Chances are, you’re looking at your P&L these days and noticing just how large the compensation number is. In fact, it’s likely created a pit in your stomach—probably the size of a boulder. Bottom line, all logic says you need to lower than expense, no matter what.
Well, not so fast. We suggest you take a deep breath before doing anything too drastic. In truth, treating pay strictly as an expense to be downsized might actually put you in worse shape than doing nothing. Let’s talk about a more measured approach; one that gives you the flexibility you need right now while ensuring your strategy remains relevant when prosperous times return. We’ll call this the “survive to thrive” approach.
The premise of this approach is that, if you apply the right principles, you can actually decrease the cost of your company’s compensation commitment but increase performance rewards—at the same time. It’s not magic and there are no mirrors. It just requires adopting a different perspective about how pay can be allocated and evaluating what adjustments make the most sense in the current environment.
The 3 Secrets
To create a productive outcome in your current rewards approach, there three things you should consider doing. And they are not mutually exclusive. You could do all of them.
1. Rebalance Your Rewards Investment
Ideally, the cash portion of your pay offering is made up of three parts: salary, a short-term incentive and a long-term incentive. (If you don’t currently have all three parts, now is a good time to add the missing piece. And we won’t include sales comp in this discussion as it requires a different treatment.) Of those three, the one that is creating the biggest strain right now is the fixed salary commitment. As long as a given person remains employed, that payment has to be made.
But what if you “unwrapped” your total compensation offering a bit and adopted a more flexible approach? This approach could either be imposed (“Folks, this is how it’s going to have to be for a while”) or offered (“You have a choice here. Which approach do you prefer?”). Here’s the concept. Using here a “sample” position, your compensation offer could be constructed with three or more options.
Option A
Salary: $120,000
STIP: $0
LTIP: $0
Total: $120,000
Option B
Salary: $100,000
STIP: $20,000
LTIP: $30,000
Total: $150,000
Option C
Salary: $80,000
STIP: $40,000
LTIP: $80,000
Total: $200,000
Under options B & C, specific performance measures determine whether there are payouts under the incentive plans. Therefore, they are “self-financed”; meaning, the value is paid out only if the value has been created. If certain target thresholds are not met, there is no payout. This puts an emphasis on value creation.
This approach is appealing because if offers the potential for lowering current cash flow commitments while still rewarding performance. But the performance awards do not increase company expense right now—and only will if increased profits merit it. At the point those incentive payments have to be made, presumably sufficient value has been created to cover them.
2. Emphasize Long-Term Value-Sharing
One of the best tools available to a company in an economic slowdown is a long-term incentive plan. For private companies, the most common of these is some type of phantom stock plan. Under this arrangement, an employer sets up an agreement to pay a future benefit to plan participants based on company growth. To do this, the company issues phantom shares of stock. The term phantom means no equity is actually exchanged. Instead, a formula share value is established (in can be based on a formal valuation, but doesn’t need to be) that mirrors a real stock share price. Shares are issued based on company-determined criteria—length of service, performance, recruiting needs, etc. The value of the phantom shares are tracked based on the formula the business has established. A payout date is set for some time in the future—five to eight years being typical.
Now, here is the magic of this type of long-term value-sharing. At the time phantom shares are issued, there is no cash flow cost to company. It is simply engaging in a promise to make a payment later. As a result, the organization can reward the performance of its people now but not have to actually drain its cash flow until later. A further benefit is that the employee does not have to declare any phantom stock shares when they are issued. They only become income when a payout is made. As a result, there is no current income tax consequence to the employee for participating in the plan.
One of the benefits of this kind of arrangement in a period of economic uncertainty is obvious. A company can reward its people now and not take a cash flow hit for doing so. However, let’s consider another dimension to this approach.
If a company has both a short-term incentive plan (such as an annual bonus) and a long-term incentive plan (such as phantom stock), it prevents itself from being in an “all or nothing” position. In other words, it doesn’t have to go to its employees and say, “Sorry gang, because of Covid-19 there aren’t going to be any bonuses this year. I wish there was something else we could do but I’m sure you understand.” (And most employees would understand.) Instead, the business leader can say, “As you know, because of Covid-19, it’s not likely we’ll be making bonus payouts this year. However, if we can meet “X” target, we will add an additional “Y” number of shares to your phantom stock account.”
In short, a long-term plan gives you room to maneuver in how you pay your people. And it does it in a way that doesn’t require you to reinvent your entire pay strategy. So, although it may feel counter-intuitive, if you do not have a long-term value sharing in place currently, now is a good time to institute one.
3. Create Structured Flexibility
The coronavirus economy is not the last time you will have to consider adjusting the way you pay your people. For example, in a robust business environment, change is so accelerated that you need an agile framework for managing compensation. In other words, you need a way to easily examine your total value proposition and determine what adjustments need to be made. And you need to be able to make those changes quickly. You need a structure that ensures you are able to be flexible.
At MPN Inc., this is one of the reasons we recommend a company set up a total compensation structure. Think of it as a spreadsheet, where across the top are listed all the pay, benefit and perquisite offers of the company. Down the left-hand side are each of your employee “tiers” (grouped by salary or job grade). The rest of the spreadsheet is filled in with the current values available under each plan to each tier (salary ranges, short-term incentive potential, long-term incentive potential, security plans, retirement plan match, etc.).
Once this construct is in place, you can easily run analytics to determine where it makes sense to adjust thing, as described in the second “secret” above. For example, you might isolate certain tiers and create a pie chart or graph that illustrates how pay is allocated across various offerings. You can look at that allocation and ask yourself whether if reflects your pay philosophy—your beliefs about what should determine how and how much your people are paid.
When you create structured flexibility in your pay strategy, you are able to manage compensation as you would an investment portfolio. Each specific rewards offering is like an asset class. And each asset class is there for a reason; it has a role to perform. As business conditions change (bad economy, hiring surges, etc.), you don’t take out all the “asset classes” and replace them with different ones. Instead, you rebalance your pay portfolio, just as you would an investment portfolio. You shift the weight given to each plan based on the overall job you need compensation to do for you at a given time.
I’m sure you join me in hoping our country will rebound quickly from the economic damage created by the Covid-19 crisis. As of this writing, the president of the United States has just announced a three-phase approach to “re-opening” our country. Let’s hope it’s successful. In the meantime, these three secrets should help you both survive “today” and thrive “tomorrow.”
