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.

In my last blog I wrote about the need to get clear on your employees’ goals and needs. Creating compensation strategies without knowing your employees’ goals is as foolish as a waiter serving a customer the meal of his (the waiter’s) choice without even handing out a menu.

 Let’s suppose you’ve figured that part out. You’ve examined your compensation programs through the eyes of your employees and you’re confident that your total rewards budget is as efficient as possible. Now what?

 Time to ask the employees to do their part. They need to understand that maximizing the value of their rewards plan is tied to the success of your company. If you don’t succeed, they don’t either.  Let the employees understand that the more profitable your company is the more you’re able to share with them. (Let’s not forget that employees are interested in much more than financial rewards. Visit here for a reminder of the other important things that keep them there and keep them satisfied.)

 Where to begin? Ask some of your employees to answer these 4 questions:

1. What’s the future of our company look like to you? (Vision)
2. What are the key things that have to happen for us to grow and succeed? (Strategy)
3. What contributions are you most excited about making? (Role)
4. Why is the creation of our future company important to you? (Rewards)

 If you don’t hear the answers you’d like to hear you’ve got some work to do. You need a unified and committed team to succeed in today’s world. Getting your employees clear on those 4 issues will lay a foundation for that unified team. As employees understand how they can contribute to the creation of a compelling future (Your Vision) they will realize how committed you are to helping them achieve Their Vision. Sounds like a “Vision-Link.”

Companies that struggle with building effective compensation strategies are often ascribing an unrealistic expectation to their rewards programs.  They want compensation to be a motivation tool; one that will impact behavior  and create change.  They are often disappointed when they don’t see quantum leaps in performance and productivity.  They subsequently label the latest incentive plan attempt “dead on arrival” and begin cursing the “compensation gods.”

What these companies don’t often recognize is that their attempt at motivation came across as manipulation to their employees.  It’s a fine line, and it is easily crossed.   Premier talent has an intrinsic sense of purpose and recognizes the value it brings to the table.  These individuals are motivated by mission and opportunity, not by financial rewards. As a result, they are not relying on a compensation program to trigger their passion.  However, they are looking  for a sense of partnership–and the company’s compensation programs become a  key validator of that message.  You see, partnership is linked to opportunity–and that is motivating to the kind of people most companies want to attract. 

Partnership is more than pay, but pay is a key component of partnership if it is given the right frame of reference.  Compensation needs to be viewed as a means of creating a unified financial vision for growing the business.  It is built in parallel with the vision, mission and strategy of the organization.  It is an extension of the business plan and defines the financial parameters of the partnership relationship the company has with its key people. 

Companies that embrace the partnership concept understand the critical nature of having a compensation philosophy statement.  That written document defines what the company pays for.  It communicate the balance the business seeks to strike between guaranteed versus at risk compensation, and short-term versus long-term rewards.  It ties short and long-term incentives to the concept of good versus bad profits, and uses the compensation construct to encourage more of the former and less of the latter.  Such definitions are critical ingredients of a sound financial partnership and offer insight to the parties involved into the best means of fulfilling the partnership’s potential.

A foundational philosophy statement provides a lauching pad for examining the components of pay that should be included in defining the partnership relationship the company wishes to have with its best people.  Salary, short-term incentives, long-term incentives, equity, phantom equity, health and welfare plans, retirement benefits and executive benefits are all weighed and evaluated in the context of partnership.  “What plans will drive performance, increase shareholder value, and meet the cash and wealth accumulation objectives of our most critical partners–our employees?”

When a company begins to think and act in these terms, it will turn the corner in its understanding of the power of compensation to be transformational in its impact.

So…when you think about compensation, think parternship, not motivation.

I assume that as you approach each new year, you don’t think about your business in modest terms.   Presumably, you have big plans, and are trying to renew your employees’ vision of the possibilities.  Breakthrough growth.  New thresholds of success.  Expanded sales and market share.  Increased profitablity.  Greater shareholder value.

With that vision in mind, you are likely trying to effectively communicate your vision to your key people. You want them to understand why that future is important and how confident you are that it can happen, with their help.  To that end, you might be holding team meetings, sending letters or intranet communications, inviting key individuals to lunch and generally trying to ignite a fire that will translate into execution and results that reflect the potential you have imagined.

Now, with such goals in mind, can you fathom any successful business leader standing in front of his team and giving a speech that goes something like this?

“This year our target is to do about as well as our competition.  We’ve studied what they are doing and hope to mirror their plan as closely as we can.  If we carefully manage expenses and make sure we keep our costs down, we should be okay.”

You are laughing right now, right?  Well, laughable or not, while that may not be the way an owner, CEO or company president approaches the communication of his business vision, it too often reflects his approach to compensation design–the one strategic tool that best communicates the relationship between vision, business plan, roles, expectations and rewards.

To make the point clearer, here are some common assersions or questions we often hear early on in our discussion with  potential clients.

• How many clients do you have in our industry?
• Can you do a market pay study for us?
• Is there a lower cost approach we could take?
• We don’t really want to add anything to our compensation budget, so please keep that in mind as you help us develop new plans
• HR handles compensation issues, you should talk to them

There are more, but you get the idea.  Can you see the obvious disconnect between these comments and a company that is trying to achieve breakthrough performance?

Compensation is usually the largest budget item for a business.  Company cash is going to be used for that purpose one way or another.  The key question is, will  it be used as strategically as every other investment in the business, or will it be relegated  to just another expense that has to be managed? 

If you have applied your energy towards becoming a world-class organization with a clear competitive advantage, why would you not apply the same focus to compensation development?  If you need to attract great talent to become a great company, why would you not offer them a world-class compensation plan?

If you are thinking that “world-class” means expensive (as in world-class hotels, first class travel, etc.), then think again.  A world class compensation strategy might simply be described as follows:

The business is committed to a compensation strategy that is fully integrated with the business plan and offers a clear competitive advantage in recruiting and retaining top talent.

Having an integrated compensation strategy simply means there is a relationship between how people are paid and the achievement of the strategic goals of the organization.  Compensation is an outcome based endeavor.  In a world-class environment, those outcomes might include the following:

• Productivity: Employee engagement and commitment reflect an ownership-like determination to drive growth, profits and shareholder value. (Owner statement–”Employees understand the company’s future and are committed to helping fulfill it because they have a vested interest in helping it succeed.”)
• Talent: Great talent is attracted to and remains with the company because they feel passionate about their role in the future of the organization.  (Owner statement–”Employees believe in the company’s ability to achieve its targets and that their contribution is vital.”)
• Measures: The cost, impact, and operational efficiency of all compensation/benefits programs are managed, monitored, measured and consistently improved. (Owner statement–”We regularly evaluate and employ mechanisms by which we can improve our systems, drive productivity and save money.”)

In a company with a “world-class” mindset, the speech given by the owner, CEO or president might sound more like the following:

“This year we anticipate having record performance.  Building on our past success, as well as the strength of the greatest talent in our industry, we expect to secure a leadership position in our market space and achieve our most ambitious goals.  You are a critical part of the future of this organization.  We can’t achieve our goals without you.  As a result, I want to make sure you understand the rewards you will enjoy if we can all work hard and achieve the performance levels we have targeted.  This year, in addition to your salary, you will pariticipate in two incentive plans–one short-term in nature and the other long-term.  Both will put you in greater control of  the financial results you can realize if we can achieve the goals we have set.”

Such a speech can only be given by a leader that understands the relationship between performance and pay, and the importance of carefully tying the two together in the value proposition employees are offered.  Such a speech will also attract great people–individuals that relate to the idea of building something and want to know that their contribution is vital.  Such individuals feel valued and counted upon, as a result, they execute differently.

So, as you approach this new year, think in terms of new standards–not just in the goals you set or the initiatives you launch, but also in the way you reward performance.  Build a world-class compensation plan.