"I'm paying my top four people $1 million. What am I getting for it?"
That question, or one similar to it, crosses the mind of every CEO that examines what he or she is paying key producers in the organization. It's an important question for a company to answer since compensation represents such a large allocation of the company's profits. And as economic challenges arise, the question carries an even greater urgency.
What are you getting right now for what you are paying in compensation? Well, you are getting the current result, whatever that might be - right? If the results you achieve this year are not measurably different than you got last year, what will you do next year to drive a different performance level? And how will pay differ as a result of those changes?
Growth implies that a different result will be achieved in the future than is being achieved right now. By extension, the strategies that have been used to get the current result can't be the same in the future if a different outcome is desired or expected. Because compensation is one of the strategic tools in a business's arsenal to affect change, companies wishing to develop a different performance result in the future can't expect to fully achieve that if its rewards programs don't correlate.
For example, if a company decides its target is to grow net income over the next three years by 20% per year, there are certain key pay-related questions it needs to ask itself. For example: What part of our compensation plan communicates our growth goal to employees? If we achieve or exceed that result, what are we willing to share? Who should participate in that growth if we meet our net income target? To what extent will key employees' participation in that growth be the fuel that brings it to realization?
If an employer is asking what he is getting for the amount of compensation he is paying - whether that is $1 million, $10 million or $100 million - he has not yet forged this kind of strategic link between rewards and the financial performance of the business.
Start With Well Defined Financial Outcomes
The starting point for becoming more effective in rewards design is in drawing relationships between different components of compensation and the outcomes the company wants to achieve. This begins with the development of an effective financial model. Such a framework is essential to projecting the results the company wishes to achieve as well as creating a template within which the correlation between compensation and company performance can be measured. Effective models will make assumptions about the financial targets the business needs to hit based upon what their achievement will mean to shareholder value.
For example, assume a company currently generates $20 million in revenue and $2 million in profit. What would it mean financially to shareholders if it could grow that profit number to $10 million in the next five years? What would have to happen within the organization for such an achievement to be realized? What would ownership be willing to pay to achieve that result?
An effective financial model becomes a tool for measuring and testing various incentive arrangements that might flow from the financial results targeted. For example, a company may decide that if a $10 million profit target is achieved over the next five years, the business would be willing to share 10% of that number in incentives for key people (or 5% or 20% or 15%). The percentage to be distributed in the form of value-sharing becomes a function of what that profit figure means in additional equity value to shareholders and what needs to be paid to "unleash" the performance level required to bring about that result.
Ideally, the modeling process helps you visualize both the financial structure that will support the projected growth and the thresholds that need to be attained if growth goals are to be realized. With a financial picture vividly embedded, the company can then shift its attention to the specific types of rewards plans and accompanying performance standards that will lead to those results.
To learn more about this topic, view the VisionLink Webinar entitled, "I'm Spending $1 Million on My Top 5 People...What am I Getting for It?"