The leaders of most growth-oriented companies are always in search of better ways to tie compensation to performance standards. As a result, they experiment with various metrics and measures associated with incentive plans they have in place--trying to find the formula for success. A few eventually land on something that works well enough. Most end up frustrated.
Attempts at building effective pay for performance strategies fail primarily because organizations define success in unrealistic terms. Their expectations are misplaced. They want compensation to either change the behavior of their people or assume responsibility for a financial result the company seeks to achieve. When it does neither, they deem it a failure. There is a better way to evaluate whether compensation is properly linked to results--and that's to better define what it should impact.
Compensation in general, and value sharing (incentive plans) specifically, is an outcome-based endeavor. Pay plans should be used as strategic tools that codify the financial partnership the business owners want to have with those who help them achieve those outcomes. Viewed in this context, a given compensation strategy is successful if it helps accomplish one or more of the following:
- Solves a Problem. This is often the most pressing reason a "new" pay plan is being considered. For example, a company has a goal to grow from $50 million to $100 million in revenue in the next five years, but finds its people mired in short-term thinking. As a result, it introduces a long-term value-sharing plan that is tied to the value increase in the business and shores up its annual bonus plan to reflect a balance of company, department and individual performance. The pay strategy addresses the problem. That's success.
- Removes a Barrier. Companies often face barriers that have an underlying pay component to them. For example, certain key employees don't feel they are true business partners in the company's success unless they are granted an equity position. Owners are reluctant to share stock but want their key people to be good stewards of their vision and growth goals. The company implements a phantom stock plan that mirrors what a real stock plan would provide but without diluting owner equity. The pay strategy removes a barrier. That's success.
- Encourages a Superior Outcome. Businesses should want their employees to assume responsibility for certain outcomes not just for getting specific results. For example, a department might hit a specific revenue number but do it at the expense of an entire customer category. To address this, a company might introduce a performance unit plan that awards "units" that have a par value to them which will fluctuate over time. The unit value is determined by anywhere from two to four performance metrics that are directly linked to the outcomes the company seeks--and will fluctuate over time. Unit values are paid out three years from the time of their issue--and an employee has to be there to receive them. The pay strategy encourages a sustained, superior outcome. That's success.
- Focuses Efforts. Those who lead organizations want employees who understand and act on what's most important. They want people who can identify priorities the way they do and have the same sense of urgency about addressing them. Pay is one way a company communicates where employees should focus their efforts. For example, a company doesn't feel its employees are sensitive to profit margins or understand why they are important. It introduces a profit pool as an annual value-sharing plan. Under the plan, up to the company's operating profit target, all profits go back to the enterprise. Once that target is met, the next $20 million is shared with employees in the pool. After that, the profits are split 50/50 between the company and the pool. Employees get up to speed quickly on where profits come from. The pay strategy focuses the efforts of employees. That's success.
At the end of the day, a company's compensation strategy should support, not inhibit growth. This happens when pay is constructed to achieve one of the things listed above. It is realized when compensation is treated as an investment to be properly allocated rather than an expense to be contained. It stems from the philosophy that companies need to be able to identify a productivity profit and adopt a "self-financing" approach to incentive planning. Success is more easily achieved and measured when this is how pay is evaluated.
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