Compensation Trends, Part 2: New Pay Strategies for a New Business Era

Yes, there is more to say about where compensation is headed and why.  Last week I discussed the talent requirements that are driving decisions businesses are making about their value propositions.  We talked about the compensation landscape and the two primary structures that companies have adopted (expansive and selective) to implement their philosophies about pay.  While that discussion answered many questions, it raised others.  Prominent among them is this one:  What new pay strategies are emerging to address the transformative era of business in which we find ourselves?  In other words, what specific rewards programs are being implemented to meet the recruiting and retention demands companies are facing?

Compensation trends point to pay strategies that reward innovation.

So, with my previous post as a preface, let’s turn our attention to a more complete understanding of where compensation trends are taking us. This time we will explore the specific types of pay plans that are receiving more and more attention these days—at least by companies who are in trying to keep pace with the issues we have been discussing. 

Performance Agreements

Performance agreements attempt to link value sharing to value creation in a very direct way.  One prominent media company discussed in The Workspan article referenced in my last post used this type of arrangement with its key high performers.  Those employees were excluded from the company-wide incentive plan (a kind of profit sharing arrangement).  Instead, they individually negotiated a “deal” with the COO and CFO of the company that defined financial, operational and leadership expectations.  It likewise defined the value of the award that would be generated if the results were achieved as agreed upon.  The agreement was memorialized in a “deal sheet” that became the basis of a quarterly self-evaluation the participant engaged in with the two company officers.  Those involved indicated that one of the primary benefits achieved with this approach was the dialogue it created between senior officers and key performers.  There were regular discussions and a clear track to follow in evaluating results.

This approach appeals to organizations wanting to achieve the following:

  • Set a very high threshold for compensable performance for its key producers—those who should be driving high level results for the organization.
  • Protect shareholders interests by creating a plan where small or even zero payouts can occur if the desired performance isn’t achieved.
  • Attract individuals that thrive in a high-risk, high reward environment, particularly when there is significant upside earnings potential.
  • Engender a mentoring environment between high-level leadership and key producers.
  • Have high performers adopt a more owner-like stewardship of the company’s success.
  • Make it more unlikely high performers will leave given the uniqueness of the financial relationship

Opt-In Plans

An approach that is becoming more popular with smaller companies and start-ups (although not limited to them) is one that offers key employees a choice in their pay arrangement.  They are given the option (opt-in or opt-out) of having either a “higher” salary and modest incentive or a “lower” salary with higher, even unlimited upside earnings potential (through short and long-term value-sharing plans).  In some organizations, key producers’ entire compensation can be variable, receiving payouts solely based on a formula (percent of revenue, profits, etc.).  The opt-in duration may differ from organization to organization or even between employees.  Some companies may have opt-in periods for a quarter or half a year instead of 12 months so they can change the payout formulas based on the priorities the company has for that interval.  Often, in this kind of arrangement the company will even suspend or differ payouts during periods of diminished cash flow—with earned income being accrued, then paid out when revenue normalcy returns or improves.

This approach can also have appeal in larger organizations that are trying to effectively launch a new division or subsidiary company.  They would employ an opt-in plan if they need to create greater flexibility in managing cash flow while providing large incentives for innovative talent to perform—and to do so quickly.

The opt-in approach appeals to organizations that wish to achieve the following:

  • Put employees more in control of their earnings potential while also sharing the risk associated with cash flow and revenue volatility.
  • Put owners in the position of limiting guaranteed payouts to key producers—thereby lowering fixed commitments.
  • Allow the organization a higher degree of flexibility in its use of capital—so it can adjust to rapidly and frequently changing economic environments.
  • Provide a “shared” entrepreneurial experience with key talent (particularly those charged with driving innovation).
  • Promote an ownership mindset without sharing equity.
  • “Self-identify” key performers. Those who are confident about their ability to perform will likely “opt-in” to the high variable pay arrangement.

Internal Venture Capital

Internal venture capital is an approach that is used primarily in larger organizations.  It is intended to support an entrepreneurial undertaking within an existing business.  The concept is self-descriptive.  A venture capital account is established and criteria for its access are defined.  The company publicizes to its key, innovative talent that it wants to “fund” great ideas that will bolster its business model and is willing to “finance” them through the organization’s venture capital account.  When this approach is adopted, compensation will often be tied to either a performance agreement or opt-in plan, as described above.   Commonly, value sharing will be aligned with the performance criteria that have been set for the venture capital account.  The intent is to create a highly entrepreneurial experience within an existing business.

Certainly, this approach isn’t for everyone. However, businesses that recognize the trends discussed in this and my past post likely also realize that they are competing against disruptive, smaller companies that want to incrementally take over parts or all of their market.  When this kind of a program is adopted, a company is essentially acknowledging that it must create the same kind of environment—and attract the same kind of talent—that smaller, highly ambitious organizations are able to produce. They hope to attract to their organizations individuals that would normally be inclined to pursue this methodology on their own.

Internal venture capital programs help companies achieve the following:

  • Attract highly entrepreneurial employees.
  • Engender a “start-up” environment within larger organization.
  • Create a clear focus on innovation.
  • Allow the organization to move quickly with new ideas.
  • Enable “mini-entrepreneurs” to leverage the resources and scale of a larger organization.

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Long-Term Value Sharing Plans

For years, companies have been using various programs for sharing value with those who help create it.  This is not a new concept.  However, in the future, the ability of a company to clearly define value creation and then have a mechanism for sharing it with key producers (in a way that properly reflects the organization’s pay philosophy) will be more critical than ever.  Why?  Because in the “new” enterprise environment, companies are competing for innovation talent, and those individuals will be seeking a relationship with an organization that operates under a “wealth multiplier” philosophy.  This simply means an organization understands that shareholders will experience a greater wealth multiple for themselves if they create a vested interest for others to participate in the company’s success.

Some leaders of private companies resist sharing value because they assume this means sharing stock—and they are reluctant to go down that road for a host of valid reasons.  In reality, sharing equity is only one of about nine different ways employees can potentially participate in the value they help create.  Two of the more common approaches used are discussed below.  For a more complete overview of the various options for long-term value sharing (and the rationale behind each approach), visit our “Which Plan is Right for Your Company” decision tree tool.  For private companies, phantom stock has become of the most popular means of providing a long-term incentive tied to the performance of the business but without diluting the equity of shareholders.  (You can learn everything you will ever need to know about phantom stock at: www.phantomstockonline.com. )

Any company that intends to grow but does not have a compensation strategy that reinforces that vision is, at a minimum, sending the wrong message to its key people.  The foundation of this post’s premise is that premier talent will expect to participate in the value it helps create.  Otherwise, individuals with unique abilities (especially “catalysts” with entrepreneurial capacity) will be inclined to start enterprises of their own where they can realize the full benefit of the growth they engineer.

Conclusions

The trends for compensation are tethered to the means businesses will use to fuel growth—and that focus is deeply rooted in transformative innovation.  As a result, organizations will need talent that can support and drive the pace at which that kind of innovation needs to occur.  And they will need a value proposition that appeals to individuals who might otherwise find themselves on a more entrepreneurial track.

It is cliché but nonetheless true to say that the 21st century is characterized by an exponential pace of change.  Businesses that intend to stay ahead of the curve will need to constantly evaluate their performance framework and determine how their rewards strategies can best support it.  They must clearly define the philosophy that will drive the development of their pay practices—and whether it will be rooted in an expansive or a selective approach.

As the change accelerates, we will see the specific compensation approaches mentioned here evolve and develop.  New ones will emerge.  Companies will need an agile approach to pay engineered within the framework of guiding principles as defined by their pay philosophy.   Innovation in compensation will need to match that of all other aspects of the business. 

In the end, companies with an unrelenting drive for success will seek compensation solutions that offer them a competitive advantage in attracting and retaining the talent that will make and keep them great. 

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