What Problem does your Compensation Strategy Solve?
One of the “filters” through which the effectiveness of a given rewards plan should be evaluated is problem solving. Every strategy should be assessed, in part, in terms of the problem it will help resolve. Too often, compensation solutions that are put in place create behaviors or outcomes that miss the target in solving key barriers a company is facing or, worse yet, create a new problem that didn’t exist before a given pay strategy was implemented. Here are just a few examples of what I mean:
- In an attempt to overcome a lack of stewardship for key initiatives (the problem), a company institutes an annual bonus plan. It later discovers it has created an entitlement mindset and placed the company in the position of paying out incentive income even during periods of distressed economic performance.
- A private business begins sharing stock with key producers as a means of overcoming attrition and the inability to compete for premier talent (the problem). In doing so, the equity position of previous shareholders is diluted and new shareholders have few options for capitalizing on value increases in the business other than a major transition event such as the sale of the business.
- The owner of an enterprise wants to overcome a short-term focus (the problem) and grow her business value in anticipation of a sale. She institutes a phantom stock plan that vests only upon the sale of the businesses–which she anticipates being in approximately 5-7 years. At the five year mark, she gets a second wind and decides not to sell the business for an indefinite amount of time. Employees are left wondering when they will realize the value they helped create. What was intended as a positive, uniting incentive becomes a morale breaker.
Certainly, many more examples of this phenomenon could be illustrated. Hopefully, the ones indicated give you an idea of what happens when inadequate attention is paid to solving the right problem with a compensation solution.
This issue is not solely a function of companies developing pay strategies without clearly identifying the problem they are trying to solve. Instead, they often don’t go quite far enough in thinking through all the relevant implications of a given strategy that’s being considered. They may be focused on the right problem but the solution they are implementing is creating more barriers than it resolves. Such is the case in the illustrations given above. The result is a company that perpetuates a plethora of “unintended (harmful) consequences” instead of (positive) “strategic byproducts.” If companies focus properly on the “right” problem and all of the implications of a considered strategy, the “strategic byproduct” multiple will become self evident and self perpetuating. Here is an example of solving a problem in a way that creates this positive effect while avoiding unintended (harmful) outcomes.
- XYZ Company is in growth mode and needs to attract certain people to fill key positions. The problem is it doesn’t want to lock in high salaries and it is in a highly competitive talent market. The best people have several career options within the industry if they are good at what they do. So, the company decides to peg salaries at the 50th percentile of “market pay” but provide significant upside potential through value sharing. They determine to provide up to 100% of salary in additional, incentive income that will be divided between short-term and long-term value sharing plans. Fifty percent of the incentive will be earned as an annual bonus and the other 50% will be applied to phantom shares, with a value that is tied to a formula built into the plan. The phantom shares vest in three years and pay out value in five. Thresholds and metrics of company, department and individual performance are set for accruing benefits under each plan–both of which ensure that value is only paid out when “sufficient” value has been created. An employee value statement is developed to demonstrate to the key producer what his total value proposition will be with the company over the next five or ten years if a targeted level of performance is achieved. He learns that he is not merely being offered a $160,000 salaried position but a $1.8 million dollar opportunity over five years with the company.
Let’s think about how this approach solved the problem at hand while creating “strategic byproducts” instead of ”unintended consequences.” The company put itself in the position of offering potential recruits a plan that was rich in upside potential while limiting guaranteed income. (Problem solution.) It framed the relationship with the new employee as a partnership with ownership to grow the business. (Strategic byproduct.) It differentiated itself in a competitive talent market without over committing on salaries. (Problem solution.) Additional strategic byproducts of this approach included an ownership mindset on the part of key producers and a more unified financial vision for growing the business. In addition, the business was able to construct a pay approach that significantly drove value for shareholders while still creating rich payouts for employees, due to a “self-financing” approach to the incentives. It created a “wealth multiplier” environment because all stakeholder rewards were tied to unified, business growth components.
In the end, most organizations need help in avoiding the pitfall of unintended consequences with their pay strategies when trying to solve problems. They need individuals or consultants that have experience with multiple options for solving key business barriers and can guide the process in a way the leverages the strategic outcomes that are achieved. The right questions need to be asked and appropriate challenges need to be made to solutions being offered that don’t adequately address the full ramifications of implementation.
This principle can be applied in other aspects of the business as well. For a broader treatment of effective problem solving in an organization see the Dwayne Spradlin article in the September 2012 edition of Harvard Business Review.
To see how phantom stock plans are often used as a strategic tool to solve specific problems within an organization while creating multiple strategic byproducts, tune into our upcoming broadcast entitled, “What is Phantom Stock and Why do I Keep Hearing about It?” Click here to register.