While Data Encore's stock-option plan was the creation of a management-committee strategy session, the impetus for Wilson Laboratories's royalty program came at least in part from the employees themselves. "Almost every engineer has invented something that's made some guy money hand over fist, and then only got paid [on an hourly basis] for it," says Dietz. Neither he nor Wilson are unfamiliar with such situations, both having done long stints as consulting engineers. "I think we both just got to thinking," Dietz continues, "that if a singer can participate in the sales of his product all his life, why can't an engineer? So Randy and I sat down with a bottle of wine one night and decided royalties were a good idea. I only wish we'd done it earlier."
The program works like this: Once Wilson and his three key engineers decide to embark on a product-development project, Wilson determines how large a royalty he will pay on the finished device. That decision is based on the product's perceived market potential, as well as its anticipated longevity on the company's products roster. Wilson then privately informs each of the engineers on the project -- usually Dietz, plus the new-product-development manager and the software manager -- of the maximum figure their work will be worth. The cap can go as high as $25,000 on the hardware design of what Wilson considers a "primary" product, and up to $10,000 on the companion software or a shorter-lived "secondary" device. The royalties are then paid out in monthly checks containing a cut of the selling price on each unit shipped -- 5% per unit for primary products, 2% for secondaries -- until the maximum royalty is met.
Although the royalty program is relatively new, "the results have been fantastic," says Wilson. He is not just speaking of retention; he is talking about attitude. "When an engineer has a vested interest in the product he's designing, you end up with a better product. Each engineer sees the project as his baby. He wants to get the maximum amount of royalty possible, so he does everything he can to make sure it sells. He puts more effort into the testing of it, the marketing of it -- and he offers plenty of constructive criticism along the way. From an owner's standpoint, this royalty program means that I'm not the only one who's interested in making sure this product gets to the marketplace."
In the beginning, Wilson wondered if a bonus system wouldn't have done as well. He didn't think so then, and still doesn't now. "Bonuses are too much like ordinary income, and from the corporation's point of view, they go on forever. With the royalties, it comes right off the top [of the corporation's books], and when you reach the amount agreed upon, [the payments] come to an end. The product is yours, free and clear."
There may be an additional benefit for the employee, as well. Some case law could be interpreted to permit royalties paid by an employer to an employee to be eligible for capital-gains status on the employee's tax return, but the Internal Revenue Service is far from clear on the subject. There is always the possibility that the IRS would reject such employee claims, and tax the royalty payments as if they were ordinary income.
Wilson and his employees agree there are other questions to be answered, other gray areas that may require definition. For example, there is no assurance that an engineer won't balk at the terms of the royalty agreement that Wilson offers. What recourse does he or she have? None, beyond simple negotiation, Wilson says. He would write guidelines if he thought it feasible, but "I think most of that has to be up to me. I can tell you, though, that I wouldn't set a $10,000 royalty on a $5-million product. I just don't do business that way." (Most of his products have been worth $1 million to $5 million, for which he thinks a royalty of $25,000 per engineer is eminently fair.) Just the same, says Dietz, "I think it'd be better for everybody if we had a few more things written down."
Could a disgruntled engineer peddle a design to the competition? Not legally, Wilson says. He and his attorney are of the opinion that the royalty agreement is a quit-claim document that details the terms of a cash-incentive program, not a bill of sale between an inventor and a buyer. Because Wilson himself originates most of the design ideas, and his engineers use his facilities and equipment, the engineer is assumed to have no ownership rights to sell to Wilson Laboratories or anyone else. Besides, they say, any claims the engineer might have had were signed away before actual research began.
If there is a problem thus far, Wilson says, it is that "the walls are thin." All of Wilson's employees know about the royalty program and who is eligible, and that has caused some jealousy. Complaints from lower-rank engineers who have not been included in the program have forced Wilson to institute a separate bonus program for them. Now, on projects for which their superiors collect royalty checks, these support people pocket lump-sum bonuses of $1,000 to $3,000. Questions are also arising as to who is qualified to work on what project. So, to handle the inquiries that are bound to increase as the company grows and takes on more projects, Wilson says he may develop a sort of point system to differentiate one person's skills from another's. And if, somewhere down the line, an engineer who was not part of a project's original royalty agreement makes what seems to be a valid claim to the spoils, "maybe I'll offer a car or something" as an appeasement. "I'm only getting my feet wet as to how to be equal with a lot of this," Wilson admits.
Data Encore, too, may have issues of fairness to consider. The stock-option plan that covers the original 27 employees has, to this point, been a one-time deal; the only new employees who have received options are those who have been hired at relatively high-grade levels, and are thus qualified for Verbatim's own, more traditional stock-option plan. Right now, there are no plans to extend the more-inclusive plan.
Still, Kenny believes in the psychological power of a stock certificate to instill feelings of belonging and ownership, and if he had his way, each new employee would serve 90 days probation "and on the 91st day receive stock." He may consider asking Verbatim for dispensation to begin doing just that, "when the time is right -- when Data Encore is in a stronger position with the company."
Surprisingly, not all employees would favor such a move. "As it is now, the stock is a motivator," says quality-control manager Roger Cook, who has an option. "If it were opened to everybody, it wouldn't be that as much. It'd be more of a maintainer, something you come to expect, like a smock or a locker."
To most Data Encore employees, the major flaw in the stock-option plan is that it isn't really their stock-option plan. "Our ability to exercise the stock option is based upon Data Encore's [profit] performance -- and that motivates us, of course," says equipment-maintenance supervisor Tom Schoen. "But isn't it odd that the actual value of the stock is dependent only on Verbatim's performance? It seems to me it should be tied to our productivity."
Kenny nods, appreciating the contradiction. "As the company grows, we will probably have to shift the emphasis so that all of our recognition programs -- stock options, bonuses, and perks -- are based more on the performance of Data Encore and less on Verbatim's. If you're going to be a separate entity, and autonomous, then you really don't want to be compensated based on how another entity is doing."
