As the economy crumbled around our collective feet, the proper design of a compensation program may not have seemed like a priority. But with more candidates than jobs available and the U.S. unemployment rate determined to break into double digits, you may be surprised to learn that compensation programs continue to play a vital role in the success of many businesses.
BLR® spoke with Janet Koechel of JFK Consulting (www.jfkconsulting.net/), a compensation expert who has been helping clients craft effective compensation programs for over 25 years.
“Even in a bad economy, it is still a popular way, and a good way, to control payroll costs, because it is linked to company performance,” Koechel reports. “If the company performs, variable pay plans pay out. If it doesn’t, unlike Wall Street investment banks, it typically doesn’t pay out.”
Companies already using variable pay for their sales and executive staffs may believe they can simply tweak existing programs a bit for nonsales, nonexecutive employees.
Koechel urges a deeper thought process. The plan’s effectiveness will depend on whom it targets and how well you draw a line of sight from each group’s duties to the company’s success. She gave some insight into what to do, and particularly what not to do, when designing these important plans.
DON’T: Make Rewards Too Small
“When designing bonus plans for nonexempt or hourly groups, the amount has to be large enough to catch their attention and be meaningful,” Koechel says. “When bonus plans were first rolled out to lower-level employees, they were as little as 1% to 3% of pay. If you’re making $30,000, that’s not enough. One of things I like to do is to set the incentive higher. I recommend companies tell hourly employees that if they meet their productivity goal, they get the equivalent of 2 weeks’ pay. That’s almost 4%, and people like it. The amount has to be enough that people will think about how they can perform in order to get it.”
DO: Educate Employees About Their Personal Impact
Commonly, employees who have no direct executive or sales impact have a difficult time seeing how their individual performance plays a part in the company’s success. This is where it is important to draw a line of sight. “It’s very important when you’re designing one of these plans that you be cognizant of employee education about the plan,” says Koechel.
“Teach the employee how they can impact the performance measures you set. If you’re an executive, you understand EBIT (earnings before interest and taxes); but if you’re an administrative assistant, you might not, nor would you feel that you could have an impact on that.
“One of the ways people handle this is to have tiers in the plan. The plan may have a corporate funding trigger, that says the plan will pay out if the company earns, for example, 10% more in EBIT than last year,” Koechel continues.
“Then you might divide people into teams, by department, hourly status, or another way. Conduct training to teach the employees how they can impact the bottom line by being productive, by showing up for work, not goofing off, monitoring use of supplies, that kind of thing. Educate the employees on how they can personally impact these corporate measures.”
DON’T: Create Unintended Contracts
“One thing [some] companies do is quote the components of the incentive plan in the employment offer letter,” explains Koechel. “That ends up creating a contractual agreement, and if the company changes or cancels the plan, they can be sued. I have seen this happen.
“Never put the details of a bonus plan in the employment letter. You can state that the employee is eligible for an incentive plan, and that information regarding the plan will be provided separately,” Koechel says.
She recommends that details of the plan be documented in a document similar to a summary plan description. “I typically do this when I’m designing an incentive plan, and I have the legal people look it over. I include a management disclaimer, saying that management has the right to amend or terminate the plan at any time.”
DO: Document Terms Of the Plan
When Koechel creates a summary description of the incentive plan, there are several key items she includes. The plan, she says, should always have a beginning and an end date, often a fiscal year or a calendar year.
“It should define who is eligible, what the components are of the plan, and the criteria for earning the bonus. Include language about what happens if an employee retires, becomes disabled, or passes away during the course of the year.
“You need to have good documentation,” she adds. “I’ve worked with companies when there was a lawsuit, and someone requests the organizational chart from 1995 because they need to know who Suzy’s supervisor was then and what incentive plan she was covered under.” Creating new plan summary documents for each year and maintaining them properly could make the difference in a lawsuit.
The right to change or terminate the compensation plan is especially important in two situations, Koechel says. One is when there is a flaw in the plan’s design that can result in an unintended windfall for the covered employees.
“For example, if there was a short supply of something, and the salesperson began stockpiling it and then sold it and made a killing on it,” she says.
The other situation can have the opposite result. “Maybe the corporate trigger threshold was too high. Sometimes, it’s the economy, or a hurricane … or 9/11 that prevents people from reaching their goals. Sometimes things are just out of your control.”
DON’T: Be Too Quick to Abandon the Plan
When employees fail to meet the mark, whether it’s due to a disaster of some kind or incorrect measures, don’t be too quick to scrap the plan, Koechel contends.
“One of the biggest faux pas companies make is to cancel the plan because it didn’t pay out the first year. In that situation, companies worry that employees won’t be motivated.
“But you can turn a negative into a positive if you identify where the shortcomings were and really educate employees about how they can reach their goals.
“Use recognition programs,” she says. “For example, let them know the company didn’t meet its goal this year. But the XYZ Department improved by 30%, so you are going to give each member $100 or something.
“Even if the company didn’t make the bonus threshold, you can sometimes still reinforce the positives and keep the momentum going.”
DO: Encourage Employees To Think Like Shareholders
“It can take a lot of patience to educate average employees so they think like a shareholder and know they can impact the bottom line,” Koechel says.
“Sometimes it’s done by establishing not only corporate metrics, like earnings or profitability, but also team goals or department goals, like staying within budget.”
But once you accomplish that shift in mindset, she contends, you’ll likely find your company is more efficient—no matter the economy.