Bob MacDonald on Business

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Pay is no Pal to Performance in Most Employee Pay Plans. And Look Who’s Being Short-Changed.

December 3rd, 2012 · 1 Comment · Building Better Business Managers, Business Management, Improving Your Business Leadership

Business compensation plans rarely perform in the way intended to encourage the payee to perform. It’s time for reform.

Most corporate pay plans are to effective compensation policy what the Federal tax code is to effective tax policy. Which is to say, they are needlessly bloated, convoluted, confusing, inequitable and highly inefficient. What was once a simple process to raise revenue to run the government, has, over time, become contaminated by other objectives and motives that have made the tax system an unintelligible morass. In the same way, business pay plans have become tainted with increasing needless complexity and the result is the same sort of inefficiency that plagues our tax code. Only it’s your salary that’s at stake, and the profitability of the company you manage or work for.

The SOP of Pay Plans

Corporate pay plans were initially developed as a simple process to provide fair pay for the performance of defined tasks. Over time, however, the system has evolved, like tax policy, as a way to achieve other objectives and satisfy personal motives. This has caused most corporate compensation plans to take on the complexity of a formula for analyzing human DNA; as a result, corporate pay plans have become highly inefficient. However, unlike the tax code that everyone agrees needs to be fixed, corporate pay plans continue to become more and more complicated and less and less effective. And there’s no agreement that wholesale change is needed.

In the Congressional world of fixing bad tax policy, real reform is difficult because everyone is protecting their own sacred cows. In the world of corporate compensation, plans continue to become more complicated and inefficient primarily because management has abdicated one of its most significant responsibilities and powerful management tools and farmed out the job to outside “compensation consultants.” These outside consultants have only one objective: to keep the fat fees rolling in. They know the only way to do that is by cobbling together plans that give the appearance of creativity and sophistication, but that are in reality nothing more than a warmed-over mishmash of peer-group comparisons. Still, give the compensation consultants credit for one thing: They have mastered the ability to take something simple and make it complicated in order to increase their own compensation.

What Smart Compensation Plans Can Achieve

A compensation plan can one of the most powerful tools a leader has to manage the business. Just look at these potential benefits: The plan can set the cultural tone of the organization, create a sense of equity, recognize those who add value, signal what is most important to the success of the company, motivate specific performance and reward those who do the most to help the company achieve the most. While such a plan can achieve a multitude of benefits, nobody said that creating a fair and just system would be easy. Using a compensation plan to achieve these results is difficult and challenging, but as difficult as that may be, transferring this power to an outside consultant shows a complete lack of understanding and more than borders on incompetence. And yet it happens everyday.

Compensation plans can be a lot of things, but one thing they should never be is an attempt to find pay-parity with competing peer group companies. The truth is that compensation is the simplest, easiest and most effective tool in the hands of a strong leader. Simple, well-designed pay plans can be a constant, consistent communication that marshals the attention and efforts of the employees in a way that joins them in parallel with the leader to achieve the vision of the organization.

How Management can Create an Intelligent Compensation Policy

A total corporate compensation plan starts with fair remuneration for the employee’s performance of clearly defined tasks, but it should be much more than that. Compensation is a broad term that includes all forms of recognition and reward for the efforts of the employee. These can include added pay for added value, sharing in the success of the organization to which the employee has directly contributed, and non-pecuniary rewards such as a promotion or public recognition of good work. The point is that a properly designed and implemented compensation plan permeates the entire culture of the organization in a way that unites line employees and management in the parallel pursuit of the betterment of all. And that kind of relationship simply cannot be developed by an outside consultant.

An efficient and effective compensation plan is the sum of three parts:

  1. Pay for the performance of a specific task.
  2. Increased reward for adding value to the performance of a specific task.
  3. The opportunity for employees to share in the value their efforts create.

It is reasonable to monitor what other companies pay for the execution of a specific task, but matching their salaries should not be the sole determining factor. A good plan will take into account not just the minimum amount required to be paid or the amounts paid by a competitor, but the fairness of a living wage. And don’t think for a moment that savvy employees ignore what their friends in comparable positions at other companies are being paid. You’ll soon discover that paying low wages simply because the competition does is terribly counterproductive. Here’s why.

It is always argued that if the cost of labor is higher than that of the competitor, then the company is at a disadvantage; but that does not have to be the case. If the pay is fair and is part of a balanced total compensation system, it can become an advantage. A recognized equitable pay system for the performance of the basic elements of a job attracts higher quality workers, reduces turnover and motivates the employee to reciprocate by working harder to preserve their job. In the end, so long as it is reasonable, the increase in labor costs can actually become an investment in increased profits.

There are at least two other embedded policy errors in the structure of basic pay plans. The first of which is that these plans establish a rigid level of pay – entry, mid-range and top level – within a specific job description. Pay levels are more often than not determined by time-in-grade and once the employee reaches the top level, they are not eligible for any further increases. This attitude is accepted and traditional in business, but it is counter-intuitive to logic. If the employee has been in the position long enough to reach the top pay-grade they are probably the most experienced and efficient at that job. Yet, no matter how long they stay or how well they do, they are locked into a set scale, because pay is defined by the task, not the performance. Even if the employee loves their job and is good at it, to receive any increase in pay, they are forced to move to another job. What sense does that make?

The other miscalculation with this structure is that every employee in the same pay-grade is paid at the same level—regardless of productivity. This means that no matter how hard or smart employees work, they receive exactly the same pay as those who “go through the motions” or slough off. How fair is that? What type of incentive does this offer for those who do more? If the standard of measurement is how many files are processed and one employee produces at twice that level, shouldn’t they be paid more? In theory, if one does not measure up the minimum standards, they are fired. Yet, when one produces well above the standard, the pay is the same. Explain that logic to me.

And Those Pay Ceilings? Nonsense

At the very core of a compensation plan, the idea of ceilings on pay-grades should be eliminated, so that those who are best at doing the job can remain in the job; and the system should develop a way (it can be done) to recognize and reward the employee who consistently does more than required.

The most important element of a successful compensation plan is a system that allows those who use their talents to add value to an organization – at any level – to share in the value they create. There are two key elements needed for this type of plan to work:

  1. It must include everyone in the organization – not just senior management – and it must be structured from the bottom up – not top down.
  2. Rewards must be based on specific activities that create value and they must be based on results the employees feel they can control and profit from.

It does not unify the organization or motivate all employees when only the top people are allowed to participate in the real rewards for the success of a total company effort. To be motivating and effective, the rewards for creating increased value should build from the bottom up and not trickle down from the top. Trust me, when management receives their rewards based on the rewards earned by those below them, they become stronger, more involved leaders.

One final note. Many corporate compensation plans are based on results that most employees feel they cannot impact. If they don’t feel they can make a difference, there is no motivation to make a difference. When rewards are based on macro items such as – increase in profits, reduced expenses, higher sales and even a rise in stock price, virtually the entire organization feels powerless to have an impact and, as a result, the compensation plan becomes powerless to impact their performance.

And the Moral of the Story …

If your company has a compensation plan designed by an outside “compensation consultant,” it is in all likelihood a bad plan. Chances are it is as complicated as and as ineffective as the Federal tax code. Sure, just like the tax code is structured to protect and take care of those with money, because Congress knows how its bread gets buttered; the consultant designed compensation plan is structured to reward the highest paid, because the consultant knows who contracts them and writes the checks.

A well-designed compensation plan can be an effective tool to gain the support of all members of the organization and motivate them to be concerned about and committed to the success of the organization. To abdicate the development of such an important part of leadership to an outside consultant is nothing less than squandering opportunity and an abdication of leadership.

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