Complexity can kill any value sharing arrangement.  Some reading that sentence are nodding their heads knowingly right now.  They’ve experienced that complexity and watched failure overcome what seemed in the beginning like just the right solution to plan design.

Companies run into the complexity problem most commonly when they try to manage behavior through the incentive plan.  They construct metrics and measures that are intended to focus the employee on specific business drivers.  By the time they construct those metrics for every category and tier in the company, they have a monster on their hands.  It’s usually about that time that our phone rings.

As you approach incentive plan design, keeping it simple has to be an overarching aim that guides the process.  To accomplish this, think in terms of deciding between two basic plan types and three basic measurement categories.  Then plan to “weight” the measurement categories by tier of employee to address the variance in impact at each level of the workforce.  Here’s what I mean.

Two Plan Types

When building a short-term incentive, a company will need to decide whether they want to use a profit-based allocation model or a targeted KPI approach.   In simple terms, a profit-based approach will focus everyone in the workforce on the profitability of the company and a pool will be used to generate payouts once a certain threshhold of profitability is achieved.  The KPI approach focuses the attention of an individual or team on defined performance indicators or intiatives which, if achieved, will drive greater profitability, revenue, EBITDA or whatever other key outcome you measure.

Each of these approaches are discussed more thoroughly in an article and/or webinar on our website.  I will refer you there for greater detail.

Three Measurement Categories

Most plan types can be managed well by “weighting” how much of an incentive will be tied to company performance, how much to team or department performance and how much should be based on individual performance.  The weighting each of these is given depends on the sphere of influence of the participating employee.  For example, tier one employees (executive level) might have a weighting something like the following: 75% company, 0% team, 25% individual.  A second tier (directors) might be allocated as follows: 25% company, 50% team, 25% individual. And so on through the tiers.

The three measurements approach allows you to have one plan while making room for adjustments to be made by category of employee based on its ability to impact company, department or individual outcomes.

Long-Term Incentives

Just a word about long-term value sharing.  The approach described above can apply to LTIPs as well, but is most commonly used for short-term incentive plan design (payouts for performance in a period of 12 months or less).  To effectively design a long-term value sharing arrangement, you will need an additional planning tool; a decision tree process that helps you ask the right questions and arrive at a suitable plan model. Ultimately, there are about nine different long-term value sharing approaches you could adopt.  Questions such as “are you willing to share equity?” lead to one conclusion or another about which plan type will be most suitable for your organization. To learn more about the decision tree process access the VisionLink article entitled: “Long-Term Incentive Plans–Which is Right for your Company?”

Once a long-term plan design is determined, a “simple” approach should still be applied.  The three measurement categories approach will help you do that.

In the world of compensation design, as in so many other things, “less” is often “more.”  Keep it simple.

It’s summer and we’re all ready for simple solutions to things.  Easy meals to fix. Inexpensive ways to entertain our kids.  Fastest routes out of town for long weekends. And so on.  In that same spirit, here are a few suggestions to simplify your company’s compensation life this season and have significant impact in the process.

1. Form a Compensation Committee. Include members of the leadership team best positioned to impact decisions related to compensation. Make sure it is headed by the CEO of the company.  Establish as its charter to treat compensation as both an investment that generates a measurable return and a strategic tool that  impacts company growth.  Establish a regular meeting schedule.
2. Create and Publish a Rewards Philosophy Statement. You don’t have to be able to fulfill the philosophy with concrete programs yet, but it will communicate the direction you plan to go and get you moving in the right direction.  Consider having a philosophy statement that commits the company to being at somewhere between the 40th and 50th percentile in terms of guaranteed compensation (salaries) but perhaps at the 70th percentile or above in total compensation.  In other words, commit to a philosophy that will begin putting a larger amount of compensation at risk.
3. Innumerate 4 to 5 Results Your Company is Seeking to Realize. These might be divided between short-term (12 months or less) and long-term (over 12 months).  They could be revenue or sales goals, profit or margin targets, new product development, market expansion or any number of key performance factors your company is seeking to improve.  Ask the committee to consider how, if at all, any of the present compensation strategies of the company are reinforcing those results as priorities to employees right now.
4. Identify the Individuals or Groups Best Positioned to Impact those Results. As you examine that list, begin formulating in your mind the “type” of compensation that will best communicate to employees their role in achieving those results.  Think in terms of how much of their compensation should be tied to those outcomes and how much should be short-term versus long-term.
5. Make a List of the Obvious Missing Pieces in Your Comp Strategy. The previous four steps should make this apparent.  For example, if you determine one of the key results you are seeking is to double revenue in the next three years, but your compensation package includes only salary and a quarterly bonus, then a long-term incentive plan is an obvious missing component at this stage.

Now, going through this exercise will not (yet) alter your overall rewards approach.  What it will do, however, is transform your thought process. And changing the way you think about pay is the first step in transforming compensation in your organization.

If you can engage in these simple steps over the course of the summer, by the fall you will be positioned to begin developing specific strategies that will bring your rewards philosophy to life and fulfill the results your company seeks to realize.  Compensation will then become a strategic tool helping to drive growth rather than an impediment to the sustained success you desire.

Here’s to a simplified summer.

For more information on this topic, view our webinar broadcast entitled “How Do I Create a Competitive Advantage with Our Compensation Programs.”

CEOs have a lot to worry about.  (Okay, forgive my stating the obvious before even gettng started!)  As a result, effective chief executives provide strategic oversight but empower others to make decisions and carry out the company’s business model and plan.  Ideally, that person has set up accountability systems that are both effective and efficient in their ability to provide relevant feedback to guide him or her in making adjustments and course corrections as necessary. 

I recognize there’s nothing new in that introduction.  However, it’s an important foundation for setting up a discussion about the CEO’s role in compensation development and management.   Here’s why.

The leadership orientation  just described, while typical and necessary, often puts the CEO too far out of touch with an essential role he or she needs to play in the compensation discussion.  Pay is a strategic tool, not merely an expense that needs to be contained.  It is an investment that needs to be properly allocated and the CEO should assume as much responsibility for the return the company achieves on that capital commitment as any that is made in the enterprise.  In fact, given that compensation and benefits are usually the largest budget item on any company’s financial statements, one could argue that the CEO should pay even more attention to ROI results being generated  in this area than almost any other the company measures and manages.

At the end of the day, the person at the helm is primarily  responsible for making sure that both financial and human capital are generating an appropriate return for shareholders–and then holding people accountable for performance levels that will ensure that outcome.

If this is true (and I submit it is), then exactly what role should the CEO play in the compensation discussion–and where (if anywhere) should  handoffs (delegation) occur?  Here are some suggestions and guidelines:

1. Establishing Pay Philosophy.  A chief executive officer must lead the philosophical discussion about pay.  Given the performance outcomes demanded of that role, the person at the helm must make clear what the company will pay for–and how that philosophy will be manifest in practice.  Where should company salary levels be vis a vis market pay?  What balance should the company strike between guaranteed and at risk pay? How much of performance-based pay (incentives) should reward for short-term results (monthly, quarterly or annual) and how much should be tied to long-term results (more than 12 months)?  Certainly, a CEO can solicit imput from key leadership members in this discussion (as well as outside consultants), but this is a core issue for which he or she must assume primary responsibility.  Every other discussion about pay will cascade from this foundational stage and the groundwork that is laid by establishing a clear pay philosophy.
2. Defining Strategic Outcomes. Specific pay programs may be developed under the direction of individuals given that stewardship by the CEO.  However, in making that handoff, the person ultimately responsible for the “bottom line” must be able to clearly define the strategic outcomes and priorities the company is focused on.  Every rewards plan that is developed must have a purpose statement–and that purpose must be tied to a specific, measureable result the business seeks to achieve.  What is the role of the pay plan if not to drive the business model and strategy of the company?  CEOs will be left wondering why they aren’t getting better results from their people if they aren’t paying attention to and fully engaged in this part of the process.
3. Establishing Framework for Discussion.  Compensation development and management is not a static activity.  A company can’t develop a plan, role it out and then “let it ride” forever more (although some companies do, by default, adopt this approach).  As a result, the CEO needs to provide the organizational framework within which best practices for envisioning, creating and sustaining world class compensation strategies can emerge and thrive.  He or she should decide who is essential to the compensation discussion, organize a committee to fulfill the oversight role and (with the help of those committee members) establish a schedule and agenda for ongoing management and monitoring.
4. Determining Roles and Responsibilities. Related to area number three above, this category implies that those involved with developing a best practice approach to building and sustaining world-class compensation strategies for their company understand their specific stewardships.  For example, who is ultimately responsible for administering a given plan?  Who will take the lead in developing a promotion and communication strategy for the overall rewards strategy?  Who will make sure successes are celebrated appropriately and in a timely fashion?  Who will monitor any legal requirements associated with the plan(s)?  How and under whose direction will the success of given pay programs be measured and monitored?  What financial information, requirements  and procedures have to be tracked and managed–and who will assume that responsibility?  And so on.  The CEO doesn’t have to make everyone of these assignments, but he or she does need to ensure that these roles get defined and that there is accountability for their fulfillment.
5. Approving Metrics and Measures.  Compensation design is an outcome based endeavor.  In many ways it’s also an exercise in reverse engineering.  We project forward certain results we anticipate achieving based on certain assumptions (revenue growth, expenses, manpower, etc.).  We determine how such growth will impact shareholder value.  We then determine what amount of that additional value we are willing to share to achieve that outcome.  We then “reverse engineer” that future value to a present context so we can clearly state how employees will participate in the value they help create.  In that process, the CEO must help define thresholds of performance (revenue growth, profit margin, ROE, etc.)  that need to be achieved before the company will be comfortable sharing value.  Specific measures and metrics for company wide performance, department or team performance and individual performance will ultimately need to be determined.  While the CEO won’t independently  set the levels in each of these areas, he or she cannot disengage from the decisions that have to be “signed off on” if the plans developed are going to be financially viable and protect shareholders’ interests.
6. Insisting on a Clear Message.  CEOs set a tone.  They can make or break a meeting or announcement based on the level of attention it receives, the passion that surrounds it and the clarity that is provided.  Likewise, a CEO must ensure that any message involving any aspect of the largest budget item on the company’s financials (compensation and benefits) is clear and helps reinforce the organization’s vision and mission as well as it’s business model and plan.  This doesn’t mean the CEO needs to deliver every message about compensation.  It does mean, however, that he or she knows what messages are being communicated and they are consistent with the compensation philosophy statement that was established and articulated at the start, under the chief executives direction.
7. Leading the Celebration.  While managers at all levels of a business should help their teams celebrate the successes they experience, the CEO needs to be the cheerleader in chief.  That role carries a weight that can’t be duplicated by others.  When employees hear from the person at the top, there is a different priority level that message attains.  CEOs should “pick their spots” but then be sure their voices are heard when good things happen.  This can be done in writing, in meetings, on intranet postings, on Facebook pages and through “tweets.”  Whatever the channel, the CEO must engage in this activity.
8. Measuring Productivity.  Perhaps the most important question to be asked about a given compensation strategy is whether or not it made the workforce more productive.  Did people become more engaged as a result of how they were being paid?  Is execution improving.  If so, are there measurable results to prove it?  Having mechanisms in place that isolate the return on investment that the company is achieving  through its human capital are critical to evaluating the effectiveness of its rewards strategies.  While a CEO does not have assume the task of coming up with the specific means of making a productivity assessment, he or she must insist it be measured and consistently review the trends the analysis portends.
9. Holding People Accountable. If a rewards strategy isn’t working, the CEO needs to know that.  And someone has to be accountable for the lack of results being generated.  If the other areas outlined in this article are properly addressed, this will be an easy step to take.  Roles and outcomes will have been clearly defined.  Accountability in this arena means that everyone in those roles understands what will happen if the outcomes intended aren’t being realized through the specific pay programs for which they have charge.  When results fall short, it will not always mean that the specific plan in question is bad or not performing properly.  However, those responsibile need to be able to “account” for why results are what they are.

Our experience has been that in companies where this level of engagement (in the compensation discussion) from the CEO exists, performance occurs at an accelerated pace.  Presumably, this happens because alignment has a greater possibility of occuring in organizations where the person at the top understands the essential and strategic role of compensation in creating a unified financial vision for growing the business.

To learn more about this issue, please view our webinar recording entitled “Why CEOs Should Drive Compensation Strategy.”

Periodically, we will receive a call from a business leader seeking our help to build a more effective incentive plan.  Often, it takes a while to determine whether what is being sought is a sales plan or a broader performance-based reward.  The difficulty in decifering which kind of approach is needed stems from the fact that many businesses don’t yet know what outcome they are trying to influence through their incentive plan(s).

With that anecdotal evidence in mind, I assume many struggle with this issue.  As a result, I offer here  some general things to consider when thinking about incentives:

• Sales Incentives–Compensation programs for sales people are typically a distinct “animal.”  Their purpose and form are centered solely on increasing sales.  Although a sales incentive might be in the form of a commission or bonus (or both), it’s focus is strictly on rewarding a certain desired sales result.  They are intended to address the following performance factor: “What the company wants sold, to whom and in what volume.”Those participating in a sales incentive could, conceivably, also receive a performance or growth incentive.  However, it is less likely they will receive the former since their sales incentive rewards short-term performance results .  A long-term incentive, however, creates a different focus and could more commonly be paid to those responsible for sales functions, particularly those whose stewardship it is to accelerate top-line growth. (See Growth Incentives below.)

• Performance Incentives–Companies that want to create focus on key performance indicators or profitability standards measured in increments of 12 months or less are looking for this type of reward.  Performance incentives seek to communicate the following to participating employees: “This is the outcome we need you to focus on during this period of time and how it will be measured and rewarded.”  Performance incentives help participants understand their role in this year’s strategy, what’s expected of them in that role and how they will be remunerated for fulfilling those expectations.  The overall incentive may reward something for company performance, team or department performance, individual performance or all three.  The “weighting” of those factors may be different for various “tiers” of employees.  Annual, semi-annual or quarterly bonus arrangements are types of performance incentives.As with sales incentives, participants in a performance incentive plan may–and commonly do–participate in a growth incentive as well.

• Growth Incentives–Organizations that seek to align the company’s reward’s strategy with its business plan should have some kind of growth incentive.  Such a plan communicates where the company is headed in the future (beyond the next 12 months) and how those that help to fuel growth will participate in that increase.  Growth incentives seek to create a unified financial vision for growing the business and send the following message to participants: “You are an important partner in our growth plans and this is how we intend to have you participate in the value you help create.”  Stock, stock options, phantom equity, SAR, Performance Unit Plans and Profit Pools are examples of growth incentives that companies commonly use to fulfill this part of their overall rewards strategy.

Most companies think in terms of specific types of plans instead of the kind of performance they seek to drive as they approach the design of their incentives.  Instead, we recommend you isolate the performance category you are trying to address as indicated above and then begin thinking of the compensation s0lutions that will drive the outcomes you seek.

At a minimum, now if you call us, we will perhaps be speaking the same language!

Certain words and phrases become part of a kind of  business “pop lexicon” as they are used and repeated incessantly over an extended period of time.  When they do, their meaning often becomes diluted.  As that happens, businesses sometimes assume “it must have been a passing fad”–so think they can now ignore the issue.

We fear “Pay for Performance” is in danger of becoming just such a phrase.  So many use it, but so few can tell you what it actually means.  Fewer still employ this philosophy, even when they outwardly espouse it.

We believe any company that wants to achieve World Class Performance must have World Class Compensation. As a result, it must understand and embrace a pay for performance philosophy and plan. Because we believe that, we’d like to tell you what we think it means.

A company is employing a pay for performance strategy if its rewards programs are structured as follows:

1. The company ties awards to shareholder financial objectives. In a true pay for performance environment, incentives drive value for shareholders and the company is able measure the impact their rewards strategies are having in this regard.
2. The business employs the right “mix” of compensation elements. Organizations that tie compensation to performance standards understand that how they pay people has a bigger impact on results than how much they pay them–although both are important.  Pay for performance means the company strikes the right balance between guaranteed and at risk compensation, and short-term versus long-term incentives.
3. Payouts result in meaningful dollars. Employees want to feel a sense of partnership with owners in achieving company goals.  This creates a unified financial vision for growing the business.  Such a unity can only happen when value sharing reaches a threshold that is “meaningful” to employees. In organizations that achieve this, employees are thinking (and hopefully saying) the following: “It’s important to me that the company achieve its goals because what I receive if it does is meaningful to me.”
4. Performance expectations are tied to factors  employees can impact. It doesn’t matter how much employees have the potential to earn if they don’t feel they can impact the outcome that triggers their award.  In too many cases, what is supposed to be an incentive turns into a credibility problem for the company.  “Sure, you tell me this is my award, but I’m not really in a position to earn it.”
5. Rewards are consistently communicated, reinforced and celebrated. This is a primary way a partnership mindset is nurtured.  Individual, departmental and company wide achievements are celebrated and employees sense they are participating in something great they helped create.  Sustained success and a culture of confidence grow out of such an approach. 

These guidelines will never go out of style, regardless of the popular lexicon that is in vogue at a given moment in time.

Okay, so Peter Drucker never really knew VisionLink.  That’s a detail.  However, his philosophy about pay at the executive and management level was “spot on” with what we believe should be a core tenet of rewards design:

Build world class compensation strategies that are rooted in pay for performance and drive measureable results.

In her November, 2009 HBR article entitled, “What Would Peter Say?” Rosabeth Moss Kanter shares the following insights into Drucker’s thinking regarding the recent executive pay brouhaha.

“Drucker would not have been surprised that incentives to take excessive risks contributed to the recent global financial meltdown.  Back in the mid-1980s, he warned about a public outcry over executive compensation…More than 20 years ago, Drucker pointed to a top-to-bottom ratio that was then rushing past 40 to 1.  Just before his death, the ratio was greater than 400 to 1.

“Drucker was not against wealth accumulation, but he was pragmatic about the work of organizations and society.  He held that the role of executives was to coordinate the actions of others whose motivation (and thus compensation) was necessary to get the job done.  But he also held that pay should be associated with performance; that was a major point of management by objectives, perhaps his most practical management contribution. Listening to Drucker might have headed off some of the excesses associated with Wall Street…in which bonuses not only were decried for their amounts but also were uncorrelated with company results…”

I suspect that most company leaders would find themselves in agreement with much if not all of the issues Drucker raises.  However, although many agree with a performance/pay correlation philosophy in principle, few are translating that belief system into consistent compensation practices.  Fewer still achieve a rewards strategy that could be considered “world-class”; one that places them in the competitive advantage driver’s seat.  A world class pay plan is one that fully integrates compensation into the business plan of the company and creates a seamless link between vision, strategy, roles, expectations and rewards.

What most companies need to bridge the gap between where they are now and where they should (and, hopefully, want to) be is a Missing Structure; a system or process that helps them effectively engineer compensation strategies that impact execution and results.   In our experience, that Missing Structure needs to include the following comp0nents:

• CEO/Board Level Leadership and Involvement
• A Clear and Written Pay Philosophy
• A Comprehensive Compensation Gameplan
• Fully Integrated and Correlated Pay Strategies and Plans
• Consistently Executed “Line of Sight” Review

These steps ensure a cohesive, consistent approach to talent attraction, retention and development.  Likewise, they provide checks and balances that protect the company from sacrificing good profits for bad or that substitute short- term performance bursts for sustained results.  When properly executed, these measures make sure that all incentive plans are self financed and pay benefits that are correlated with increased shareholder value, and other critical measures.

Many of the companies that have made headlines in recent years lost sight of these important principles as it relates to compensation development and management.  Again, Peter Drucker’s observation is a correct one.  He stressed that:

“…ensuring the long-term health of the company–and eschewing short hits that jeopardize the future–is executives’ primary job.”

We are happy to know that Peter Drucker agrees with us.

The Seven Imperatives

Growth companies understand that economies are cyclical.  Times of surge and prosperity are countered by periods of contraction and downturn. Great companies plan accordingly. To flourish during difficult economic periods, business leaders in growth oriented companies must strategically address the role of their human capital and reward systems in meeting the challenges they face. The following Seven Imperatives should guide any business leaders thinking in such times.

1. Assess Your Talent Pool–

Know who your best people are and make sure they know what their role is in the future of your company, especially at this time.

2. Create a Pay for Performance Philosophy and Strategy–

Now is the best and most critical time to align pay with performance. This starts with identifying a philosophy that defines how the company will address rewards issues in good economic times and bad.

3. Focus on Strategy not Just Tactics–

Your long‐term vision for growth hasn’t changed just because the economy is hurting. Strategies drive growth, tactical changes manage costs.

4. Define Clear Performance Expectations–

Star performers want a clear understanding of the key results indicators they are responsible for and what their stewardship will impact.

5. Nurture an Ownership Mentality–

An ownership mindset permeates an organization when there is “line of sight” between the shareholders’ vision and strategy, the roles and expectations of key people, how those individuals are rewarded for generating those results and how well those rewards align with personal goals and objectives.

6. Build a Value Statement–

The best way for a key people to visualize their financial future with your company is to receive a statement that summarizes and projects forward the total value of that relationship if performance expectations are met–salary, short-term incentives, long-term incentives, 401(k), etc.

7. Cut Business Expenses First, Incentives Last–

Reward performers and reinforce the results you need to continue to achieve—don’t try to resolve the company’s financial woes on the backs of your best people.