Best Practices: Compensation

Building a Plan to Attract, Reward and Retain Top Performers

The Changing World of Compensation

In today's business environment, attracting, retaining and motivating the kind of people who can sustain a fast-growing organization requires most companies to think differently about how they pay their employees. According to TEC speaker and compensation expert Catherine Meek, five "catalysts" are reshaping the entire field of compensation:

1. Changing business world. In a world dominated by new technology, the Internet, and an increasingly diverse workforce, outdated compensation programs become an anchor rather than a support for the organization.
   
   
2. Changing workforce contract. Today's workers are loyal to themselves first and the company second. Such a workforce requires a very different kind of compensation.
   
   
3. Organizational values and culture. Too many companies have little or no connection between their stated values and what the compensation plan rewards. Matching organizational values to performance requires a new approach to compensation.
   
   
4. How work gets done. The way companies get work done has undergone a dramatic revolution. You can't reward cross-functional teams with a compensation plan built around a top-down, command-and-control structure.
   
   
5. Lack of results. Traditional programs don't reward employees for cutting costs or increasing profits, two essential elements for survival in today's world.

The new compensation model incorporates a number of fundamental principles, including:

• A "total" compensation mindset
  
  
• Linking compensation to corporate strategy
  
  
• Pay for performance
  
  
• Tailoring to culture and values
  
  
• Generating a cost-effective return on invested payroll dollars
  
  
• Compensation as a competitive weapon
  
  
• Focus on the customer (internal and external)
  
  
• Recognizing and rewarding superior performance
  
  
• Reflecting competitive requirements
  
  
• Being open, well-communicated and understood by employees at all levels

Of these, suggests TEC Speaker Ron Fleisher, the most dramatic change is the shift to pay for performance. Today's compensation models need to:

• Pay for performance, productivity and results
  
  
• Create a behavioral model that dictates how people will perform
  
  
• Reduce the need for supervision and encourage creativity and initiative
  
  
• Focus on reinforcing company profitability rather than automatically increasing fixed expenses

Compensation Strategy

Before designing and implementing a compensation plan, you must first develop a clear and compelling strategy. Meek, Fleisher, and TEC speaker Karen Jorgensen have identified the following "expert practices" in this critical area:

1. Define your compensation philosophy. A focused compensation philosophy answers fundamental questions such as: What do you want to pay for? How do you want to pay for it? What is your competitive posture? How will you split up the pie?
   
   
2. Link compensation to your overall business strategy. This involves identifying your top strategic objectives, defining what they mean in terms of organizational behavior and designing your compensation plan in a way that rewards and recognizes those behaviors.
   
   
3. Change the culture and reinforce it with compensation. Compensation alone won't get the results you want. In order to create permanent behavior change, first change the culture and the environment, then use compensation to reinforce those changes.
   
   
4. Reward the behaviors that drive the results. In order to reward behavior that drives results, you have to know what creates value in your company. Value gets created in two ways -- doing the things your customers want, need and desire, and doing them in a profitable manner. Without both, a company won't survive for the long term.
   
   
5. Think total compensation. In today's fiercely competitive labor markets, compensation provides a powerful tool for attracting and retaining quality people. Remind employees that their compensation includes a lot more than just base pay.
   
   
6. Measure your return on invested payroll dollars. To determine whether you're getting a good return on your invested compensation dollars, measure it.

Compensation Plan Design

Once you have all the elements of strategy in place, you can begin to build the actual compensation plan. Although compensation plans come in a variety of shapes and sizes and have widely different goals, our experts agree that certain fundamental principles should lay the foundation for every plan design.

1. Get alignment. To succeed over the long-term, says Fleisher, all compensation plans must meet the needs of three critical entities:
   
   
• Customers (as measured by the increase in sales)
• The company (as measured by profitability)
• Employees (as measured by who gets rewarded for taking care of the first two)
  
  
2. Know the difference between satisfiers and motivators. Satisfiers (base pay, benefits, etc.) allow you to attract and retain people but they don't motivate performance. Motivators (pay for performance incentives, empowerment, job opportunities, etc.) motivate people to improve performance. The best compensation plans use both appropriately.
   
   
3. Get employees involved. Giving employees a say in one of the most important aspects of their jobs creates a perception of fairness and objectivity and encourages them to buy into the compensation plan.
   
   
4. Recognize the difference between results and effort. Successful compensation plans pay for results. At the same time, they also recognize effort because sometimes employees work hard but fail to achieve the desired results. Make it very clear that your philosophy is to pay for results, advises Meek, but don't ignore effort.
   
   
5. Define, measure and track performance. In order to pay for performance, first define performance in specific, objective, quantifiable terms. Then measure it and track it.
   
   
6. Check trust levels. Before designing a compensation plan, check organizational trust levels. If they're low, employee resistance will kill any chances of success. To raise trust levels, says Fleisher, provide frequent, accurate and strong communication, and under-promise and over-deliver.
   
   
7. Avoid discretionary measures. Although easy to implement, discretionary measures minimize the impact of the reward and can cause hard feelings when people receive different bonuses.
   
   
8. Constant communication. Although primarily an implementation issue, communication also falls under plan design because if you don't build in enough time, effort and resources for communication and education, your plan will go over like a lead balloon.
   
   
9. Frequent reinforcement. Changing behavior over the long term requires two essential ingredients: reinforcement and reward. Try to get the reward as close to the behavior as possible, but use good judgment when determining payout intervals.

Implementing the Plan

If you have done your work properly in the strategy and design phases, say our experts, implementation should naturally follow. However, the following practices can smooth the implementation process.

• Communicate constantly.
  
  
• Make sure the plan creates alignment with customers, the company and employees.
  
  
• Use measurement information to keep people focused on the plan.
  
  
• Consider a bridge program.
  
  
• Separate base pay from incentive pay.
  
  
• Define the playing field.
  
  
• Designate a champion.
  
  
• Check with an experienced attorney.
  
  
• Celebrate success.

As a final check before installing a new compensation plan, advises Fleisher, ask the following questions:

• Are we paying for time or productivity?
  
  
• Does our compensation program reduce the need for employee supervision or maintain it?
  
  
• Will our compensation program encourage initiative and creativity or simply reinforce the status quo?
  
  
• Does our compensation program automatically increase our fixed expenses?
  
  
• Does our compensation program reinforce company profits or simply pay for individual effort, regardless of company profitability?

Incentive Plans

Incentive plans, particularly those that share profits with employees, have a number of benefits. According to our experts, these include:

• Unlocking hidden employee creativity
  
  
• Fostering alignment and greater employee commitment to organizational success
  
  
• Reducing turnover of good performers and increasing peer pressure on poor performers
  
  
• Increasing profits and improving morale
  
  
• Providing strategic and economic advantages over competitors
  
  
• Providing recruiting advantages in the marketplace

Despite these benefits, says Fleisher, incentive programs are not the sole determinant of successful change. To improve performance, change the culture and then use incentive compensation to support the new culture.

Incentive plans come in a variety of shapes and sizes. Each has its own advantages and disadvantages that need to be considered before deciding which one best suits your organizational culture and strategic goals.

• Organizational incentives create awareness of, and alignment with, company goals and objectives, but employees may fail to see the relationship between individual and company performance.
  
  
• Individual incentives force people to focus on specific goals, but they may foster internal competition rather than teamwork. Without proper thresholds, they may pay out even though the company fails to earn a profit.
  
  
• Team/group incentives foster cooperative behaviors and information-sharing, but may reduce individual motivation and (without proper thresholds) may pay out when there are no profits.
  
  
• Gainsharing focuses attention on key business measures and pays out only when productivity gains or cost savings are achieved. One disadvantage is that employees may go to extremes to cut costs or realize gains.
  
  
• Lump-sum merit plans help control fixed costs while reinforcing pay for performance. Over time, however, base pay usually lags behind market. These plans can also cause cash flow problems.
  
  
• Discretionary rewards are very easy to administer but have little or no impact on performance. Employees often come to view them as an entitlement rather than a reward.

"The primary goal of any incentive/variable pay program is to change behavior," explains Jorgensen. "Linking the program to your strategic objectives ensures that you reward only those behaviors that will lead to accomplishing your business goals."

Incentive Plan Design Issues

An effective incentive plan should be customized to the unique needs of your company. Before rolling out the plan, Jorgensen recommends considering the following issues:

• How do you measure the goal?
  
  
• Who participates in the plan?
  
  
• How will the payout be determined?
  
  
• How often does the plan pay out?
  
  
• What are the threshold numbers?
  
  
• How do you define salary?
  
  
• Who has responsibility for administering the plan?
  
  
• Who measures performance?
  
  
• Will you pilot the plan?
  
  
• Does the plan pay all monies due or does it have a hold-back provision?
  
  
• What is the life of the plan?

Implementing Incentive Plans

Incentive plans have a wide variety of names: gainsharing, profit sharing, incentive pay, pay for results and more. Regardless of what you call them, say our experts, they all include three fundamental elements:

1. Vision. A clear vision helps to define what you want to accomplish, which sets the parameters for the plan design and the elements within the plan.
   
   
2. Objectivity. Successful incentive plans totally eliminate any possibility of subjectivity on the part of management or uncertainty on the part of employees.
   
   
3. Simplicity. Make sure every employee understands the goals, how they contribute to achieving those goals and how they will get rewarded when they do.

To implement your incentive plan:

1. Identify the plan goals and pay philosophy. Define the goals that need to be achieved in order to trigger the incentive payouts, how much employees will earn and how the plan compares to the marketplace
   
   
2. Conduct market research. Before putting any incentive plan in place, study the market to determine what type of plan makes the most sense for your company.
   
   
3. Set very clear, specific payout thresholds. Don't create a plan that pays incentive rewards when the company doesn't reach the desired profitability goals.
   
   
4. Determine how to divvy up the pie. Once you determine what you can afford to pay, decide how to distribute the profits.
   
   
5. Put the plan into action. Once you unveil the plan, meet regularly and often with employees and supervisors to make sure people understand the plan and the actions they must take to meet the stated goals.
   
   
6. Track and measure performance. In order for any incentive plan to succeed, you must track and measure performance and give feedback to employees on a regular basis.
   
   
7. Review and adjust as necessary. As the plan unfolds, ask questions like:
• Are we rewarding the right behaviors?
  
  
• Are the payouts timely enough to reinforce the behaviors?
  
  
• Are we on track to meet our company goals?
  
  
• Are we improving productivity and morale?
  
  
• Is the plan operating in alignment with customers, the company and employees?

"Properly designed incentive plans offer flexibility and adaptability," explains Meek. "More important, they don't lock you into any long-term financial commitments. Keep in mind that incentive plans involve a process, not a one-time event. Don't be afraid to tinker with your plan and make adjustments along the way."

Establishing Market Base Pay

Establishing fair and equitable base salaries lays the cornerstone for any variable pay compensation plan. Jorgensen recommends a six-step process for establishing market base pay:

1. Develop a pay philosophy. Research your company's past pay practices and identify how you intend to pay employees to reflect current market rates.
   
   
2. Establish a compensation committee. The committee develops and administers the pay process, acts as champion of the compensation system and develops pay policies.
   
   
3. Conduct a market survey. The compensation committee conducts market surveys within the industry and for comparable jobs outside the industry.
   
   
4. Evaluate the survey data. The committee then compares its findings against internal salaries. In some cases, it establishes job grades and ranges to provide a framework for assessing individual pay levels.
   
   
5. Adjust salaries as needed. If the committee finds salaries to be significantly higher or lower than market, it makes recommendations for increasing sub-par salaries and bringing inflated salaries more into line.
   
   
6. Communicate the plan. Constantly communicate the plan in company meetings, orientations for new employees and supervisory training. Unless you educate employees on why you're shifting to market base pay and how it benefits them, you may get a lot of resistance, including turnover.

Getting Employee Buy-In

Fleisher recommends daily meetings to educate employees about the plan, provide reinforcement and improve performance. These meetings operate best under the following ground rules:

• Meet in groups of four to six employees.
  
  
• Each group is led by a department head or designated team leader.
  
  
• Every employee participates every day. No exceptions.
  
  
• Meetings never last more than 15 minutes. Any unfinished business gets carried over to the next day.
  
  
• Each group uses a daily scorecard to measure its performance against the compensation plan goals.

When looking for ways to improve performance, do not allow the meetings to become finger-pointing sessions. The goal is to create a positive, forward-looking environment where people understand the goals, know what they have to do to achieve them, and constantly look for new and better ways to get the job done.

Incentive Plan Success Factors: What TEC Members Say

A recent survey by Meek's firm, Meek & Associates, asked 312 TEC member companies about their use of incentives and bonuses. The four most successful incentive plan practices, as reported by these TEC members, were:

1. Linking incentives to the company's business results
   
   
2. Tying the plan to performance (quantitative and qualitative)
   
   
3. Communicating as much and as frequently as possible
   
   
4. Involving employees in the process

The four biggest mistakes in incentive plan design and implementation were:

1. Insufficient communication and feedback
   
   
2. Lack of alignment with the business strategy and objectives
   
   
3. Using discretionary measures
   
   
4. Setting unrealistic goals

When asked what they would do differently the next time around, TEC members responded most often with:

1. Tie incentives to results and performance
   
   
2. Communicate, communicate, communicate
   
   
3. Pay out more frequently
   
   
4. Share financial and business information

Non-Cash Rewards

Increasingly, companies are including non-cash rewards and recognition as one important element of their overall compensation program. These plans tend to be simpler in design and execution than cash-based plans. Nevertheless, says Jorgensen, companies should consider certain essential principles before putting a non-cash reward plan into action.

• Take care of the cash side first. In order for non-cash rewards to have an impact, employees must make enough money to meet their basic needs.
  
  
• Find out what motivates your employees. Find out what your people like and offer a number of choices because not everyone wants or needs the same thing.
  
  
• Combine recognition with reward. After an employee earns the reward, acknowledge them publicly.
  
  
• Get employees involved. The best programs allow employees to recognize and reward each other.
  
  
• Link the rewards to performance. Use non-cash rewards to drive the behaviors that will lead employees to accomplish your organizational goals. Set specific goals and targets, define the measurement criteria and promptly reward the performance.
  
  
• Use non-cash rewards to measure hard-to-measure indicators. Non-cash compensation allows you to start rewarding employees in areas where you don't want to commit hard dollars because of the difficulty in quantifying the measures.
  
  
• Change the plan frequently. Non-cash reward plans tend to have a short "shelf-life" (typically 12 to 18 months). To keep the plan from becoming stale and bureaucratic, change it on a regular basis.
  
  
• Don't forget to say "thank you." Above all, employees want to hear 'thank you' from their boss. Never underestimate the power of saying "thank you."

Using Employee Focus Groups

Employee focus groups can help you determine the recognition and rewards that fit your organizational culture. Creating a compensation focus group, says Jorgensen, consists of three simple steps:

1. Form the team. Gather 10 to 15 employees from various departments and management levels, making sure every level in the organization has at least one representative.
   
   
2. Identify the purpose of the group. Make sure employees understand that the meeting is for information-gathering purposes only, that management will evaluate and make decisions at a later time.
   
   
3. Gather the information. Ask employees the following questions:*
   
   
• What reward systems in this company are working now? Why?
  
  
• What reward systems in this company are not working and what would you like to see changed?
  
  
• What would you like to see changed about the way we reward employees today?
  
  
• If we could design a reward system that didn't cost too much, what gifts or other items do you think would be appropriate?
  
  
• How do you think employees should be recognized in this company?
  
  
• What recognition awards would be identified as helpful in designing a reward program?
  
  
• Have you had recognition and/or non-cash awards at former companies? How were they designed? How did they work?
  
  
• Any other thoughts on how to recognize and reward employees?

Non-cash rewards provide a very cost-effective means of incentivizing your workforce. But if done badly, the programs can breed resentment and ill-will among different groups of employees and between staff and managers. Getting input from employees will greatly increase your chances for success.

*Questions copyright 1996, "Pay for Results: A Practical Guide to Effective Employee Compensation," by Karen Jorgensen, Merritt Publishing, Santa Monica, CA.

Contributing Experts:

Ron Fleisher

Ronald Fleisher is president of Creative Bottomline Solutions Inc., a management consulting firm that specializes in three primary areas: negotiations, compensation programs and crisis management/corporate turnarounds. A retailer from the time he graduated college until the end of 1993, he has been president of several retail companies, as well as Medical Supplies of America, a distributor of durable medical equipment to the home health care industry. Ron has worked for such major companies as Dayton Hudson's Target Stores and Sears. He received his bachelor's degree from Temple University and his master's degree from the University of Maine and has done additional graduate work at Babson College.

Ron serves as a TEC Ambassador, is on the TEC Speaker Advisory Board and has given more than 200 speeches in the last two years. He serves on the board of several major corporations and was most recently asked to join The Leadership Mastermind Group, a think tank of business leaders from the United States, Canada, Great Britain, Singapore and Australia. The group's mission is "to define and advance the art, science and practice of leadership."

Karen Jorgensen

Karen Jorgensen is president of Jorgensen Human Resource Solutions, a consulting firm that specializes in helping small, privately held companies resolve compensation and human resources issues. A nationally recognized expert in the human resources field, Jorgensen has written several books on human resources issues, including "Pay for Results: A Practical Guide to Effective Employee Compensation." She has appeared on several local and national television programs and has taught classes at Wharton Business School, UCLA, Glendale College and Loyola. She is an active member in Professionals in Human Resources Association (PIHRA), the National Society for Human Resources

Management (SHRM), the American Compensation Association and the Los Angeles Compensation and Benefits Association. With more than 100 TEC presentations under her belt, Jorgensen regularly addresses TEC groups on the subjects of pay for results, discipline and termination and hiring and motivating employees.

Catherine Meek

Catherine Meek is president of Meek & Associates, a consulting firm specializing in performance improvement through research, development and implementation of programs designed to attract, retain, motivate and reward employees. With nearly 30 years' experience in the human resources field, she is a frequent speaker and seminar leader for a variety of organizations, including the American Management Association, the American Compensation Association, the Financial Executives Institute and the Inc. Conference. One of TEC's most sought-after speakers for the past decade, she has delivered close to 200 TEC presentations on designing compensation programs and performance management.

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