Is Your Compensation Plan Driving or Hindering Growth?
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.
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.
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:
- Determine the total investment currently being made by the company in all rewards programs–salaries, commissions, bonuses, benefits, long-term incentives, etc.
- Identify a capital account for the company–all cash, equipment, inventory, etc.
- 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.”
- Determine the company’s most recent 12-month net operating profit, after tax (NOPAT).
- 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.
- 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.