Every dime you spend on compensation should be working for you. But all too often this money is viewed as the cost of doing business. Of course, the term "investment" these days leaves a bad taste in everyone's mouth. But we are talking about investment in the sense of getting a fair return on your money. So let's explore how you can be sure you are getting a fair return on your compensation investment.
Base salary is the money you invest to acquire talent in the market place. This talent is freely traded and you must pay a certain amount for certain knowledge, skills, and abilities. And as the value of a particular type of talent increases over time, you must stay current or you run the risk of being outbid for that talent by your competitors. This aspect of compensation is more of a purchase than an investment. But as it relates to base salary, the investment aspect comes into play is when you consider why you would increase a person's pay. If you increase pay because they had a good year (as occurs with pay-for-performance or merit-based pay) you are not making an investment; you are providing a reward. And because a base salary increase, once given, is paid again and again each year, you will continue to reward the same person for the same performance year after year for as long as they are employed. This is hardly a sound investment.
On the other hand, if you increase a person's salary because they have acquired additional valuable knowledge, skills or abilities, you have made an investment in the outcomes they will accomplish in the future with these newly acquired skills. This is why base salary increases should be tied to increased competencies, not past performance.
Properly designed cash incentives are investments, pure and simple. By telling employees what they need to do, and what they will earn when they do it, you are investing a certain amount of money in a specific outcome. And you only pay the money, when you get the result. The amount you choose to pay defines value of the outcome. Like any good investment, you must define your expected return in order to avoid a bad deal. So when you decide to link a certain achievement to, say, a $5,000 payout, you must be certain that you receive a proper return in excess of that amount.
HOW TO DECIDE WHAT AN OUTCOME IS WORTH?
When I design incentive plan goals and payouts, I follow a few simple rules:
3:1 -- Results that directly influence the company's bottom line (such as expense savings, reducing bad debt, or increased revenue) can be shared with the employee(s) who produce them in the ratio of three to one. That is, for every three dollars of expenses saved, I am willing to share one dollar with the person(s) who produced it.
5:1 -- When the connection between a person's actions and the results of the business are less direct, but are still clearly measurable and have a significant impact on the economic success of the business (such as increased productivity, reduced lost time injuries, reducing days sales outstanding (DSO), or reduced cycle time), improvements can be shared with the people who produce them in the ration of five to one.
10:1 -- When the connection between a person's actions and the benefits to the business are important but are not easily measured, I assign the best possible value to these outcomes and set payouts in the ratio of ten to one. Examples of this type would be leadership skills, mentoring, customer satisfaction, employee relations. These are all important, but none is easily measured. Even so, if you decide to payout a certain sum for improvements in these areas, you must feel comfortable that the benefit to the business outweighs the amount paid by at least ten-fold.
THE CONCEPT OF THE "LEAVE-BEHIND"
Another way to establish whether or not you are getting your money's worth when setting up goals, is to identify the "leave-behind." A "leave-behind" is anything left over after the goal is achieved that represents a benefit to the organization even if the person who created it left the company immediately thereafter. This is a critical element in effective goal-setting for incentive plans.
Take, for example, the implementation of a new SKU system for a retail business. The first step in the process might be an analysis of available technology, a review of competitive practices, defining desired improvements, and creating an implementation plan. The next phase might be identifying vendors, selecting technology, and installing the system. And the final step might be going live, testing the system, and training everyone in its use.
Many incentive plans make payouts before anything tangible has been left behind. The problem with this is that if the proper interim steps have not been defined, it might be possible for the person assigned to this task to leave in the middle and the company might have to start all over with their replacement. In such a case, there have been no "leave-behinds."
The best approach is to quantify the value of each key deliverable that represents a "leave-behind." For example, if a partial payout were to occur at the point where a completed project-plan was approved, this plan could still be implemented by a replacement even if the person who created it left the organization before the next step begins.
By thinking about your goal-setting and associated payouts as investments in specific outcomes, and linking this to the concept of the "leave-behind," you are well on your way to guaranteeing that you always get a great return on your compensation investment.