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From IMC of St. Louis, http://www.imcstloius.org Compensation and Benefits Incentives Glue Strategies Together How Mid-Sized Companies Make Their Strategies Work
By James E. Mittler, CMC
Basically this was a quote from one of my clients. His actual words were “Jim, I see the compensation and incentive plan that you have developed as the glue that will hold our managers accountable and focused on our strategic objectives and initiatives.” At first glance, this may seem to be a lot of responsibility for a lowly compensation plan but in reality, he was absolutely right. We cannot expect the achievement of strategic objectives unless all of the reinforcement mechanisms available to management are clearly aligned with those goals and objectives. Compensation is a significant reinforcement and change tool that must support the desired behaviors and actions.
As we begin to look more deeply at this concept or precept, some background assumptions need to be stated. The first basic assumption or fact is that you have decided that change is necessary or desirable. Necessary, because you may well find yourself out of business or acquired by a competitor unless things change. Desirable, because you have identified opportunities to increase market share or profit if you can institute some changes in operations or employee actions. If you do not have a necessary or desirable need for change, then doing business as usual will suffice for the moment. Although, in today’s environment, I have not seen many businesses that are free from external pressures.
Having determined our need for change, let’s look at a process that will expedite the achievement of the desired results. The first step in the process is to take the time to accurately define exactly where you are today in terms of operating success. This will include some comparisons to past operations and to a relevant peer group of companies. For you to tell me that you are making a 2% after-tax profit or an EBITDA (Earnings Before Interest Taxes Depreciation and Adjustments) of 8% is all well and good, but without the correct frame of reference the numbers are meaningless. Grocery chains, for example, have historically felt that they were doing well if their after-tax profit was a penny on the dollar. So, if my stores were making two cents on the dollar, I can be pretty sure that I am at the top of my game. Conversely, anything less than that penny is probably signaling trouble.
Once you know how you are performing, it is time to tell your employees what you have just learned. Rest assured, you will not be surprising them – they know how the business is doing. Don’t ask me how, but they know. Maybe it is from discussions with suppliers, or salespeople, or customers, or competitors, or employees in other departments, but they know. So, while your pronouncement of “how things are going” will not surprise anyone, it will certainly go a long way to improving morale and their appreciation for your honest and forthright trust in them.
Now that we know where we are today, where do we want to be in the foreseeable future, in one year, three years, or five years? Is our Holy Grail market share, gross margin, net margin, successful new product introductions, or what? With the end defined so accurately that it can be clearly articulated to all employees we can now begin to establish the strategic plan to reach those goals. While not the topic of this installment of the CEO Partner Series, this involves the SWOT (Strengths, Weaknesses, Opportunities, and Threats) analysis of your business and then the development of the strategic plan.
With a plan in place, we will now look at our support systems. For this series, we will pay particular attention to the compensation and incentive systems but, be mindful that there are many other reinforcement systems in place in every organization from the underlying culture to your management style.
Does the compensation plan support and foster the achievement of the strategic goals or inhibit the process? Will the compensation plan help us to attract and retain the quality and quantity of talent that will be required to reach our goals? These are just two of many questions that we will have to answer as we move forward with the refinement of a current plan or the re-design and replacement of an outmoded system.
Let’s assume for a moment that we have identified that our current method of operation is highly centralized and controlled. Further, we have decided that a more participative and results oriented management process will produce better results. Also, we have determined that while our relatively high base salaries, automatic annual increases, and lack of incentive plans have worked well in the centralized and controlled environment, those plans are not what will be needed as we reshape operations. Likewise, the type of person that is attracted to a highly predictable and secure compensation plan is probably not the type of intrapreneur or risk taker that will be needed to succeed in the new marketplace.
Changing the compensation plan by reducing everyone’s base pay by ten percent and adding an incentive plan that will allow the competent performers to earn back not only the lost salary, but also an additional ten percent in incentive compensation will change behaviors. Some employees who have high security needs and lower levels of confidence in their ability to excel will probably leave your employ. They can’t or won’t “bet on themselves” and do whatever it takes to earn that bonus. This is not all bad, because you are loosing your underperforming assets, not your superstars. A new plan of this type will also help recruit and retain employees who believe in their capabilities and their ability to earn that bonus.
I recall a time when I was explaining and incentive matrix to a new employee, being very careful to cover all of the levels from threshold, to plan, to maximum. After discussing the first threshold level target and associated incentive, the employee interrupted and said “what are the targets and incentives at the maximum?” Somewhat surprised, I shifted to that column and discussed those numbers. When we finished, I asked “why didn’t you want to discuss all the intermediate levels?” It was music to my ears when he said “Why should I concentrate on the intermediate levels when I plan to earn the maximum that is available?” Keep sending me employees like that and the sky is the limit.
A change in the compensation plan of this magnitude is very significant and would probably be reserved for one of those desperate “need to change” situations just short of company collapse. There are a lot of alternatives to move from a non-supportive system to one that fosters the desired actions and results. One alternative that is less extreme and generally more suited to the “desire to change” situation is the phase-in of incentives. This may take the form of eliminating the annual automatic salary increase and replacing that amount by a like amount of incentive until the desired base salary/incentive mix is achieved. Key to this step is the understanding that the design must match the needs, desires, and current conditions that are unique to your company today. This is not the time to attempt to adopt a cookie cutter approach to compensation plan design. It is a time to recognize that your business and your business situation are unique and therefore require a customized solution. I have yet to find, in over twenty years of consulting, two companies that are exactly alike – two that have the same product mix, the same customers, the same market share, the same manufacturing systems and equipment, the same employees, the same needs – and until you can find that exact match, their compensation plan will not be right for your company.
With the new plan designed, reviewed, and tested it is time to tell your employees about the new system. This should be a very straightforward and open discussion of the new compensation plan and how it is designed to support the strategic plan and what they must do to earn the incentives and how that performance will be measured. Following the introduction and resolution of any questions or concerns, I favor instituting a weekly or at least monthly tracking system for the common measures of the plan. Assuming that one of the measures is market share or gross margin; create graphs or charts that show current performance, stated goal, and your progress toward that goal month by month or week by week. Not only will the frequent reporting keep the target in everyone’s consciousness, it will also dispel any employee concerns or uneasiness about “management’s control of the numbers.”
From this point, keep reinforcing the desired changes and new targets. Tell everyone how well they are doing both numerically and culturally. Remember, if you were a highly paternalistic or controlling manager, it is going to take time and multiple repetitions of your new participative style before they will believe that you want to and are going to change. It will be a struggle not to answer an employee’s question when they ask “what should I do about this customer request for a refund?” and to instead say something like “they are your customer and that is your responsibility, what do you think is fair?” and then living with their decision.
Finally, stay the course. Change doesn’t happen overnight, if it did we would all be at our perfect weight, blood pressure level, and cholesterol count. Change is a journey, not a destination. So, as you reach that next level of success, set new, loftier goals and strive toward them until they are JTWWDTAH (Just The Way We Do Things Around Here) and a permanent part of your culture.
To summarize, the first thing we need to do is to decide if change is desirable or necessary. Assuming we decide that it is, then we should define the current state of the business, employees, culture, and systems. With today codified we can establish goals and new standards of performance. Next we should design and implement compensation and incentive systems that will support and foster the desired change in behaviors. As CEO it is also your job to change, to stay the course, and to refuse to allow anyone to retreat to the old way of doing things. Change can be traumatic, unsettling, hard, and desirable. Incentives are an effective glue to make sure the changes stick.
James E. Mittler, CMC is president of J.E. Mittler & Company and can be reached at Mittler@mittler.net. Additional information is available at www.mittler.net.
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