Building Unified Financial Visions

What are the purposes behind your compensation programs? For example, why do you pay salaries? Why do you offer bonuses? How about your retirement program? Does it have a fundamental business purpose?

The obvious answer is that no one will work for you if you don’t offer a competitive package? But let’s dig a little deeper. A lot of trouble goes into determining the right levels of pay (market standards and all that). And a lot of work is put into designing the “right bonus plan.” Every total rewards decision is analyzed and re-analyzed. Why?

We could get lots of different answers to this basic question. Here’s mine: to build a unified vision for growing the business.

This answer assumes a few things. First, the business wants to grow. I take that as a given. In this day and age, all businesses must grow to survive. What’s needed to grow? A solid business plan. Capital. People. A commitment to execution. Customer responsiveness. Creativity and innovation. All these and more. How does a business culture capture and produce all these elements? Answer: a unified vision.

You have a unified vision when every employee (well, virtually every employee) (a) understands the business purpose and finds it compelling, (b) sees a personal role and contribution he or she can make to that purpose, and (c) feels accountable for the results. The rewards program, in this formula, is the capstone to the results. Said differently, positive results lead to profits. Profits indicate the employees delivered, to one extent or another, on the business plan. Responsible companies respond by sharing some of those profits with the people who helped generate them. All forms of compensation ultimately should reflect the belief that the employees contributed to something meaningful.

(Note that I”m not strictly referring to “profit-sharing” bonuses or even exclusively to incentive plans. The entire pay budget is theoretically a reduction in profits. Every piece must contribute to the genertion of same.)

In this formula, the incentive plans are not trying to force behavior. Instead, they reinforce valuable contributions. The more unified employees are in understanding the principles behind the formula, the more committed they just may be to delivering on the vision set forth by senior leadership or shareholders.

Ask any CEO or owner that question and chances are you will get a response something like this: “Hmmm. Not sure.”  Ask the same CEO what the largest budget item is on the company’s financial statement and the response will likely be: “Compensation.”  Does anyone see the disconnect here?  How can a company leader not know whether the highest financial investment the company is making is driving or hindering growth?

This happens, of course,  because most companies don’t have mechansims for assessing the impact rewards are having on critical performance indicators and outcomes.  And so they continue to pour millions of dollars into something that isn’t being measured (for results) in the same way other large capital investments are evaluated.  (Sounds like a government entitlement program to me….but that’s for another blog.)

For a business to get its arms around this concept, it must be able to determine both the soft and the hard criteria it will use to measure the relative success of a given compensation strategy.

Soft Results

These outcomes don’t show up on the income statement or balance sheet, but they have a real impact on the financial results of the company.  And they can be measured.  Essentially, these fall into the following categories:

Partnership–Do employees feel like participating partners in the company’s business successes?  If compensation isn’t creating this link in the minds of employees, they aren’t mentally participating in the company in the same way as ownership.

Clarity–Through compensation, does the company effectively communicate and reinforce its organizational standards and the value of the total rewards opportunity?  In other words, do employees make a connection between the financial results of the company and the fulfillment of their own financial objectives–in a non-manipulative fashion?

Engagement–Has the company achieved a crucial level of employee commitment, passion and execution?  Is compensation creating a sense of stewardship that reinforces the intrinsic motivation all employees need to perform at the highest levels?

These areas can be effectively measured through carefully engineered surveys.  VisionLink’s Alignment Appraisal is one such tool for performing an assessment of this type but you may be able to come up with your own.  Regardless of the tool used, if these issues aren’t being measured, you don’t yet really know whether your compensation strategies are driving or hindering growth.

Hard Results

When it comes to  outcomes that have a real dollar impact, the issue becomes one of measuring productivity.  How does the business determine the amount of value that is created through financial capital at work in the company as opposed to the productive output of its people?  To make this contrast, the company should consider performing an analysis such as VisionLink’s ROTRI calulation.  Here are the figures measured and contrasted in such a process:

1. Determine the total investment currently being made by the company in all rewards programs–salaries, commissions, bonuses, benefits, long-term incentives, etc.
2.  Identify a capital account for the company–all cash, equipment, inventory, etc.
3. Assign a cost to that capital account–an amount such as your borrowing rate or a  return you feel shareholders should expect to receive on that working capital (10 to 12% are typical).  We’ll call this your “capital charge.”
4. Determine the company’s most recent 12-month net operating profit, after tax (NOPAT).
5. Subtract the capital charge from the NOPAT.  We will call this your “productivity profit”–the amount you will consider attributable to people capital at work as opposed to financial capital at work in your business.
6. Divide your total rewards investment into the productivity profit.  This becomes your ROTRI percentage.

Once you arrive at your ROTRI figure, you will likely instinctively ask, “is this good or bad?”  Actually, it’s neither.  For now, its just a benchmark–and your ROTRI will be different from another company’s percentage depending on margins and a number of other factors.  The key issue is whether or not your ROTRI improves year to year.  If it does, then you can conclude that productivity is improving.  If productivity is improving, it is easier to conclude that your rewards strategies are having a positive impact on results–therefore they are driving rather than hindering growth.

Don’t Be Caught without an Answer

In summary, if you are leading an organization, you don’t want to be left wondering whether your company’s largest financial investment is draining or fueling  growth.  You need to know.  Hopefully, some of the measures indicated above will help you get a jump start on figuring out what your answer will be going forward.

Too often a company’s compensation strategy discussion begins in the wrong place.  It starts with questions about design or amounts.  This occurs because, in most instances, the company is just trying to solve a problem.  And usually, its hope is that there is a way to simply “plug the hole” that’s making the “dam leak” so they can move on to what’s really important.  When someone in such a circumstance calls us, this tendency is manifest pretty quickly.  Once we’ve listened to the issue and explained our process, the potential client reveals their frame of mind with a question that is set up something like this:

“So, how long will it take to work through your process?  We are coming up on our employee reviews in four weeks and we told them a while back we would be introducing a new bonus plan at that time.  Can we get this done by then?”

Such a question, while asked innocently enough, reveals much about how that company views compensation. It is an issue to be managed, not a strategic tool to drive certain results  in the business.  Seldom is the core problem a design issue.  It’s an alignment issue. This is because rewards planning is an outcome-based endeavor that needs to reinforce the strategic focus of the company.  A four-week excercise in re-engineering the bonus plan is not going to drive a different outcome for the business ,and year or two later the company will be back at square one trying to solve the problem all over again–and probably asking the same questions.  (What did Einstein say?  “We cannot solve our problems with the same level of thinking that was used to create them.”)

To avoid this tendency, let me suggest six steps that an outcome-based approach to compensation planning should include.

1. Identify your company’s core strategy.  Reduce it to a one paragraph statement that everyone in the organization can recite.
2. Define three to six strategic intiatives that have to be achieved if the strategy statement is going to be fulfilled.
3. Identify where in the organization key decisions need to be made relative to those intiatives (department, team, pair, unit, division, subsidiary).
4. Model what financial value (for shareholders) will be created if those initiatives are successfully carried out.
5. Align the organizational roles with the strategic intiatives that have to be carried out if the value modeled is going to be achieved.
6. Now approach compensation development in the framework of that broader strategy discussion.

Certainly, there are other pieces that need to be managed for the outcomes in question to be fulfilled.  A company needs to be able to identify key decisions the company needs to make.  It needs to organize its macro structure around sources of value.  It must figure out what level of authority decision makers need.  It has to align other elements of the organizational system, such as information flow and processes, with those related to decision making.  It must ultimately nurture a sense of stewardship and help those responsible develop the skills and behavior necessary to make and execute decisions quickly and well.   Incentives, then, and other elements of compensation, must become mechanisms for structuring the kind of “partnership” you will have with those responsible for the outcomes and how a unified financial vision within the company will be defined.  (For more information on the examples given in this paragraph, please see The Decision-Driven Organization in the June 2010 edition of the Harvard Business Journal. Marcia W. Blenko, Michael C. Mankins, and Paul Rogers, all of Bain and Company, are the authors.)

We are living in a business age of rapidly changing cycles where flexibility and decision making skills will make the difference between thriving, surviving and dying.  Compensation must be discussed in a framework that acknowledges that reality.  If it is, a company will find itself with a powerful rewards program that will allow it to attract the decision makers described above and move the company from a reactive problem solving mode to outcome-based achievement.