With a new year on the horizon, now is a good time to think about how to get more out of your rewards plan. By “more,” I mean driving a better return on the significant investment you make in compensation through higher performance, improved engagement, better results and increased shareholder value. You won’t get that kind of “more” by simply refining your budget or adjusting projections on a spreadsheet. Instead, you will need to make strategic changes. Here is what I mean.
Business leaders spend hours tweaking bonus metrics or reviewing salary data to try and pinpoint the exact amount they should be paying their people. In general, their guiding philosophy sounds something close to this: “I want to pay the least amount I can and still get the most productivity possible for the dollars I spend.” In other words, they are looking at compensation as an expense that needs to be minimized instead of as an investment that needs to be properly allocated. The focus is on how much employees should be paid instead of on how they should be paid. The latter emphasis means you examine the range of rewards plans that are available and determine which should be included in your pay strategy and how they should be balanced. How much someone should be paid is a consideration, but only after determining how you can best use compensation as a means of reinforcing the vision and business model of the company.
To help you achieve that kind of alignment, I offer five simple tips for your consideration. Try these next year and see if you don’t get better results from your compensation investment.
1. Define Your Pay Philosophy
If you’ve followed this blog for any length of time, this not something new to you. I bring it up in virtually every post I make. But for good reason. You will never have a successful compensation strategy if you do not have a clear pay philosophy.
Before you can decide how you are going to pay your people (as well as how much), you must decide what you believe about what employee earnings should be based on. VisionLink’s belief is that compensation should largely be tied to value creation. So, your pay philosophy should first state how your business defines that term. It should then articulate with whom value should be shared. From there, you can state what you believe the balance should be between guaranteed and variable compensation and between short and long-term value-sharing.
2. Shift From Incentives to Value-Sharing
Value-sharing is the modern way businesses adopt a “pay for performance” approach to compensation. The term incentive plan is not really relevant any more and is at odds with how you want your people thinking about their financial relationship with you. Incentives are manipulative by nature (“If you want this you’ll need to do that”). Value-sharing grows out of a wealth multiplier philosophy that says all stake holders should benefit from the business growth they help produce. It is an outcome-based approach. It is also self-financing in nature. If employees add value, they are essentially creating the funding source for their compensation. As a result, value-sharing payouts are not really “costing” the company anything. Similarly, if enough value isn’t created, then no value-sharing occurs. This gives employees upside earnings potential while mitigating downside financial exposure for shareholders.
3. Calculate Your Productivity Profit
If you are going to make the shift from paying incentives to sharing value, then you will need to understand the concept of “productivity profit” and learn how to calculate it. Here is one way to approach it:
Define a capital account. At a minimum, this should be made up of total shareholder contributions plus debt--and any other assets owners deem to be related to their investment in the business.
Account for a capital charge. This is a percentage of the capital account that represents the return shareholders expect to receive before sharing value with employees. It is the opportunity cost of owner capital being tied up in the business. Some companies use their borrowing rate for this while others employ a number that owners agree best fits their investment expectations. Anything from 8 to 20% is common.
Calculate your productivity profit. This is arrived at by first applying the capital charge to the capital account and arriving at a number. Next, you will subtract that number from the net operating income of the business for the year. The difference is your productivity profit. The capital charge accounts for that part of the company's profit that is attributable to the shareholder's capital at work. The remaining profit is deemed to be derived from the performance of human capital at work.
Make sure value-sharing come out of productivity profit. These three steps help you define what value creation means in your business. It happens once shareholders have received a pre-determined return on their capital investment.
4. Adopt a Total Rewards Approach
One of the ways to make your pay strategy more effective is to frame it within the context of a broader employee value proposition and experience. In other words, don’t expect pay alone to transform the performance of your people. It shouldn’t have to bear that burden.
Compensation has an impact when it is seen and communicated as one of four parts of a Total Rewards offering. Employees need to experience all four elements if they are going to fully engage and perform at the levels you want. Here is what a Total Rewards Strategy should include:
A Compelling Future. For employees to be "compelled," they must be convinced their contribution is essential to the success of your company, even to the extent you are unlikely to achieve your growth goals without their help. This is part of what “permits” them to stay committed to their work and sustain a sense of pride—not just in what they are personally accomplishing but in what the organization achieves. And they want to know their contribution has meaning beyond just hitting profit targets and growth thresholds.
A Positive Work Environment. Employees want to have a role that is consistent with their unique abilities—and engage with other individuals who are similarly situated. Individuals working together within the realm of their distinct talents gives birth to unique teams. That combined force unleashes a collective passion and creative energy that leads to success. Winning then becomes a contagious expectation which further fuels deep engagement. A culture of confidence results.
Personal and Professional Development. Employees sink deep roots in an organization when they are experiencing improvement, both personally and professionally. This occurs when your people feel as though they are getting better because of the resources with which they engage in their role and by virtue of the stewardship you have asked them to assume. Their participation on a unique team is part of this. Superior technology, effective strategic planning, training, mentoring and more—all combine to create an environment where people feel they are set up for success. This combination leads employees to feel a sense of purpose and pride and a willingness to approach their roles with passion.
Financial Rewards. Compensation in a total rewards structure is designed to promote a sense of partnership. It should grow out of a clear pay philosophy that articulates how the company defines value creation and with whom it believes it should be shared. This approach encourages employees to assume a stewardship mindset about their roles—taking ownership of the outcomes the company needs them to fulfill. Pay strategies that promote partnership strike the right balance between salaries and value-sharing—and between short and long-term performance rewards.
5. Market a Partnership
Employees will only devote themselves completely to an organization if they feel a sense of partnership with the owners and leaders of the business. This is particularly true of key producers. They want to feel as though they are an integral part of a growth strategy for the company and every part of their employee experience needs to convey that—including and especially the way they are paid.
One of the ways to effectively market a partnership to your people is by creating a value statement. This is not a historical summary of the value of their comp and benefits plan. Instead, it is a prospective look at the value that will accrue to their benefit over the coming years if the company meets its targets. It gives you the opportunity to show the financial value of the partnership you have with them. It allows you to say to a person you are trying to recruit (or to a current employee) something like the following: “We are not simply offering you a $160,000 salaried position in our company. We are inviting you to assume a role that could create $1.8 million dollars for you over the next five years (or whatever the figure is).”
As you head into 2019, I encourage you to start incorporating these tips into your approach to pay design. They will breath new life into your compensation plans. Those plans will then become strategic tools that help you drive greater employee performance. They will also make your value proposition more compelling and competitive when it comes to attracting and retaining the talent you need.