Most business leaders know precious little about their company’s compensation strategy, other than it is a huge expense item on their P&L. That needs to change. In today’s business environment, this issue is critical for two reasons. First, enterprise leaders should be able account for and justify the return they are getting on such a large company investment year after year. Second, pay has become a strategic issue because it either fuels or dilutes both employee and company performance. Chief executives need to know which is true for their companies.
With that in mind, as you start the new year, I encourage you to examine the 10 questions below and see how comfortable you are with your answers. For those questions that make you squirm a bit, perhaps you should commit to making changes in your pay approach that will make you more comfortable with your answers.
Assessing Your Current Pay Strategy
1. What is the amount of your company’s total compensation investment?
Ideally you should know the both the total amount you are investing and how it breaks down by individual pay component: salary, bonus, commissions, long-term incentive plans, equity sharing, medical benefits, retirement plans, security plans (life, disability, long-term care insurance), executive benefits and perks, vacation pay, sick pay, etc.
2. What is your ROI on that investment?
Do you have a formula for determining what you are getting for what you are paying? Consider learning about productivity profit and how this key measure can help you determine the value being created by your workforce.
3. Which is better for your organization—higher salaries or higher incentives?
Striking the right balance between guaranteed and variable compensation is a critical factor in improving the return you get on your compensation investment. Where should your organization be in this regard and how might it differ from one employee tier to another?
Both are important, but which is most important to your business right now? "Peter Drucker once wrote that the manager’s job is to keep his nose to the grindstone while lifting his eyes to the hills. He meant that every business has to operate in two modes at the same time: producing results today and preparing for tomorrow.” (Ken Navarro, Strategy + Business)
If this is true, you must be able to determine how to find the right balance for rewarding both. This goes to the heart of “pay for performance” in the 21st century.
5. How much value should you share in an incentive plan?
If you want your people to create value then you must have a means of sharing it with them when they do. So how will you do that and in what proportion? This requires serious thought and analysis. Calculating productivity profit can help with this. Paying incentives out of productivity profit makes them “self-financing.”
6. How many metrics should your bonus plan have?
Here’s a clue: less is more when it comes to incentive plan metrics.
7. What is the most critical metric upon which bonus payments should be based?
I’ll make it easy for you: profit.
8. What philosophy should guide your decisions about pay?
Only you can determine this. What is it your people should be paid for? How should value creation be defined and with whom should it be shared? How much should be used to reward short-term value creation and how much for long-term? Where do you want to be vis a vis market pay?
All these questions (and more) should be answered in a written pay philosophy statement.
9. How do you make sure your pay strategy is properly balanced?
It starts by knowing the realm of potential pay plans to consider. Then it becomes a matter of determining which components should be part of your overall strategy and how much weight each should be given. This is an easier exercise if you have a clear compensation philosophy.
10. What results should your pay strategy be producing for your company?
Compensation is (or should be) an outcome-based endeavor. As a result, you need to determine what results you are trying to produce before you can decide what pay strategy is most suitable. Then your pay approach will be focused on rewarding the outcomes you seek instead of arbitrary measures or individual performance targets.
If this brief exercise has been a bit uncomfortable for you, don’t be discouraged. It is for most chief executives. Give yourself a day to grieve over your past errors but then turn your attention to fixing things. There is too much at risk in today’s business environment to ignore this issue. Compensation requires a strategy. Strategy requires leadership. Leadership starts at the top. So, get started. You have the whole year in front of you.