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Dangle The Carrot!

How Pay for Performance Plans Attract and Retain The Best Employees While increasing Profit

“The belief that a performance compensation system creates employee accountability is wrong, just as wrong as the company that believes Christmas bonuses create productivity.” Tony Burruano, CEO Gold Gerstein Group

Fluctuating business conditions, poor financial controls, poor cash management, not understanding information and receiving incorrect information can either be killers or can be an opportunity to solidify yourself in your market as a profitable, solid company. If you are already profitable and balance sheet strong, then you can be the “Gorilla” in your market by guarding against the following seven mistakes, and instituting correct controls.

How to Prepare for Performance Pay Systems

  1. Create a plan of revenue and profit that is achievable to your revenue and profit goals for the 12-month period for which the Performance Pay System is intended to be in effect. This plan should define the critical processes to be accomplished; what specifically is expected of the critical people around those processes; the methods of measurement available to your company; and finally, create a monthly financial forecast of that plan which includes the dollar results you desire.
  2. Test the concepts of the plan for three months. Explain what you wish to accomplish with your plan to your key or critical people. Let them know that prior to the implementation of a performance incentive program, there will be a 3-month test period. “Spiff” them if they achieve their objectives for this 3-month test period. You will know your company is under control when they achieve their objectives for a 3-month period. A company out of control will never succeed with a performance compensation system.
  3. Learn how to measure what you have defined as critical to the success of the plan during the 3-month test period. Measurements should be timely: daily, weekly, monthly as required; measurements need to be accurate; and the critical people that receive these measurements or “Score Cards”, need to be responded to. Respond by explaining to them what they did right if it is working so they repeat it, or immediately correct what is not working and explain to them the stated timeline of correction and the result intended.
  4. Re-interview your key staff. Rate them as an “A” player,“B” player, or below. Determine whether you have the right employees in the right positions. Imagine starting your company over again with all the knowledge of the business you have acquired and with the customers you currently have. What do you consider the optimum organizational structure, staffing, and correct pay rates? Identify those in your current staff who fits perfectly (an “A” employee), who is almost there, (a “B” employee), and forget about everyone else. That process should be revealing. You need to staff with “A” employees at critical process and management positions within 2 years. “B” employees moving rapidly to “A” levels are fine. “A” level employees moving quickly to “B” are not, and forget about anyone else. There is a series of books available by Bradford D. Smart, Ph.D. called “Topgrading”, which describes this process. Reading about the process is a good preparation for top grading your employees. Read other books such as “Good To Great: Why Some Companies Make the Leap…and Other’s Don’t”, by Jim Collins, which describes the difference between being “just OK” as a company and being a top performer.
  5. Consider exactly how many years you would like to keep a key manager or employee. Considerations of age, replaceable skills, importance to the revenue and profit plan, and their ability to enhance your business team are critical to this precursor to “Golden Handcuffs”. You can also determine what is important to the key or critical employee for a 3-year period (money, security, whatever) in the interviews. A “non-qualified” plan of paying for long-term disability insurance and life insurance for key people is a method of avoiding additional payroll taxes, pension or profit sharing costs, and workman’s compensation costs on some of the currently paid incentives earned.

You Are Almost Ready

Assuming your test period was successful, the feedback from the employees that were tested was positive, your measuring systems worked, and you are able to take what you learned and “fine tune” the business plan, performance standards, and Pay for Performance system so that it’s relatively easy, understandable to each employee, and is adaptable to a score card system, you are ready to design your Pay for Performance plan and implement it. It is critical that you conduct a “sanity check” at this stage:

  1. Rewards are given to employees for performing beyond expectations. Those rewards for performing should not come profit, but should come out of the excess dollar amounts the stockholders should receive as a return on investment. Determine the amount of that threshold.
  2. Define the specific expectations of your “internal customer” and your “external customer”. If your plan supports the “promise” that you make to your external customer (service, response, time, courtesy, money); if it supports your revenue and profit plan (it must); if it supports concepts of teamwork and centers of excellence (people within various departments that have to work together to fulfill the internal/external customer commitment); and the expectations don’t break laws or regulations, you can progress to step #3. Remember that incentives should be based solely on measurable areas that are important to your business plan and areas that the employee’s activity impacts. Do not include costs or activities that fall outside a person’s individual or group control.
  3. Make the Pay for Performance plan easy to measure. Make the measurements accurate. Make the Score Cards timely in their delivery to the participating employees.
  4. Create a plan that the “A” employees see as “fair”.
  5. Create a plan that easily communicates your business objectives, reinforces your stated “Customer Promise”, reduces overall operating costs as a percentage of revenue, and potentially attracts new “A” employees from either the “B” pool or from outside the company. Earned performance pay is important. How you manage it is important. It is important to have your employees prepared to “sell” your company to other “A” employees. The more “A” employees you have, the more money your employees will make and the more profit the stockholders will make.

Implement The Plan

  1. Create multiple performance compensation plans that reflect exceeding expectations of your business plan at various levels. Show examples of what employees could potentially make with the various plans. Find out what you, as a stockholder, could make.
  2. Define how the Pay for Performance will be paid. Quarterly or semi-annual payments with a portion deferred to the year-end are preferable to a plan that only pays out at year-end. Remember, you can’t pay out on January 1. Let the accountants get the numbers right first. Target a payout after completion of the year-end financials (another sanity check). Remember that in the plan, the stockholders must define what they want in salary and return in total. You receive yours first, before determining the final amounts for your employees. Try April 15th as a final payout date. Also, consider the amount of your cash flow before establishing the date. You may have cyclical trends that reflect liquidity that should be addressed such as bank covenants, work in progress and inventory build-ups. Do not forget your deferred portion beyond the current year: Golden Handcuffs. Deferral within the incentive year and beyond is as important to a successful plan as paying a portion of the incentives during the year. Never pay an interim incentive earned in full prior to the end of the year. Employees will not pay you back if they fail to succeed during the course of the year and they have not completed some activities within the interim period. Pay them something prior to the year-end, but not the largest portion of the incentive earned to date.
  3. Implement your “Top Grading” process. Do not carry “C” and “B” level employees, or your “A” employees will become frustrated and ultimately the plan will not perform as intended, or it will ultimately fade away and fail.
  4. Do not be afraid to modify the plan each year, or correct an issue within the year. Within the construction or job shop manufacturing industries, often the concern is that the employees cannot be held accountable to mistakes by the sales or estimating departments or by commodity fluctuations in long-term contracts with price sensitive materials. First of all, if you do not have an effective pre-construction or production process in place that includes employees who produce such as a shop manager, field superintendent, project manager, estimator, engineers, and/or sales person, then you are not “in control”, and should not have an incentive program. If the targeted incentive is for something the person cannot control, they should not be directly incentivized for gain or loss with respect to material pricing or buy-out gain or loss, but the person estimating and purchasing should. If the stockholder is putting up their own money to purchase a position in commodity materials that is a gain over the estimate, the shareholder should not include the gain in the incentive plan. If the shareholder loses, it should affect the overall profit pool amount. If the shareholder is using “idle” money to play in areas that are not the normal operations of the business such as stocks, real estate, joint ventures, etc, that profit or loss should be excluded from the plan.

After A Year of Success

After you have enjoyed some positive experiences with your plan, communicate the results in a marketing hand out when you are interviewing for new “A” employees. Create a process that motivates your “A” employees to reach out to friends and competitor company employees to “talk up” the way your company treats employees. Good employees want good employees around them, always. No one wants to be dragged down by poor performers. If your employees can replace a co-worker that is holding them back by finding a better person or if they “sell” the company to an interviewee, they will. Some companies offer incentives to their employees for referring people that are hired and stay for a specific time period at the company. You can try that, but I have never seen it work. What I have seen is that a happy employee who wants a better working condition by replacing non “A” employees, tends to see “what’s in it for him”, and does not need further incentive.

In summary, get control of your company operations. Follow that with a simple and targeted performance compensation system. Incorporate deferral of a portion of the bonuses via Golden Handcuffs. Use accurate and timely Score Cards. Market the results to new “A” players when needed. Do all these things, and you’ll build the profit and value of your company to well in excess of your top competitors who don’t address these basics concepts of Performance Compensation Systems.

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