John Davis, CEO of Air Systems, in San Jose, Calif., now a part of the publicly traded company Group Mac, has successfully reduced a large chunk of his fixed overhead: the annual raise for administrative employees. Nearly all of the approximately 140 employees who work in the office at this 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 after the company experienced a near-fatal downturn -- a $600,000 loss in 1990 caused painful layoffs. As the company recovered, Davis wanted to grow without increasing fixed overhead. Instead of annual raises for administrative employees (union workers aren't included), he set up two bonus pools linked to monthly and quarterly profitability. The first, which he calls a profit incentive plan, or PIP, 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 entitled to have the percentage increase. The second 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. So far, so good: In 1998, Air Systems revenues reached $111 million.

Davis's system has required some tweaking. Under the PIP plan, for example, the longer an employee has been with the company, the higher the portion of the employee's compensation that is 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," and he's determined to see it implemented in the rest of Group Mac. He admits that the company's low base salaries create recruiting challenges. "But we've got enough history now to show job candidates," he says, adding that those who join the fast-growing company tend to be more willing to take risks.

Davis isn't the only entrepreneur to advocate the concept of moderate base salaries plus an ample bonus plan as a means of rewarding employees while containing fixed costs. In The Great Game of Business (Doubleday/Currency, 1994), the book he coauthored with Bo Burlingham, Jack Stack, well-known CEO of Springfield ReManufacturing Corp., argues that such compensation systems help companies maintain a resourceful mentality. That's because employees share in the company's profits when it does well -- but in a way that won't increase fixed costs and thereby impede the company's future ability to compete. "It's like getting a raise, maybe even a very substantial raise, over and above your regular salary, but in a way that doesn't jeopardize your future employment," Stack writes.