Many business leaders we work with don't draw a distinction (in perception or practice) between their business strategy and their business model. As a result, they approach decision making differently than they would if they saw these things as related but distinct functions. Certainly, poor compensation decisions emerge out of environments where rewards aren't properly connected to the business plan. Here's why.
Business models refer to the logic of the company--how it operates and creates and captures value for stake holders in a competitive marketplace. (See "How to Design a Winning Business Model," HBR, January-February 2011, Ramon Casadesus-Masanell and Joan E. Ricart) It defines policy choices, asset choices and governance choices (how the company will address decisions over the other two choice issues). Strategy, on the other hand, is a plan that relates to activities the company will engage in to create a unique and valuable position in the marketplace.
A key issue, then, is how a company will integrate compensation into the logic of the business model. The policy choice has to do with the underlying philosophy that will guide the development of all compensation strategies. The asset choice has to do with how rewards components (salary, sales incentives, performance incentives, growth incentives, etc.) will be applied and assigned to the company's human resources. Governance has to do with the ongoing practices and structure that will be used to ensure that pay will continue to reinforce the business model.
Here's an example of what I mean. Let's say a company's value proposition initiates certain reinforcement cyles that expand its position and secure its customer base. Wireless phone service is a good example. By contract, a person has to buy a two-year service and everytime they upgrade to a new phone, they get a discount and have to renew for another two years. It is a self perpetuating model. The revenue structure is built on renewing wireless service contracts, sales of hardware, ancillary services (such as data pages) and so on. Certain outcomes, then need to be reinforced in every aspect of the company's choices. Compensation must reflect and reinforce the revenue reinforcement model and fully engage employees in a mindset of top-line renewal plus growth.
In such a framework, leadership needs to look at compensation through two interdependent sets of lenses:
- Structure--This facet needs to address the question: "what processes will ensure that every decision made relative to compensation will have the proper impact on strategy, cost and productivity in support of our model?" Structure gives the company a decision making and implementation framework.
- Mindset--The other category poses this query: "what specific pay programs will ensure that our employees take ownership (a stewardhsip) of our business model and its support strategy?" This has to do with employee engagement, focus and sustained execution.
If either of these dimensions of compensation development and management is neglected, certain dangers emerge. If the structure is not there, then strategy, cost and productivity issues are not addressed. The danger then is that employees take the company in the wrong direction (at odds with its business model), it spends rewards dollars that don't necessarily drive value for shareholders and employees, and the company does not produce an "above market" return on its total rewards investment (capital could have been better invested elsewhere).
Likewise, if mindset issues are not properly addressed, the company can develop great pay strategies but the employees don't understand them, or the rewards programs are disengaged from issues they can impact. The dangers that emerge in this arena are that employees see incentives as entitlements, no ownership mindset is in evidence, there is a general lack of clarity about the future of the business and the company is unable to unlock the full passion and focus of its workforce.
Because I see this negative pattern emerge all too fequently, it is my recommendation that any compensation discussion begin with a basic question: "What is our business model?" Until and unless a business can define that, it will be hard pressed to develop a compensation plan that will drive growth instead of hindering it.
For more insights on this issue, join us at our webinar next Tuesday, January 25 entitled "The Eight Fatal Compensation Mistakes."