Third in our series on Compensation in Private Companies written with our compensation partner and long time collaborator Kieran O’Reilly of Flintlock Consulting.
Variable pay was born of employers eager to resist additional fixed cost. They realized that to increase revenue or grow profit employees were going to have to do more and naturally wanted additional pay for their efforts. Paying a portion of the gains evolved into communicating in advance the additional compensation that would be available for achieving agreed targets. The “compensation incentive plan” came to include increasing the speed of repetitive tasks (piece work), commissions to encourage sales, and equity to achieve improvements in share price.
Variable pay is an essential component in the process of attracting talent. In fact many companies adopt “incentive plans” simply because everyone else does and as we explored in our last blog, has become subsumed into Total Compensation.
Public companies are required to disclose the design and payout of their variable pay plans and “governance” pressure to follow “best practice” has caused homogeneity. Governance has been pursued at the expense of designs better suited to an organization’s goals. Doing the same as everyone else does not lead to differentiation.
Private companies are not under pressure to conform to competitive practice and successful ones increase the impact of variable pay by designing incentives that support their culture and values, and that drive long term strategy. For example a design may include:
- A common goal(s) – where the same objective applies to all participants with amounts paid differing by position or level in the organization.
- Tiered objectives – might include measures for the top team that reflect strategy that will have a significant impact on the organization, with lower staff levels rewarded for their implementation. Such plans are often known as scorecards.
- Profit sharing – a traditional incentive where a portion of profit is distributed to eligible participants. These are simple to communicate and require minimal administration.
- Multiple Targets – a plan that rewards relative achievement (i.e. +/- target) against a group of operational or financial goals which may include milestone achievements that may extend beyond a single measurement period.
- Segmented Rewards – incentives that reward performance in a specific commercial activity for organizations operating in several differing segments.
Incentive plans create greater value when they are driven by clear well communicated measures. Few successful companies retain totally discretionary systems where awards are based on subjective evaluation but most retain discretionary adjustments where unforeseen circumstances prevented objectives from being met. In larger organizations where several executives are involved in assessment of performance and payout written “plan rules” will ensure consistency and internal equity.
Business owners particularly ask why go to the trouble when incentives do not elicit any change in behavior or performance? Experience shows otherwise and psychology aside several elements need to be present for an incentive to be successful:
- Communication – participants need to be informed, about the plan and how to reap the benefits. Given the investment involved we find it surprising when companies do not promote their incentives.
- Performance Expectations – failure to set reasonable, achievable expectations and measures, vital to engagement and plan authenticity will render it ineffective.
- Consistency – extenuating or “special” circumstances should be recognized on an exceptional basis but not so often that they create inequity or favoritism or the perception that the plan can be gamed.