Rewarding Performance and Success: Compensation For A Changing Workforce
COMPENSATION SYSTEMS
The success or failure of an organization can be dependent on the quality of the employees. Pay is not only important in terms of cash, but it tells your staff who you are as an organization, the value system you have, and the skills and competencies you are willing to reward. Do you value team work over individual contribution? Do you look at long term versus short term? Do you reward performance on a variable or fixed basis? What kinds of performance measures do you use—only numbers? That performance measure communicates to your organization that end results–not how it’s done–are what matter.
Compensation in the broadest sense includes all of the elements of reward, recognition, and systems in the employment condition, not just cash. Variable pay, incentive pay, and performance-based pay are similar but there are big differences in terms of the bonuses and incentives.
Corporate America needs to rethink the way it pays people, both from a structural as well as a philosophical perspective. Most compensation systems were developed in the 1930’s and 1940’s and haven’t changed much. With business competition global now, there is an impact on your human resources. Team work is more important today. Compensation can reinforce the culture, but it can’t change it and solve all your management problems.
LINKING COMPENSATION To Business STRATEGY
How can we use compensation to achieve our business strategy? Compensation and business strategy need to be linked. Ninety-eight percent of all compensation in corporate America comes in the form of fixed income. It’s a high fixed cost and an upward spiral. To change it, we lay off people. Pay has maintained a fairly consistent increase of 4% to 6% –except during the late ‘70’s and early ‘80’s of double-digit inflation.
We have created an entitlement mind set in employees. They believe they are entitled to an increase once a year, regardless of performance. Most organizations do not analyze or receive an appropriate return on the individual.
The effectiveness of any reward–the ability to reinforce performance–decreases rapidly after a short time period. Compensation that is annual is not promoting an appropriate return. Another reward system should be considered.
According to “Putting the Work Ethic to Work,” a survey done throughout the U.S., almost three-quarters of the surveyed employees felt there was not much they could do to influence pay. They didn’t believe there is a correlation between their organization’s productivity and their own individual success. Only 9% thought they would gain from productivity gains. A corresponding survey done in Japan showed 93% gave a positive response to this same question.
Another survey asked employees to rank important work characteristics. Having a challenging job was at the top. Job security ranked fifth. Managers who were asked to rank how they thought staff might respond were off in their expectations. Only half the managers realized a challenging job was important to employees. Three-quarters of employees thought that making a contribution to the company was important, while only 39% of managers realized this.
Seventy-one percent of employees wanted involvement on the job, yet only 23% of the managers felt that was important to them.
If we want commitment in our organizations, we have to lessen the gap between what we think employees need and what they are saying they need and want. We have to be committed to our employees.
In a merit pay system, there is an annual increase and there is a merit budget linked to inflation or competitive patterns. There is also a matrix that indicates the higher you perform, the higher your increase will be.
If the average increase in corporate America is 5%, but an outstanding performer got a 9% increase, that would mean $16 a week extra after taxes. If you want outstanding performance, you have to be prepared to pay outstanding rewards.
CHANGING COMPENSATION SYSTEMS
The reason many companies are reluctant to change compensation methods is because it is difficult to sit down and have an open dialog about the company and question the performance of each employee. It takes some time to change a compensation system.
The most difficult barrier is the opposition from top management. The second barrier is the question of the ability to measure performance and/or the unwillingness to measure performance. First you have to define what you mean by performance.
You have to educate and train employees about why you are changing your compensation system. There will be lots of resistance by everyone. There may be a feeling of loss of control by management. If you are thinking of changing your compensation philosophy, this recession is providing you with a window of opportunity in which to do it.
CRITERIA FOR CHANGING
What are you trying to accomplish as a company? Is compensation linked into your business strategy and objectives? Compensation can be used as a tool. It is also a significant outlay of dollars in terms of operating costs. Would you look at other investments with so much abandon? Is compensation tailored to your organization’s culture and values? Does compensation reflect competitive requirements? Is compensation motivational?
In Japan, workers receive an average of 25% of total pay in the form of a flexible bonus. In America, the average is 1%. Adjusting a payroll plus or minus 25% versus vs. 1% is a significant competitive advantage or disadvantage.
It takes three to five years to have an effective flexible pay plan. You need to investigate and identify what arrangement makes sense for the organization. It will be different for every company.
Compensation costs include other costs, such as benefit costs that emanate from base salary. You are not only increasing base salary each year, but increasing it times 1.3% or 1.4% with the additional benefits.
No compensation program will have effect unless the foundation of treating people with dignity and respect is in place. That includes job challenge and a good work environment.
Five percent and 10% incentives are not enough. You need more like 13% to have some leverage. ‘Satisfiers” are what attract and retain people. These include the work environment, the challenge, the benefits. The “motivators,” such as recognition programs and pay for performance, get people excited. You don’t motivate by increasing the satisfiers.
INCENTIVE PROGRAMS
Organization incentives reward overall company performance. Most are growth-oriented for start-up companies or are profit-based. They are typically formula-based. There is little subjectivity or discretion in them. For this plan to be a motivator, you have to spend the time to help people understand where they make the difference. You have to educate and communicate.
Individual incentives focus on the measures that the individual can control. You need to do significant training in individual performance measurement. There may be few organizations in today’s environment where these can be effective.
Tn the middle are team or group incentives. They create different channels of communication. For an effective team plan, you need to provide support and well-defined performance measures.
Another kind of team plan is a gain-sharing plan. Gains are shared with employees in an objective bonus formula plan. The plan requires participation within the organization. It requires employee commitment and trust and is heavily impacted by peer pressure. You need to be prepared to share financial information with employees in a plan such as this.
Pay decisions can be made by employees. If you are pushing decision-making down into the organization, the employees can make a decision about compensation, as well. The layers of management can decrease when decision making is handled by employees. The more power and decision making employees take on, the more they will question the number of supervisors, the level of supervisors, etc. The teams feel they can make the decisions, and a supervisor can be an additional cost.
Meritorious awards are for recognizing special contributions or events. You want the contributions to be related to your business strategy or your value systems. Values might include innovation or customer service. There are many things you can do. Money or a gift can be awarded and/or recognition can be given by displaying the employee’s photograph and a description of his/her outstanding contribution. Recognition should be public and visible. Many employees feel that they aren’t recognized. That is an important issue.
A CASE STUDY
A hypothetical company can be used to provide insights into compensation arrangements. The profile is a manufacturing company with unique manufacturing processing capabilities in a niche market. Annual sales are $5 million; net income is $200,000. There are 50 employees and three key executives heading operations, finances, and sales. The CEO is the sole owner and intends to stay that way. In looking at the longer term incentive issues, we have to come up with a longer term plan that simulates ownership without giving up equity.
A question to start with is what is the company’s differential advantage in the market place? What is the desired balance between profitability and growth? The kind of compensation program you would develop for a start-up company is different than the one for a mature organization.
What is the relative importance of short versus long term for management incentive plans? What are the immediate business priorities? The priorities for short then are revenue growth, profit improvement, increased market share, and enhanced customer orientation.
Revenue growth means two elements of growth: total volume or total revenue growth and profitable revenue growth. That relates back to a need for balance between growth and profitability. The sales compensation program will focus not only on total revenues but on product mix or profitable revenues. The specific objectives of the performance pay are to increase total revenues by 20% and profitable revenues by 30%.
Profit improvement is defined by net income and cost containment. The specific objectives of profit improvement are to increase net income by 20% and reduce expenses by 5%. You want employees to see that reducing expenses is an important element of profit improvement, which they can control on an individual basis.
Increased market share can be defined in two ways–new and existing customers. Existing customers will need to be sold new products. Employees would need to develop business for 15 new target customers–defined and identified–and 10 new customers.
Enhanced customer orientation will be measured in three ways: customer service, quality, and customer awareness. This means on-time delivery, zero recall, and making sure every employee goes through customer service skills training.
The risk has to be spread throughout the organization. What are the values of your organization? The CEO wants people to think like an owner. Team work, technical innovation, and pay for performance are important values.
What is the desired competitive posture of the organization? Part of the compensation philosophy has to be how you want to compete in the market place. In total compensation, the company would be willing to be above market, but only if it is based on above-average results. A lot of companies pay above-market compensation for below-market results and performance. Total compensation and base salary is going to only pay up to market.
What is the desired mix between fixed versus variable pay, short versus long term, and direct versus direct? Direct is cash compensation and indirect includes benefits, recognition, etc. A 401K plan is an indirect benefit. Benefits should be tax effective. Equity will be only for capital accumulation purposes.
In this company, the focus will be on variable pay, short term spending, and direct compensation. There is only a finite amount of money. With any extra dollars, the benefit program will not be increased, but the cash compensation will be. You need to have a compensation philosophy clearly outlined.
How much financial data are you willing to share within the organization? If you are not willing to share information, then you shouldn’t have certain incentive programs. This company will disclose to employees revenues and sales in relative improvement measures. The P and L will be shared with executives.
How much autonomy or control should your managers have? They manage resources–financial, capital, and human. Why not have them make compensation decisions? Guidelines and a budget can be established, within which they set up compensation systems.
Of note is that the differential between executive pay and work pay in 1991 was 217. In the Japanese system, it is 60 to 1.
SPECIFICS IN The CASE STUDY
For executives in this hypothetical company, 60% of compensation will be salary; 20% will be short-term cash compensations and 20% long-term cash compensations. For managers, it will be a 75%-25% split. In the administrative support, the split will be 90%-10%.
The total compensation for a manager of accounting will be $45,000. Of that, $35,000 will go into base pay. At the production operator level, $18,000 is the total, and $16,200 is the base pay (90% of $18,000).
There will be some leeway in the entry rate for new employees. You bring the person up to market when they become qualified. It might take six months to a year. There does not need to be a big range for salary because there are other compensation factors.
For salary indexes, there are published surveys. “M & M” is not the best survey to use. You can use trade associations and consulting firms. Small- to medium-size entrepreneurial funds can use “Growth Resources,” a survey outlining top management positions and all elements of compensation. It is published by Panel Publications.
ANNUAL TARGETED INCENTIVES IN THE CASE STUDY
The overall philosophy for short-term incentives is to reward for performance, contributions, and for achieving the goals that are critical to the company’s survival and success. Performance will be defined—depending on function and position–as company, team, individual, or a combination. Everyone will be on some incentive plan.
Incentives can be based on how well the company does as a whole. This has to be based on team work. There are links between departments. Company performance is measured by revenues and net income. You set a threshold, a target, and an outstanding level.
There are other elements, in addition to financial results, that are part of the value system, such as customer service. The incentive amount can be adjusted plus or minus 25%, based on customer service. The threshold level is the level at which you are willing to start paying incentives. If the threshold level is not achieved, there are no incentives.
The target level of performance is the level you expect to achieve in the performance pay. The outstanding level is the maximum you are willing to pay the executive and represents truly stretch objectives and outstanding levels of performance. To put a cap on the up side makes sense, because there is a cap on the down side-a base salary.
You can have a linear relationship between threshold and target and put in kickers above target. Target is the operating plan for the year.
Revenues, net income, and on-time delivery can be easily quantifiable. How do you measure an employee’s customer responsiveness and awareness? It can be handled by subjective judgments.
EXAMPLES OF INCENTIVE COMPENSATION
For the hypothetical manager of accounting, the incentive is $10,000–the targeted incentive amount. The incentive is 20% company and 80% team.
In accounting, the issue is not how individuals perform, but how the whole department performs. You want the department to be efficient. It will force the accounting manager to filter the objectives into the department. There can be two aspects of the measures. One incentive can be for the work to be produced on time. The other can be for the accuracy. You can reward for one and not the other.
You want sales people to get total and profitable revenues. There will be no incentive paid unless 90% of the quota is achieved. Commissions will be paid then. There will be three levels of incentives. For 90%-100% results, 3% of the incentive from each 1% improvement in quota achievement will be paid. If the employee does not achieve the product mix desired, but results are above 100%, the company will pay 4% of the incentive for every 1% of quota achievement. The employee is bringing in increased revenues, but not profitable revenues. If the employee brings in more than 100% and the right product mix, then the company will pay 8% for every 1 % improvement.
If the product mix is less than 75% of total sales, there are rewards for revenues, but at a lesser rate than if the employee gets 75% and above. In getting 95% of quota, $14,875 will be paid. If product mix is met and 120% of quota is met, the payment is $45,500.
GAIN SHARING IN Tim CASE STUDY
The performance measure in the gain-sharing plan is cost containment, decreasing the controllable expenses from the base period to the current period. The base period is eight quarters. Controllable expenses are materials, supplies, equipment maintenance, and workers compensation. The formula will only measure controllable expenses, not costs the employees cant control, such as rent.
Wherever the employees save, the company is willing to share 50% of that by putting it into the incentive pool. For every dollar saved, 50 cents will go into the incentive pool. There will be a quarterly cash distribution, based on percent of pay for each participant. If there are 30 participants, then the average pay out would be 9.3%.
PROMOTING AND MAINTAINING COMPENSATION SYSTEMS
Sell and market your compensation plan effectively to your employees. Task forces are critically important in getting credibility into the compensation program, in getting buy-in from the beginning. An education process for the employees is necessary to support a commitment to the long-term objectives, as well as the short-term costs. For example, understanding is needed about the balance between cutting maintenance costs and and the necessity of proper maintenance.
You cannot put in a compensation plan without monitoring it. Compensation plans have life cycles and should be reviewed on an annual basis to see if they are meeting your needs and objectives.
Rewarding Performance and Success Compensation For A Changing Workforce – Catherine Meek