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As companies look to the new year, and budgeting, the issue of compensation packages is sure to be high on the discussion list. Companies are facing some particularly difficult times in this area:

  • Pushing up costs:
    • High inflation levels pushing up demands for increases that will at least keep pace
    • Ongoing skills shortage is adding pressure to pay, too, if companies are to retain key staff
  • Pushing for cost control:
    • The impact of inflation on company costs
    • Borrowing and working capital costs increasing
    • Declining spend by customers already being felt in many markets
    • Potential recessionary times ahead could impact revenues and profitability

How can leaders address these conflicting goals and keep company morale high and retain staff while also ensuring the ongoing sustainability of the business?

The starting point is to review your current compensation systems. If, as is so often the case, the basic design was formulated many years ago and tweaked somewhere since, it might be worth going back to a complete redesign as so much has changed in the past 3 years. You can think of this in much the same way as adopting a zero-based budgeting approach – part of the 4th ‘C’ in my article, “Inflation – Reducing the Risks to Your Business with the 5 Cs.”

The MIT Sloan Management Review has described the modern workplace “as a stool whose three legs —efficiency, effectiveness, and quality of life—must be kept in balance. For the stool to remain upright, all three legs need to be sufficiently strong.

And this is the key nowadays: the addition of the ‘quality of life’ dimension to the traditional measures of efficiency and effectiveness. A strong and positive company culture is arguably the most important determinant for success nowadays as is clear from the research into what makes companies great, and a company’s reputation is also of increasing importance for staff, customers and the wider stakeholder community, too.  

Interestingly, in companies with a strong culture and reputation, total pay ranks lower on the list of staff concerns, so this is certainly an area where companies should be paying attention. Issues such as work time and location flexibility, annual and parental leave, volunteering opportunities, in-office subsidised meals and health care, and other perks can make a huge difference, often at a lower cost than straight pay.

Similarly, historic incentive packages based wholly, or largely, on financial performance are being looked at closely as potentially damaging to the longer-term interests of the company due to their typical focus on the short-term. In fact, it often leads to fraud (the $7+ billion accounting scandal at Steinhoff was arguably driven by executive incentives), a very short-term focus by executives and others alike, and impedes medium-long term performance as a result. In many cases, the variable portion of an executive’s package is 80% variable adding to the pressure of a shorter-term focus.

How do your compensation packages fit with these trends?

The best place to start is to look at your company’s overall vision and goals, and think about how to map compensation to these, for both long-term and short-term incentives. If you don’t already have an OKR framework in place, now’s the time to do so. Tie incentives to individual objectives (typically short-term, often changing quarterly) that lead to OMGs (medium-term, annual to 3 years) and then to your overall BHAG and vision (longer-term).

Look at your culture – how well does it map to your strategy? For example, if your business is focused on excellent service but incentives are based on revenue, there’s a mismatch and the potential for behaviour that doesn’t fit your stated ethos. Does your strategy and vision, or your incentive program need to change?

Find out how well your vision and the goals are understood throughout the business – by people at all levels. If it’s not clear, your team is almost certainly underperforming – whether or not they’re achieving their current incentive goals – and you need to urgently change this to ensure clarity and consistency of understanding.

Coming back to culture – do you have a culture of true accountability running from the boardroom to the front desk? If not, how quickly can you instil this – it makes an enormous difference to motivation, productivity and, ultimately, profitability and growth. And it will ensure your vision and goals are better understood, too.

Once you’re confident your culture maps well to your vision and goals, which are clearly understood throughout, look at where your business sits in terms of compensation in relation to its peers in your market. Are you able to easily attract the people you want? Does your team believe they are fairly rewarded at all levels? Consider, too, the gap between lower pay levels and executive pay levels and whether this might be viewed as excessive. Answering these questions will give you a starting point for any necessary overall changes at various levels.

Now you can review your compensation plans thoroughly, knowing where the end-point needs to be for each level.

Start with understanding what portion of each salary level should be incentive-based, and what should be fixed. Essentially, people need to earn sufficient at a basic level to meet their typical monthly needs, with incentives being the thing they strive for to provide those extras that everyone likes for their family and themself.

Similarly, the incentive program should not be such that significant over-performance can cause the company distress (I’ve seen this happen in the past), nor to encourage people to take risks and adopt behaviour which would be counter to the company’s culture and vision. There’s a good deal of debate now as to whether leadership packages should be set with incentives accounting for 80% of their total package, or if the basic portion should be set a fair bit higher and the incentive portion lower, with a lesser overall amount.

The other point about incentives is that they cannot be guaranteed – they should be designed to be achievable with reasonable effort under normal conditions, requiring a fair bit of extra effort to over-achieve these to any degree.

And it’s equally important to make provision for what happens in the event of sudden downturns or other things outside the control of those at different levels. Consider the implementation of a “parity pill” measure as described in this MIT Sloan Management Review article, for example.

Now map the incentive portion at each level to the broad goals and objectives for that level, determining what portion is to be based on individual goals, and what on team or company goals. This split is important to ensure that while individual performance is important, they need to be pulling in the same direction as their team/s and the company as a whole.

Finally, map the program to your OKR framework to ensure a fit with your vision, goals and objectives for the business at each level.

While this can be a complex exercise, if carried out properly it will not only enhance your overall culture, but raise motivation, productivity, growth rates and profitability, too – while providing a buffer against the potentially difficult times that appear to be on the horizon.

Let me know your thoughts on this process in the comments section.

 

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I work with high-performance owner-led businesses to enhance their growth, profitability, cash flow and business value.

If you’d like to have a conversation about your business, vision, strategy, culture, or any business challenges or concerns, book a free 30-minute call with me here. I’d be delighted to talk with you.

 

#BusinessFitness #Accountability #Budget #Change #CompetitiveAdvantage #Culture #ESG #Growth #JobSatisfaction #Leadership #Motivation #People #Planning #Strategy #VUCA #2023

 

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