Share The Wealth

Employee compensation plans that pay off.

Magazine Contributor

April 1, 1997 7 min read

This story appears in the April 1997 issue of Business Start-Ups magazine. Subscribe »

As Pat Byrnes studied the financials for his company, Actuarial Consultants Inc., he could not escape one disheartening fact: Profitability for his Torrance, California-based pension consulting firm was slipping. "Expenses were going up, and profitability was going down," says Byrnes, the company's president and co-owner.

The root problem: Year in, year out, employee salaries kept rising due to annual cost-of-living increases, but tough competition forced Byrnes to keep a lid on the fees he charged client companies. "So I drew a line in the sand and said, `There has to be a better way to compensate employees,' " says Byrnes.

Byrnes promptly found that way. He essentially told his employees there'd be no more pay increases unless there were corresponding gains in productivity and profitability. "This focused employee awareness on the fact that if we don't make money, they don't, either," says Byrnes, who introduced a plan that, in a nutshell, gives employees the opportunity to earn sizable bonuses--but only if the company prospers.

How has it worked? "This year [my] average employee got a bonus of over 9 percent, a lot more than I would have awarded in pay increases," says Byrnes. The payoff for him: "The company's profitability is climbing. This truly is a win-win situation."

Byrnes isn't alone. Companies large and small are revamping compensation systems that haven't been working, says Gary Roberts, a management professor at Kennesaw State University in Kennesaw, Georgia. "Traditional approaches to pay haven't been based on any understanding of human nature and what really motivates people."

How have traditional approaches to compensation flopped? "Raises have become an entitlement. They are not a good motivator because they aren't tied to how individual workers perform," says Kathryn Bartol, a management professor at the University of Maryland in College Park. "The flaw that prevails in many businesses is that [raises] just don't reward hard work. In most businesses, every year workers get a raise, with slight individual variances for performance, which don't amount to much. But that's changing. Companies are finally realizing that pay is a big piece of competitive strategy--and you have to put your money where it counts."

Proof that many companies are looking for ways to get a bigger bang for their payroll bucks comes from a recent survey of 750 companies by management consulting firm Towers Perrin in Valhalla, New York. Fifty-eight percent of the businesses surveyed indicated they were engaged in comprehensive reviews of their pay strategies. Further proof is a survey by Watson Wyatt Worldwide, a human resources consulting firm based in Bethesda, Maryland. Eighty percent of the 694 organizations it polled said traditional rewards programs had only limited impact on the behaviors they were designed to encourage. Says Dennis Morris, a Watson Wyatt senior consultant, "Companies are finding there is no link between what employees do on a daily basis and the rewards they receive."

Earning Power

How do you make your money work better for you? The approach fast gaining favor is the one taken by Byrnes at Actuarial Consultants, where most--possibly all--pay increases are in the form of incentives linked to employee accomplishments and overall business profitability.

The benefits? For starters, money is handed out only if the business's profits justify it, so that puts an abrupt halt to the painful habit of handing out raises even in years when profits tumble. A second plus: "Bonuses are awarded just for this year--the money has to be re-earned each year," says Bartol. "This controls costs, particularly in years when the company doesn't do as well."

Easy as it is to preach putting employees on incentive programs, in practice many such efforts have fallen short of expectations. But lessons have been learned about how to design effective programs.

" `Line of sight' is a critical concept," says Jerry Newman, a management professor at the State University of New York and Buffalo. This means that for any incentive program to work, employees must be able to see the relationship between what they do and the pay hike they get. "The closer the performance measures and rewards are to what employees do, the better they motivate workers," adds Newman.

"The line of sight for most employees is very short," stresses Morris. That means you've got to work hard to identify results that individual employees believe they can influence--and that actually boost the bottom line. Then set up rewards that strongly encourage workers to do more of what's linked to profitability.

Here, small businesses have a huge advantage. "The entrepreneur is close to the action and should be able to fairly quickly set meaningful objectives for each employee," says Mark Weaver, a management professor at the University of Alabama's College of Commerce and Business Administration in Tuscaloosa.

Next step: Sell employees on the fairness of your plan. "Many businesses fall very short in terms of getting employee buy-in," warns Newman.

"Communication is critical," agrees Bartol. "Employees have to understand why you are making changes." Redouble your efforts to communicate to employees how the new approach can put more dollars in their pockets.

At Actuarial Consultants, Pat Byrnes first explained in detail why changes were needed, then set up a system that keeps employees on top of the company's numbers. "Every Monday morning we hold a pow-wow to explain where we're going, and monthly we distribute the financials to every employee," Byrnes says. "Doing this has focused our employees' attention on the fact that if we don't make a profit, a substantial piece of their income is in jeopardy."

Money Matters

How much income should be at risk? One rule of thumb is that no more than 20 percent of an employee's pay should be incorporated into incentives, "but that doesn't always work, especially in small companies. In entrepreneurial businesses, incentives that can double base pay can be great motivators," says Weaver.

Byrnes, however, has found that higher-level workers are much more open to incentive pay--"they understand what we're doing and why"--while lower-level support personnel are less willing to put sizable cash at risk. Many don't understand the concept; others simply don't have much entrepreneurial zeal. So Byrnes' plan reduces the at-risk amount for lower-level employees but increases the stakes for high-wage earners.

How often should bonuses be distributed? Experts agree "a year-end bonus is practically worthless as a motivational tool," says Weaver. Why? It runs afoul of the line-of-sight consideration. Often employees have forgotten what they did to get a bonus, so when one shows up, they attribute it to luck rather than hard work. That means the bonus won't do a thing in terms of shaping and influencing their future behaviors.

The cure? More frequent bonuses. At Actuarial Consultants, checks are handed out quarterly. Time frames longer than three months rarely get results, and some businesses may need to consider a monthly distribution. Either way, a heavy burden of work shifts to you: "It's an enormous amount of effort to implement an incentive plan," says Byrnes. "Just sitting down every quarter to evaluate each employee is a lot of work.

"None of this is easy, but once you accept that the old ways won't work anymore, you know you've got to come up with a different approach to paying people--one that works for them and for you. That's the only way to prosper."

Robert McGarvey writes on business, psychology and management topics for several national publications. To reach him online with your questions or ideas, e-mail rjmcgarvey@aol.com.