But firms don’t seem to be satisfied with their pay packages and, at my consulting firm, the most highly requested engagement is for designing (or, more commonly, redesigning) incentive compensation.
The reasons vary. Perhaps the current plan is not sustainable from a profitability perspective over time. Or maybe the plan is not delivering the intended and needed outcomes. Either way, they come to us when they find that their incentive plan needs an upgrade to align compensation with the company’s overall success.
To back up for a minute: Think of base salary as fair compensation for an employee’s role and responsibilities, while incentive compensation should be geared toward meeting or exceeding stretch goals for the firm, the individual or perhaps both.
Both should be part of a well-documented compensation plan, which covers a lot more than just how much you pay people. Every firm should have a thorough compensation plan designed to make the most of your “people investment” — by attracting and retaining good people; motivating them to improve their performance, and directly tying performance to delivery against the firm’s business plan and goals.
The most aggressive, competitive firms in the industry take just such an approach. These firms make sure they have a human capital strategy — a strategy for how to manage, develop and retain their key talent in a way that ties to the overall business plan.
Every firm needs to leverage a unique combination of rewards and incentives that will work best for that firm, its people and its clients. From a practical standpoint, a comprehensive compensation plan should have five key components: base salary and incentive compensation (both short and long term), as well as benefits and other nonfinancial rewards, retirement plans and equity/ownership options. You’ll need to customize each of these to fit your firm’s strategic objectives and competitive environment.
But ultimately, salary and incentives remain the primary drivers in any firm’s compensation program.
A key part of any salary and incentive program — and one that is often ignored by firms — is the need to set baseline expectations, with documented job descriptions and performance goals and objectives.
All compensation — but especially base salary — should come with a specific set of expectations that can be measured and evaluated. By documenting the firm’s expectations, employees know what specific tasks and results are expected as a baseline, and what additional performance and stretch goals will result in higher compensation.
Those clear metrics for success will help guide employees in aligning their efforts with firm goals, and building their skills for higher achievement. They will also help firms establish the stretch goals that will eventually determine incentives.
Define a base-salary range for each position, based on both the value of the position to your firm and the market value of the role. Revisit those salary ranges on a continuing basis and adjust as needed with market changes. You can move employees within the range as their job responsibilities and skill sets change over time.
Incentive compensation is a bit trickier. The goal here is to leverage employees’ own motivation to improve behaviors and practices that drive the firm’s success. As a result, incentive plans should be tied to specific objectives and outcomes — showing employees how the incentive is a financial partnership between them and the firm.
I usually caution firms against two other types of compensation increases. Automatic cost-of-living adjustments are problematic because they increase a firm’s fixed costs and are not tied to measurable results that have a positive impact on the firm. I also recommend staying away from discretionary bonuses, which are generally paid without regard for any measurable criteria. These are less effective in motivating behavior, since they do not create a clear tie between pay and performance; they can also foster an entitlement mentality for employees.
Whether your firm needs a new incentive plan or simply wants to overhaul an existing one, use the following steps to design the plan.
1) Start with the firm’s strategic goals. Be sure you’re designing an incentive plan that is in alignment with your firm’s strategic goals and initiatives. Strategic goals may include an aggressive financial growth plan, new market development, key additions to the team, product or service specialization, and potential acquisitions.
2) Create a compensation philosophy. The purpose of a good compensation philosophy is to attract, retain, and motivate good people. Considerations when developing your compensation philosophy should include: How competitive is the advisory services industry in your market? What is your firm’s cost structure and future financial outlook? Most important, how does your compensation philosophy fit into your overall business plan?
3) Determine eligible positions. Decide what goals and objectives are desired and determine who will participate. I recommend allowing everyone to participate, regardless of their role — because doing so uses the incentives to build a unified vision for the firm. You’ll also want to define the percentage of “at risk” or incentive compensation for each employee.
4) Identify the funding source. A key element of your plan design is to ensure the highest possible level of fiscal responsibility, while still ensuring controllability for each plan participant. The following funding options ensure that the plan is generally self-funded: percent of firm revenue, percent of firm profit and percent of firm profit above an operating profit margin threshold.
5) Set the incentive drivers. Individual-based incentive drivers will vary based on role.Types of work that push the incentive drivers include business development, investment performance, firm revenue growth and client retention. The incentive drivers can be based on team performance and/or individual performance, but I recommend not having more than five performance metrics to a plan. Having too many metrics tends to dilute the overall focus of your individual employee and team.
6) Run the numbers to make sure they work. Model the implications of your pool and determine the potential cost of the plan. Make sure you consider a good year, a bad year and a great year, and be sure to factor future growth into the modeling.
7) Get team input (and buy-in). Get employees who will be participants in the plan involved in the design process early. Ask employees how they are contributing to the success of your firm and then begin the process of creating stretch goals that align with your key initiatives. Getting employee input also helps create buy-in from your team.
8) Communicate and implement the plan. Once the plan is complete, communicate the plan and determine how it will be tracked and monitored. Although your plan may need to be adjusted or tweaked year over year, a well-designed plan should not be redesigned every year. Rather, a consistent plan that is well designed and implemented will engage and retain your key talent.
Determining the exact mix of salary and incentive for each employee is more an art than a science. Each firm must find its own optimal mix, with the understanding that all compensation to some degree needs to be tied to objectives and performance against those objectives.
That’s what maximizes the value of your most important investment: your people.