John Davis, CEO of Air Systems Inc., in San Jose, Calif., has done a great deal to attack a big source of fixed overhead: the annual raise for administrative employees. Nearly all of the 100 employees who work in the office at Davis's $55-million air-conditioning and heating contracting company forgo the security of a fixed annual raise. In exchange, they get the opportunity to earn much more through bonus programs tied to the company's financial performance.

Davis started his incentive plan nearly seven years ago, after the company experienced a near-fatal downturn, capped in 1990 by a $600,000 loss and painful layoffs. As the company recovered, Davis wanted to grow without increasing fixed overhead. He decided to take the radical road of no longer giving annual raises to administrative employees.

Instead he set up two bonus pools linked to the company's monthly and quarterly profitability. The first he calls a profit-incentive plan, or PIP, and it kicks in each month that the company makes its profit projection. The PIP payouts are designed to be the incentive-compensation equivalent of a raise: Davis says the payouts average about 5% to 6% of eligible employees' monthly salary, and each year, an employee is eligible to have the percentage increase. The other pool adds quarterly bonus checks that, according to Davis, are worth far more than even a stellar raise if the company makes its profit goals for the quarter. (Davis says that most of his approximately 500 union workers aren't included in the incentive plans.)

Davis's system has required some tweaking. Under the PIP plan, for example, the longer a person has been with the company, the more compensation he or she has that's not guaranteed. So every three years, employees can question their base salary using industry benchmarks and opt to add half their monthly PIP profit sharing to their fixed income.

Davis calls his compensation plan "the biggest asset we have for employee retention." He admits that the low base salaries create recruiting challenges. "But we've got enough history now to show job candidates" the advantages, he says, adding that those who join the company tend to be more willing to take risks.