as a collective effort. One way to do this is to adopt a pay-for-performance model.

Last week, General Motors (GM) announced that it would start to share its profits with its hourly workers as part of a larger agreement the company signed with the United Auto Workers (UAW) union.

This week, the UAW is wrapping up talks with Chrysler. Ford (F), which signed a tentative agreement with the UAW on Tuesday, already shared profits with its hourly workers when it gave them $5,000 after announcing its 2010 net income in January. Chrysler initiated a profit-sharing plan back in 1985, but stopped making payments in 2006. The company is currently negotiating with the UAW, and it should reach a payment plan agreement in the next couple of weeks.

The UAW and the Big Three are trying to create auto manufacturing jobs in America that still allow carmakers to profit, despite the lower cost of manufacturing in many other countries. So far, both Ford and GM have tried to walk that line by creating more entry-level American jobs for workers with lower starting salaries. Both companies have indicated that they will include signing bonuses and profit sharing plans for these workers.

Many different types of companies use a pay-for-performance model -- think of a sales executive who works on commission -- but the benefits of profit-sharing at car companies represents a profound shift in manufacturing. Modern manufacturing is team-oriented, says Jim Kochanski, a senior vice president at consulting firm Sibson. "One person working faster on the line doesn't speed up the line anymore," he says, and successful financial incentives must reflect that.

Manufacturers in general are primed for this compensation system because they can use very specific performance metrics: producing more units in less time for less money spells positive business results.

The lack of these kinds of metrics can make the model controversial. For example, many states are considering introducing performance-based pay for teachers. Those proposals have gotten mixed-feedback, since better student performance can be difficult to quantify.

But governments and companies alike are looking to pay-for-performance models because they are so cash-strapped. Especially in challenging economic times, companies need to make sure they reward top-performing employees and otherwise spur their workforce to produce profits.

"People are watching pay in a way that they haven't before," says Myrna Hellerman, also a senior vice president at Sibson."I think that management has to be more engaged in the pay process than it was before the downturn."

Companies also need to communicate these new goals clearly to their employees. That's something that has actually improved, in general, since the recession, Hellerman says.

The need for a clear compensation process drove GM's recent shift. "One of GM's goals was to develop a profit-sharing formula that was simple and transparent and would help employees understand how they could contribute to the success of the business every day," says Kim Carpenter, GM's manager of manufacturing and labor communications.

The company is tying payouts to hourly employees to the whole company's earnings before income and tax, a publicly available figure. In other words, the world can watch GM's earnings and resulting payouts. This way, under ideal circumstances, car workers can share a common goal of earning and, on a larger scale, helping their employer stay in business.

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Shelley DuBois
Shelley DuBois
Writer - Reporter, Fortune

Shelley DuBois writes on management issues for Fortune.com. Before joining Fortune, she was a producer for National Public Radio's Science Friday and worked for Wired. Shelley has a graduate degree in science, health and environmental reporting from New York University. She lives in Brooklyn.

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