This chief executive’s reasoning seems logical, does it not? But it reveals a flaw in the way most business leaders think about compensation. The CEO’s assumption was that he could essentially pay for the performance he wanted. His focus was on how much he would pay his people. He would later come to learn that how he paid his people was more important than how much he paid them. He needed a compensation plan that would get his employees to:
• Own the primary outcomes for which they were responsible in their roles.
• Think like owners when it came to strategic priorities.
• Focus on consistently driving the revenue engine of the company.
• Ensure the company hit its profit targets each year.
• Contribute to the long-term growth of the business.
At this point, you may be asking something like this: “You expect a pay strategy to accomplish all that?” Well… yes. What do you expect it to do? In fact, if it’s not, then it’s really not doing its “job.” Compensation is a strategic tool that should be employed to help employees become better aligned with owner interests. It should turn employees into growth partners. This only happens when business leaders learn to strike the right balance between guaranteed and variable compensation, and between short and long-term value sharing.
The “Which is Better?” Question
Most chief executives intuitively know that there should be some relationship between how employees perform and how they are paid. But for most of them, the question is reduced to: “Which is better—higher salaries or bigger incentives?” Because so many company leaders think in those terms, we devoted last week’s webinar broadcast to answering that question.
The reality is, it’s a false choice. A company needs the right balance between those two things, there’s no question. But it’s not as simple as deciding to either pay generous incentives or just go with higher salaries. And in our webinar broadcast, we made the point that there is not a “one size fits all” approach to determining what the right balance of elements is in a pay strategy. Each company’s circumstance is different, and therefore, their pay formulas will be distinct as well. However, there are common principles that all company leaders should follow in carving out a rewards approach for their organizations. In our presentation, we discussed three:
1. Have a clear value creation definition.
This should be the starting point for every company that is embarking on the development of a compensation approach. Leaders must be able to determine how the contributions of their employees will be measured. They need to know the point at which the profits of the business are attributable to their people at work, as opposed to owner assets, goodwill and the like.
The natural outgrowth of a value creation definition is a compensation philosophy. While your value creation model determines whether you can afford to share value, and to what extent, your philosophy articulates with whom value will be shared and what form it will take. Your pay philosophy is the place you flesh out what you want compensation to help you accomplish, and therefore, what balance there should be between not just guaranteed and variable comp, but between short and long-term incentives. Among other things, the process of defining your belief system about compensation forces you to decide how much you want to emphasize rewarding annual versus sustained performance.
2. Align compensation with your recruiting strategy.
Of course, creating this alignment presupposes you have such a strategy. That strategy should include the identification of the specific roles you need filled to achieve your business plan, long-term, as well as the outcomes those roles need to produce. Once you know what roles need to be fulfilled, you can compare them with the talent you currently have. The gaps that analysis reveals should become the target of your recruiting efforts.
To attract the kind of talent you need to fill the roles you have identified, you need to understand your audience. The largest talent pool right now is millennials. The tendency is to generalize about what that demographic is like and what they will or won’t respond to in a compensation plan. In fact, there are multiple segments within the millennial audience and each has a different expectation when it comes to pay. You need to understand how those you wish to recruit will evaluate your compensation offer and what they want it to help them accomplish.
3. Build structured flexibility into your pay strategy.
It can be a daunting task to build a pay strategy that is agile enough to appeal to various employee constituencies—and be adaptable enough to respond to the exponential nature of change that all businesses these days are constantly experiencing. It can almost feel like a new compensation plan needs to be introduced every year, if not every quarter.
Structured flexibility means you approach your compensation design like you would the construction of an investment portfolio. In the latter, you choose the asset classes that are best suited to the long-term objective you have for wealth accumulation. As economics shift, you don’t change out the asset classes and put new ones in. Instead, you rebalance. You give different weight to different classes depending on how the economy is impacting them.
Think of the various compensation and benefit programs you offer your employees as asset classes. Pick the ones that best reflect your value creation model and pay philosophy. You will then weight them differently by tier of employee—with some participating more in incentive compensation than others, and with distinct balancing between short and long-term rewards. Over time, as either your recruiting needs change, or the economy surges and wanes, you can “rebalance” your compensation “portfolio” accordingly.
So, what is the right balance between salaries and incentives for your company? I don’t know. But I do know that following these three principles can help you answer that question.