“Tis the season” to figure out how much bonus your employees are going to earn this year, is it not? For some of you, that’s not a big deal. You have a formula and your people will be paid a benefit accordingly. However, I suspect others of you are lying awake at night trying to figure out how much you’re going to share. You don’t have a formula, your plan is highly discretionary and that combination has turned December into one extended nightmare. Well, let’s talk about how you can get a better night’s sleep, shall we?
I should hasten to say that even those of you who have a formula are likely not pleased with the incentive payouts you are making. You sign the checks while wondering if you are doing the right thing. Studies show that only 10 percent of enterprise leaders are actually happy with the bonus plan they offer. So, if you are part of the 90%, you probably feel ineffective at tying the benefit your employees are getting to actual results. You may even be one who ends up paying bonuses when your company hasn’t been profitable. (Yikes!) In short, whether you have a formula or not, your plan could probably be better and what we’ll discuss here will be relevant.
So how does all this happen? As a business leader, you intuitively know a component of compensation should be performance-based. You also know it makes sense to share value with those who help create it. And beyond all that, to attract top talent, you know you need to offer a robust incentive plan. But you constantly wonder what kind of metrics should drive the benefits and how to make sure your plan balances both employee and shareholder interests?
Well, there is a solution to this dilemma. Ultimately, there are five principles you should be following if you want to build an incentive plan that produces the right results. The problem is, most companies short-cut the plan design and evaluation process by simply manipulating metrics; all in the belief the changes will drive the outcome they want. But, as you’ve probably learned, more metrics are not the answer. Applying the right principles and building your plan on the correct premise is the solution.
So, let’s talk about that premise and those principles.
The Right Premise
Most organizations view incentive plans as a means of getting employees to behave the way they want. The term bonus or incentive implies as much. “If you do ‘A, B and C,’ you’ll earn a ‘bonus.’” Once that approach is adopted, the battle lines have been drawn. Employees will quite naturally become focused on the metrics. “What do I have to do to maximize my income, today—or this year?” The problem is, that’s not likely the mindset you want your people to have. But unfortunately, that’s the way you are paying them to think. Because your plan and its metrics reward behavior.
Most business leaders want growth partners, not robotic employees. They want individuals who will think like owners and take a stewardship approach to their roles in the organization. Being stewards means people think like owners and take responsibility for getting the outcomes their role exists to produce. And if that’s the way you want your employees to think, you should provide a pay program that reinforces and rewards roles and outcomes. So, how do you do that?
Companies that are committed to developing “growth partners” who perform essential roles (as opposed to paying employees to fill positions) build their compensation offers on a wealth multiplier premise. They believe its both fair and wise to share value with those who help create it. If people participate in the wealth multiple they help create, they are more likely to want to create more of it.
So, how does this differ from metrics that reward behavior?
Wealth multiplier organizations focus on outcomes, not behaviors. You don’t earn something “extra” by performing certain tasks. You increase your earnings by creating more value. Such organizations don’t even use the term “incentives.” Instead, they value-share. When we get to the five principles, we will discuss the metrics that undergird a value-sharing approach (as opposed to those that reward behavior). But as it relates to the core premise upon which any variable pay plan should be based, the concept of value-sharing is that everyone is “in this” together. “We’re part of a team that is trying to build a future company which will be bigger and better than the current one. Everyone has outcomes for which they are responsible. So if each person takes ownership of the results assigned to their role, we’ll be happy to share the economic fruits you produce.”
The 5 Principles
Once you’ve accepted the premise of value-sharing, the principles that make it happen become somewhat self-evident. Here is how they can help you create a more effective approach to providing performance-based pay.
1. Define Value Creation. Every organization must work this through on its own. There isn’t a universal formula. You must be able to identify a level of profitability or revenue growth or (pick an indicator) that stands as the threshold beyond which value is considered to have been created by your “growth partners” (employees). In other words, the capital investment of shareholders must be protected first. You must account for a return to owners before deciding value has been “added” by your workforce. At VisionLink, we call that threshold productivity profit.
2. Articulate Your Value-Sharing Philosophy. Once you’ve defined value creation, the next logical step is to state your belief about how much value should be shared and with whom. The natural extension of your philosophy in that regard is what form value-sharing it should take and what periods should it compensate. How much should reward short-term versus long-term performance? In rewarding long-term results, does the company want to share stock? If not, what type of value-sharing plan should the business provide to encourage the sustained outcomes it wants its people to produce? All these things should be part of a compensation philosophy statement that governs your decision-making for both variable and guaranteed pay plans.
3. Address Two Performance Periods. To be successful, business owners must be able to pay attention to two things at once. They must ensure the business model is producing the revenue and profits the company is relying on every 12 months while simultaneously focusing on how that model can drive future growth. Both are critical. The short-term feeds the long-term. Shareholders and other senior people must avoid making decisions for today or this year (as well as short-sighted actions) that are going to hurt growth in the long-term.
Well, company leaders need people throughout the organization that are likewise able to focus on two things at once—short-term business results and long-term company growth. As a result, the way “growth partners” are compensated must reinforce that kind of thinking. Value-sharing in particular must reward both short and sustained performance. As a result, at VisionLink we recommend companies adopt one, overriding value-sharing philosophy but build plans that reward two, separate performance periods; one for driving yearly results and the other for outcomes produced beyond the next 12 months. In other words, a short-term value-sharing plan and a long-term value sharing plan.
4. Use the Right Metrics. If value-sharing is based on the premise that everyone is part of a team, and therefore growth partners “live and die” together, then the governing metrics of each variable pay plan should have the same starting point or root. In other words, whatever other measures are adopted, the base metric must be met first. For short-term plans, that metric should be profit or profit growth. Long-term plans should be tied to business value growth. Again, the short-term measure enables the long-term result. You can’t growth business value if you aren’t producing annual profits. So, both outcomes should be clearly communicated and rewarded.
By basing variable pay on these kinds of metrics, you are aligning growth partner compensation with shareholder interests. That promotes an ownership mindset throughout the organization and helps fulfill the wealth multiplier premise upon which value-sharing rests.
5. Market a Partnership. Value-sharing turns your employee value proposition into a partnership agreement. It financially codifies the relationship you will have with your people and demonstrates that you view them as vital contributors to the company’s future. As a result, they way you communicate your value offer becomes a key part of creating a successful approach to variable pay.
If your organization adopts the premise and principles outlined here, it will likely have a compensation offer that includes a salary, benefits (perhaps including executive benefits), a retirement plan and both a long and short-term value-sharing program. It will have a philosophy that guides decision-making for your compensation offer and enables you to articulate the belief system that guides both how and how much your people are paid. As a result, you are able to market a true partnership to people you are trying to recruit and retain in the business.
In other words, if you do all these things, as you attempt to recruit and retain top talent, you’ll be able to say something like this: “This is not just a $160,000 position we are inviting you to fill. We are hiring you to fulfill a role that exists to produce these outcomes for our company. If you succeed in doing that, this is how our compensation package will benefit you. In short, this is not a $160,000 per year salaried position. This is a $1.7 million opportunity for you over the next five years.” (Or whatever the figures are for your business.)
So, there you have it. If you adopt a value-sharing premise and then apply these five principles, your “incentive plan” will be transformed from a liability to an asset.
But perhaps most important, you will get more sleep in December. You will feel good about the payout checks you are writing because they will represent real value being produced by your people. You will have a philosophy that drives your compensation offer and those who make up your workforce will view themselves as growth partners, not just employees.