Last June in our Compensation Alert, we discussed how to develop a compensation strategy. As year-end compensation planning approaches for many companies, we think this topic is timely and worth revisiting with updates to address current trends.

Compensation strategy is part of a company’s human resource strategy and should be integrated with all other elements of human resource planning. A compensation strategy—a formal, written statement capturing the organization’s views and approach to compensation—serves as a guide and touchstone when designing new HR programs or evaluating existing ones. In addition, a clear compensation strategy lays a foundation for communication transparency when giving employees the rationale behind pay and benefit decisions.

Compensation Strategy Planning Elements

Like every strategy guiding your business, your compensation strategy should align with your business priorities.

Here are six elements to guide you through the design process:

  1. Gather Information: Obtain information and perspectives from your stakeholders, including directors, executives, managers, employees and customers. Take a close look at external and internal factors having a direct and indirect impact on your pay strategy. External factors include trends in supply and demand for talent, your relationships with your customers and challenges you are having in the current marketplace. Internal factors include your company’s business culture, values and strategic initiatives, as well as the core competencies of your current and future employees.
  2. Business Lifecycle: Consider your organization’s business strategy and human resource strategy, as well as where your business may be in its lifecycle.
    • Inception Phase – At this stage cash is tight and organizational structures and systems are informal.
    • Growth Phase – Here cash is tied up in growth; often developing the HR infrastructure becomes critical during this stage.
    • Maturity Phase – Mature organizations have cash and organizational structures are in place.
  3. Consider Demographics: Early career employees may need different incentives than those further along in their work lives. For instance, entry level employees may be willing to accept lower base wages in exchange for larger cash incentives or professional development opportunities. Employees nearing retirement may be willing to trade some amount of pay for greater medical and retirement benefits.
  4. Benchmarking: Gather information on salaries and wages so you understand how your organization stacks up against competitors and where your pay is relative to market rates. This approach involves understanding an organization’s relative positioning, but not necessarily blindly following. It also considers the economics of the business, so you can decide what’s best for the organization.
  5. Test Initial Strategy: Develop an initial strategy statement, then share it for feedback from stakeholders. When evaluating your compensation strategy, make sure it is equitable, fair, fiscally sound, legally compliant and provides a framework to effectively communicate with employees.
  6. Revise as Needed: Once you have implemented your compensation strategy, monitor and evaluate its internal impact – pros and cons – making changes as warranted. In addition, adapt your strategy to changes in the external business environment while keeping its intrinsic value.

How Competitive Do You Need to Be?

Understanding competitiveness begins by defining the markets where your organization competes for talent and business. Does your company recruit talent on a local, regional, national or global basis? Gather relevant salary data so that you can adjust your compensation strategy based on geographic differences in pay. Some industries, occupations and job levels, too, may be more competitive than others.

Establishing a market competitiveness target is a key element of an organization’s compensation strategy. Does your company plan to pay at, above or below market for the jobs in your portfolio? Based on your analysis, you’ll need to decide if you want to lead, lag or match the market.

For example, if you are currently paying below market median, your reputation is solid, business is good, or talent is plentiful, you may want to continue that approach. But if you currently have great employees and recruit only the best, need skills in short supply, are in a less desirable geography or the cost of living is high, you may want to target above the market median. These and other considerations must be weighed when developing your salary structure.

What Should be Rewarded?

Your compensation strategy should be tailored to meet your organization’s unique needs and circumstances. Most compensation strategies include:

  • Base salary has an important role in compensating employees as it establishes ongoing job worth and reflects employee performance. When deciding how wide to make salary ranges, make sure there is a clear purpose for each segment in the range. Also consider how you expect employees to move through the salary range as they advance in the organization.
  • Annual incentives are meant to reward annual performance. Once you determine who will participate in the incentive program and what the incentive opportunity will be, set performance measures and a feedback schedule so everyone is on track. Include financial and performance measures for both the operating company and supporting business units.
  • Long-term incentives, in contrast, are meant to reward a longer performance cycle and typically are part of an executive compensation program. The timeframe for these incentives is typically two-to-five years. Reward systems establish forward-looking performance conditions and include cash and equity.

What motivates employees can differ greatly, so use a mix of rewards.

In Summary

How your company spends its compensation dollars – often an employer’s largest expense – deserves a strategic plan aligned with business goals. In today’s rapidly changing employment environment, it’s time to leverage the most important asset your organization has: its people.

Contact Us

Please contact me at nlappley@lapppley.com or (847) 864-8979 to discuss any comments or questions you may have about how to develop a compensation strategy. Feel free to forward this email to anyone else who may be interested.

A lot has been written about the interests, attitudes, and behaviors of Millennials (those born between 1981 and 1996). Among the facts that have been reported, primarily by the Gallup organization, these stand out:

  • Millennials will account for 50 percent of the US workforce by the year 2020.
  • Only 50 percent plan to be with their current company one year from now.
  • Only 29 percent are engaged at work.
  • At the 2016 Sales Compensation Conference, research done by Michael Ahearne, a professor at the University of Houston, suggests that Millennial salespeople are more interested in a leveraged compensation plan than their traditional peers

Based on our research and experience, we believe the following should guide the treatment of Millennials:

  • Millennials want to grow in a job that fits them.
  • They enjoy more periodic feedback than other generations.
  • They have a firm desire to be considered for a “fast track” promotion if their performance warrants.
  • Millennial salespeople want to be rewarded for their results.

All of this signals the importance of rethinking how to recognize and reward superior performance of an increasing population of Millennials in the sales organization.

So, what are some of the ways to consider?

Possible Approaches

Following are four possible approaches. Understandably, careful analysis will need to be undertaken to ensure any new approach or program can be aligned with a company’s overall culture and reward strategies.

  1. Career Pathing. To better retain Millennials offer individual career growth paths that spell out how a salesperson of any age can advance in the organization. According to reports, Credit Suisse, the international financial services company, did just that and believes that its 1% increase in retention can save $75 to $100 million a year.
  2. Outstanding Achievement Award. For all salespeople who clearly demonstrate stellar achievement, for example candidates for “The President’s Club”, offer them a new, end-of-year special bonus that can be used to support their outside-work deep interest. Examples could be a local community group (Boys & Girls Club) or the local alumni chapter of the college they attended.
  3. Enhanced Engagement Opportunities. To better engage Millennial salespeople, offer all employees some new or enhanced opportunities to participate with company executives. One example is providing structured networking with senior company executives (Sales VP, CFO, CMO, VP Operations, VP HR). Video chats, such as an “Ask the CEO” forum, might also be considered.
  4. More leverage in the Compensation Plan. Move, for example, from an 80/20 compensation plan for sales people to a 70/30 plan.

Survey Your Salesforce

Not sure your Sales Compensation Plan or talent management programs need a major change to accommodate Millennial salespeople?

Consider evaluating where you stand today by conducting a Salesforce Survey with the entire salesforce asking for the recipient’s age category and opinions on a number of topics, e.g., career pathing, training, current compensation pros and cons, and incentive leverage. The survey results can offer a baseline snapshot of today’s situation. From there, discussions can be started to lay a forward path.

If you would like to discuss this topic or your other salesforce compensation needs further, please contact Tim Weizer at tim@salescne.com or 312-479-6411 or Neil at nlappley@lappley.com. Also feel free to share this article with anyone who might be interested.

For the first time in four years, the national U.S. salary budget increase average is higher than 3%, nudging up slightly to 3.1% for 2018. This also is the first time when the actual salary increase has met the previous year’s projection. Further, U.S. salary budgets are projected to reach 3.2% in 2019.

Capturing information from 19 countries and 5,499 survey submissions, the annual survey of rewards professionals by WorldatWork finds that variable pay programs, such as performance-based bonuses and other incentive plans, remain the most popular in the U.S.

The chart below shows actual and projected salary budget information for the U.S. broken down by employment category.

Why Aren’t Salaries Rising?

So, with a national unemployment rate of 3.9%, new higher minimum wages in many municipalities, federal tax cut stimulus and rising corporate profits, why haven’t we seen more robust wage growth? Hiring gains have been steady with an unprecedented run of 94 straight months. In fact, the U.S. labor market added 157,000 new jobs in July. May and June employment gains were revised upwards to 213,000 and 248,000, respectively. May’s 3.8% unemployment rate was the lowest since 2000.

Yet, average earnings rose only 2.7% on a year-over-year basis.

There appears to be no easy answer to why salaries haven’t tracked with inflation. Rather, it appears to be a combination of factors hindering employers’ willingness to fund larger increases. We note, however, that from past experience employers typically take one to two years to adapt to upswings in the inflation rate.

Two Markets that Are Heating Up

Counter to overall salary trends, wages are rising rapidly in the recovering retail sector, however. Low unemployment has made hiring difficult in this segment of the economy, boosting wages. According to data gathered by job website Glassdoor, retail cashiers’ wages in July grew by 5.4% to $28,145 from a year earlier. Consulting firm Korn Ferry, in a separate study, found nearly one-third of retail corporate executives received at least 100% of their targeted bonus, more than double the 15% reported during the same period last year.

In some areas of the country, such as Wisconsin, wage growth is outpacing national trends. In May, for example, the average private sector wage in Wisconsin increased 6.4% over the same period in 2017, according to the U.S. Bureau of Labor Statistics. In comparison, the country’s wage change was 3.1% for the same timeframe.

Wages gains apparently are not a one-month phenomena, either. Wisconsin averaged a year-over-year increase of 5.7% in the first five months of 2018, compared to 2.7% for the U.S. The region also averaged an increase of 4.1% for both 2016 and 2017, outpacing U.S. wage growth both years.

What’s Ahead

In the increasingly tight labor market, employers must closely monitor labor markets to remain competitive and deploy cost-effective reward strategies that effectively attract and engage talent. We encourage employers to review their compensation strategy statement for their competitive pay target, then determine if they are tracking at the targeted level of competitiveness.

Please contact me at (847) 921-2812 or nlappley@lappley.com if you would like to discuss further. Also, feel free to share this article with anyone who might be interested.

In his 2015 book Misbehaving, Nobel Prize-winning economist Richard Thaler addresses the concept of loss aversion and its impact on decision making. “Roughly speaking,” he asserts, “losing something makes you twice as miserable as gaining the same thing makes you happy.” For this reason, given the choice, people tend to put more energy into reducing losses than actively pursuing gains. In a sense, he says, “Loss aversion operates as a kind of cognitive nudge,” the inversion of no pain, no gain.

Humans Aren’t Rational

A professor at the University of Chicago Booth School of Business, Thaler won the Nobel Prize in Economic Sciences for his groundbreaking work in behavioral economics. Among his greatest contributions: challenging the notion that we are always rational beings and pioneering the idea that often we act in ways inconsistent with economic theory. In the spirit of transparency, I am also an alumnus of the Booth School.

So, why does loss aversion matter to salesforce compensation?

Consider a recent story in The Wall Street Journal reporting on a new compensation plan for Bank of America’s Merrill Lynch unit. Critics of the plan argue instead of rewarding brokerages for growth, the plan punishes them if sales targets aren’t meant.

The plan emphasizes cross-selling of Bank of America’s retail-bank products, rewarding brokers with more new clients and referrals to other parts of the bank. So, while revenue growth still matters, asset and liability growth matters more for broker compensation.

If minimum sales targets are not met, the average broker generating $1 million in revenue could lose up to $10,000 from their monthly paycheck, a 2% drop in pay. Conversely, brokers meeting the new targets will receive an increase in pay.

Bank of America executives say the new compensation plan is designed to boost shareholder value and retain Merrill Lynch’s top performers for the long term.

Carrot or stick: What works best?

The Merrill Lynch example illustrates an important issue every VP of Sales confronts: what works better to motivate more sales people to equal or exceed their assigned sales quota? Do penalties or rewards spur the most asset growth? How do companies move the performance distribution of salespeople to the right of the status quo?

The loss aversion principle offers food for thought. Let’s say, for example, that the salesforce incentive plan has four components. One of them is product mix with a weighting of 25% and an on-target payout of $X. The salesperson is paid the $X upfront when the year’s plan is communicated. At the end of the year, if the product mix quota was not achieved at 100%, then the $X would be clawed back.

Under this scenario, there will certainly be individual winners and losers after a major change in compensation structure like the one Merrill Lynch has made. That’s why a good deal of time and attention should be paid to developing and communicating any new sales compensation plan.

Sum and substance

Are you considering changes or new incentives for your salesforce compensation plan? Often change is advisable when a new corporate strategy is being implemented or to attract and retain the right kinds of sales people. Experimentation and adjustments that align with changing market forces is beneficial.

If you would like to discuss this topic or your other salesforce compensation needs further, please contact Tim Weizer at tim@salescne.com or 312-479-6411 or Neil at nlappley@lappley.com. Also, feel free to share this article with anyone who might be interested.

Late last year, Congress passed and President Trump signed into law the Tax Cuts and Jobs Act (TCJA). The sweeping tax reform law reduces the marginal corporate tax rate at the federal level from 35 percent to 21 percent. This and other changes to tax law are boosting profits and will save businesses billions in taxes this year. So, how are they spending all that money?

Most companies are reinvesting their tax savings in strategic ways that drive business performance. So far, shareholders are reaping the greatest rewards, according to an analysis by investor Paul Tudor Jones’ Just Capital. Job creation is the second largest area for investment with 20 percent allocated. Jones’ nonprofit is tracking spending by companies in the Russell 1000; 133 companies have announced their intentions to date.

In addition, a recent Ernst & Young (EY) survey finds most employers are either planning to or have already made changes to enhance compensation through bonuses, salary increases and other pay benefits. Seventy three percent of companies surveyed expect to accelerate mergers and acquisitions.

Considering these and other trends, now is a good time to revisit your business compensation strategy to take advantage of opportunities that effect employee pay. Before making any long-term decisions, however, let your company’s business goals be your guide so that tax savings are invested where they will do the most good.

Making Tax Reform Pay

Tax cuts have contributed to growing optimism about the U.S. business outlook. And that optimism has translated into a strong economy.

Still, companies must be nimble to adapt to changes in the new tax law. Making the right strategic moves on where to invest tax savings requires thoughtful planning. Here are a few areas to consider:

1. Equal Pay – As more people keep a close eye on the pay gap, employers everywhere are working to eliminate wage discrimination based on sex, race, age, disability and other classes protected by federal laws. In this environment, they are evaluating how they can structure their compensation system so that it works for all employees. This means developing policies and compensation strategies that reward people performing well in the same jobs with similar work experiences, skills and education equally.

Yet, implementing changes means choosing a structure that pays internal employees fairly and is competitive externally. Consider using a portion of the tax break to identify any anomalies in your compensation structure. Then, develop solutions to pay disparity that can be implemented in phases over a reasonable time-period, as budget allows.

2. Shareholder Return – Shareholders who have invested in your organization expect a fair return. You can pass along tax savings to shareholders with an increase in dividends. This can take the form of a one-time payment or an increase in the quarterly rate. Another option: share buybacks.

3. Business Expansion – Companies who want to expand geographically, diversify product offerings or tap into new customers may choose to invest their tax savings in a merger or acquisition. With M&As, compensation programs must also be merged. Make sure your compensation strategy includes these important elements:

  • Competitive Pay Analysis – As the market for top talent gets tighter, attracting and retaining employees gets more challenging. This may be a good time to revisit the competitiveness goal defined in your organization’s overall compensation strategy. Consider using the tax reduction to fill in pay gaps. Look at national, regional and local market trends. Increases may be either to the entire organization or to select segments where compensation has increased faster than overall market wages.
  • Base Salary – The annual salary measures ongoing job worth and ongoing job performance. Under the TCJA, the performance-based compensation exception to executives $1 million pay cap has been eliminated. Now, compensation for the CEO, CFO and the three other highest paid executives is capped at $1 million regardless of whether compensation is performance-based or not.
  • Annual Incentives or Bonus Plans – These reward executives for reaching annual milestones or other incentivized, short-term financial goals. Cash is still the dominate incentive for private companies. Be sure to set goals for profitability or revenue growth as key performance measures. In January hundreds of companies announced employee bonuses resulting from the tax reform law. Although the pace of these announcements has slowed, more and more companies are following the national bonus pay trend.
  • Long-Term Incentives – This incentive rewards executives who create long-term value, a win-win for all when strategic objectives are met. You will also want to specify the length of the performance period, eligibility requirements, incentive opportunities, performance measures, and the payout or holdback schedule.

Whether your business is small and closely held or ranks in the Fortune 500, the new tax law will have wide-ranging implications for your compensation plans in 2018 and beyond. Please contact me at (847) 921-2812 or nlappley@lappley.com if you would like to discuss further. Also, feel free to share this article with anyone who might be interested.

In today’s competitive employee marketplace, effective communication of your total rewards package can help be the determining factor in securing high performing employees.

A total rewards program is made up of several elements including compensation, benefits, recognition, performance management, talent development, and work-life effectiveness. There is much to consider when developing and understanding complicated rewards programs. That’s why it is so important to communicate them effectively.

Here are some elements of communicating rewards.

Include All Elements

It’s a mistake to communicate only compensation or pay elements of the reward package. As noted above, rewards include other elements than just compensation. Employees often have the mindset that they are doing a job and their organization is paying them to do it. They overlook the other investment their employer is making in them.

So highlight what your company is doing to support their employees other than just what they receive in their paychecks. As a result, if employees recognize what their company is doing to support them, there is a better chance that they will feel a greater emotional connection to the organization.

Bring it Down to a Personal Level

Start the conversation or presentation with more general items. Lead with a discussion of the organization’s business strategy and culture and show how the rewards programs support that strategy and culture. Explain the company’s human resources strategy and how compensation philosophy is an integral part of that strategy. Then discuss how individual employees are part of the overall strategy and culture and how they contribute to that strategy.

Be Rigorous About Details, Documentation, and Data

Each organization has preferred levels of transparency. But continue to tie communications to the company’s compensation philosophy. Explain how, when, and why the company makes decisions as it does, and plan to talk about them regularly, from one-on-one conversations to all-hands meetings. Outline your approach to gathering and analyzing data, which both provides clarity and ease any suspicion that there is bias at play.

Leave no ambiguity as to how individuals can increase their earning potential. And provide a total rewards statement, whether it a report you generate from your compensation software or a simple spreadsheet or word document. Create a report that lists the rewards each employee receives.

Provide Manager Training

Managers are the front line for explaining and administrating compensation. It’s often their decisions that affect salary increases and bonus/incentive payments. They need to be confident about having tough conversations about pay with employees. So arm them with details to explain the organization’s programs and the information need to back up their decisions.

Contact Us
Contact Neil Lappley to discuss communicating rewards programs or share this post with anyone who may also be interested in these projections.

It’s Review and Planning Time

In this issue of the Salesforce Alert newsletter, my colleague, Tim Weizer, presents some key questions that need to be answered in reviewing a salesforce incentive plan.

The Sales compensation review and planning season is upon us. The focus on sales compensation is understandable as selling is, by far, the most expensive part of strategy implementation for most companies.  Five times the expenditures on all media advertising; 20 times larger than the money spent on all online marketing and advertising in 2013.

Here are some questions to ask.  Focusing on these areas can help determine whether you have areas of concern.

#1.  IS THE BIG PICTURE CORRECT?

In today’s fast paced world, quality often is not given enough emphasis over a quick answer.  A holistic approach is needed to ensure that proper time and thought are given to plan design and any potential unintended consequences. As one CEO remarked that the company took its time to ensure “…we didn’t have sales compensation becoming disconnected from the overall financial result of the business.”  The CEO wanted to ensure that the company was paying for the right strategic results.

The basic premise is that a sales compensation plan does not exist in a vacuum.  It needs to be closely aligned with the company’s business and marketing strategies and goals.  Also, the plan must address both internal and external forces impacting the sales job and selling process.

#2. ARE THE PLANS PROPERLY CALIBRATED TO THE VARIOUS SALES ROLES?

Setting the same percentage of base salary as the incentive for target performance for all sales positions is often evidenced in plans.  This may be a serious mistake.

Careful sales job analysis should be undertaken to properly reflect each position’s impact and influence on a sale.  This analysis then becomes an important part of determining the right pay mix per sales role in your company

#3.  DOES THE CFO HAVE CONCERNS?

When the design allows too many sales reps to max out on incentive earnings, the CFO may be anxious about the inherent risk in the plan’s design or to “pushing” fourth quarter sales into the first quarter of next year.   While 60 percent of the salesforce should achieve quota or above, a recent survey stated that only 4 percent, on average, maxed out.  If your result is significantly higher, then multiple analyses should be conducted to determine the reasons (e.g., Quota and territory design analyses).

#4.  IS THE PLAN UNBALANCED WITH TOO MANY MEASURES?

While communicating management’s goals to the field, too many measures or objectives result in the measures receiving little or no attention.  Four should be the maximum number of incentive measures.  This statement is backed up by a Hay Group survey of 700 companies that reported 85 percent of respondents had 4 or fewer incentive measures. Also, any single incentive measure or objective accounting for less than 15 percent of the targeted incentive opportunity is simply wasted. A good idea would be to review the actual percentage of your salesforce that achieved 100 percent or more of quota per measure.

#5.  ARE THE PLANS TOO RISKY?

To quickly increase sales, a company may decide to provide a higher leverage of incentive to total cash or an uncapped incentive opportunity versus the past design.  This action may produce significant risks in terms of cost control, uneven production scheduling, or even upset key customers due to delivery issues.

#6. WILL ASC 606 IMPACT THE PLANS?

New Revenue Recognition Standard requirements go into effect on December 15, 2017 for public companies and the end of 2018 for private companies.  Companies in industries such as Aerospace and Defense, Automotive, and Engineering and Construction are likely to be impacted given their use of long-term contracts. Take a moment now to ask your CFO if ASC 606 impacts your sales compensation plans.  If so, find out what data the CFO needs from you to address this topic. Also, investigate if the timing of incentive payments may need to be adjusted.

To learn more or discuss your sales compensation concerns, please contact Tim Weizer at tim@salescne.com or Neil Lappley at nlappley@lappley.com.

According to the WorldatWork’s annual Salary Budget Survey, survey participants are planning a slight rise for salary increase budgets to 3.1 percent for 2018, up from 3.0 percent this year.

With a tight job market, low unemployment, inflation seemingly under control, and reported employer financial gains, a larger growth in salaries might be expected. There are other factors that might explain the plateau in growth, including the increased use of variable pay and the use of non-cash rewards, or an overall more conservative pay philosophy. It is also important to keep in mind the impact of several important regulatory actions have had on salaries: the rising minimum wage in certain regions and the overtime rule. It’s entirely possible that these changes have not been reported as a salary budget increase in some cases. While the overtime rule has been blocked, many organizations had implemented the changes and chose not to undo them. So the picture may be brighter for the workforce than it appears.

Keep in mind that salary increase budgets may vary by industry and geography location. The WorldatWork survey showed this year that there was little variation between states, ranging between 2.9 and 3.1 percent. There appears greater variation by metropolitan area, ranging from 3.0 to 3.3 percent. Highest budgets are reported by high-tech areas.

Selected Survey Highlights 

  • Base salary increases are being awarded to 89 percent of employees in 2017.
  • Promotional increases were awarded to 7.9 percent of employees in 2017. The size of the average promotional increase remained unchanged at 8.4 percent.
  • The percentage of organizations using variable pay increased by one percentage point to 85 percent in 2017.  This increased use of variable pay has been seen for several years and likely reflects organizations looking to further their pay-for-performance philosophy, without adding to fixed costs.
Nonexempt
Hourly
Nonexempt
Salaried
Exempt

Salaried

Officer/

Executives

Average percent
budgeted 2017
5.0% 5.0% 13.0% 35.0%
Projected percent paid 2017 5.0% 5.0% 12.0% 35.0%

Employees are still seeing increases in pay through improved variable pay plan payouts.

Retention of Critical Workers
As we have reported earlier, employee retention is a significant concern to many employers. It appears that efforts to retain workers, particularly high performers, high potentials, and critical skilled workers, may need to be ratcheted up. From findings of a study by Spherion Staffing, employees seem more willing to test their options. The study reported that 25 percent of workers planned to look for a new job in the next three months. At the same time, 35 percent plan to do the same in the next year.

With an improved economy and overall job market, employees believe they have more options available. As such, they believe they can demand a higher salary from their current employer or a competitor. Twenty percent cited compensation as the primary reason they plan to explore their option, more than any other employment factor.

Some workers believe their employers do not appreciate their contributions, making them more likely to move to a new company that will. Feeling undervalued topped the list of non-financial factors workers gave for their interest in exploring alternative job opportunities. At the same time, 23 percent of employees felt their organizations were putting less effort in to retain them than last year.

Contact Us
Please contact me at (847) 921-2812 or at nlappley@lappley.com to discuss planned compensation actions for 2018 and forward this email to anyone who may also be interested in these projections.

Variable pay has evolved greatly over the past five to 10 years, and is expected to change more in the future. However, variable pay programs and changes to them have not occurred without challenges.

Prior to the 1970s, the concept of the annual bonus was primarily reserved for the executive level and based on discretionary payments for accomplishing individual objectives. The need for employers to better control their fixed costs led to variable pay in the broader workforce. Organizations also saw that these programs were effective in focusing employees on critical objectives, motivating the achievement of desired results, influencing the way they performed their work, and helping to better align programs and work efforts with the organization’s mission and strategy.

What’s New?
Variable pay has been on the leading edge of one of the foremost changes in compensation philosophy since formal compensation programs were introduced. It has been driven by shrinking expenditures on salary increases, rising cost of employee benefits, and large increases in funding and expenditures on broad-based employee bonuses. Since variable pay increases do not add to, or compound, future costs and are usually dependent on performance results, companies have expanded their overall compensation investment with greater spending on variable pay.

During the past 25 years, salary increase spending has been cut in half (from 5.5 to 2.8 percent of payroll), while funding for bonuses has tripled (from 4.2 to 12.8 percent of payroll), according to AON Hewitt surveys from 1990 to 2017. Variable pay has filled the gap this created in compensation growth.

The shift in spending from salary increases to variable pay has been in parallel with the expectation that bonus programs would become much more important for achieving pay for performance. Initially, broad-based bonus programs focused mostly on organizational goals. Profit-sharing and gain-sharing plans were early examples. In recent years, there has been a drive to create a stronger line of sight in variable pay plans by incorporating greater managerial discretion and a greater focus on individual performance.

What’s Next?
Recent trends and approaches in variable pay programs show several future directions. Organizations will break away from one-size-fits-all plans to ones that have a small common enterprise-wide component and varying measures and weights intended to better measure the performance of a business unit, function or department. Calibrated plans will take the place of homogeneous plans, and we will see more winners and losers within the organization based on different levels of achievement.

Greater use of qualitative measures will also increase. Early generations of incentive plans relied heavily on quantitative measures. There is a growing recognition that critical outcomes and employee behaviors can be enticed by programs that do not use quantitative formulae. However, these qualitative measures may not be always precisely measured.

In the future, almost all variable pay programs will increase or decrease payouts based on individual performance achievement. In the next 5 to 10 years, this will become a mainstay in pay for performance plans.

Levels of spending on broad-based variable pay plans will also continue to increase as organizations expect it to continue to grow. This will most likely be the result of shifting funds from other rewards programs, such as salary growth and some benefits programs.

What’s Challenging?
Variable pay programs have their difficulties. Many organizations struggle to identify the right measures and weightings. Some have too many measures, which leads to diluting their relevance. Some have too strong a reliance on quantitative goals, where measuring outcomes qualitatively may better represent the organization’s strategic goals. And some are stuck on historical measures that have been used in the past and are unwilling to give them up.

More organizations are implementing an individual pay for performance component to their programs. But according to the recent AON Hewitt survey, employers have had no greater success in differentiating rewards by performance level than what they have experienced with their salary programs. The keys to successfully implementing a pay for performance component of variable pay plans is the quality of goal setting, manager training and accountability for differentiating, and the ability to define differences in employee performance.

Effective communication of variable pay continues to be an area of difficulty for organizations. Employees must know what is expected of them, and it should occur at the beginning of the planned year. Additionally, it is critical that employees receive feedback throughout the year. Furthermore, periodic feedback of results vs. organization-wide goals should occur at least quarterly.

Evolving Role of Variable Pay. In the past two decades, variable pay has gone from applying to only the top executives to the primary driver of pay for performance for all employees in the organization. The concepts of variable pay continue to evolve as organizations push them down further in the organization. What will not change is the growing importance of variable pay and the expectation for shaping employee behaviors and motivating the achievement of key business outcomes.

Please contact me at nlappley@lappley.com or (847) 921-2812 to discuss any comments or questions you may have regarding the implementation of variable pay programs in your organization. Feel free to forward this email to anyone else who may be interested.

Compensation Strategy: How to Develop
Last month’s Compensation Alert discussed the importance of having a compensation strategy. In doing so, we posed three questions that organizations need to know:

  1. Are your compensation programs competitive? To answer this question there is a need to answer the question of:
  2. Are compensation programs doing what you need them to do? And to answer this question the question needs to be answered:
  3. What does your organization want its compensation programs to accomplish?

Compensation strategy is part of a company’s human resource strategy and should be integrated with all other elements of human resources. External factors, such as, trends in supply and demand for talent, customers, markets, and challenges affect where an organization is. Internal factors, such as core competencies, values, culture, strategic initiatives, and skills of current employees additionally affect an organization’s human resource strategy.

Compensation strategy is used to design new programs, evaluate existing programs, and communicate programs.

How to Develop a Compensation Strategy: This month’s eNewsletter will discuss the steps to develop a compensation strategy. Development begins by gathering information from several sources:

  • Obtaining information and perspectives from stakeholders including directors, executives, managers, employees and customers.
  • Considering the organization’s business strategy and human resource strategy, and its stage in the business life cycle.
  • Benchmarking the organization against competitors for both employees and in business. This involves understanding an organization’s relative positioning, but not necessarily blindly following. It also considers the economics of the business. Then deciding what’s best for the organization.
  • Developing an initial trial strategy and testing it with stakeholders.
  • Implementing, monitoring, evaluating and revising.

Understanding competitiveness begins with defining the markets where the organization competes for talent and business. The market typically will vary by level and perhaps by function. It incorporates geography including local, regional, national and global. It will also typically vary by industry and occupation or profession.

Market competitiveness target is a key element of an organization’s compensation strategy. Considerations to position at less than the market median include: stable environment, great reputation and opportunity, high benefits, high scrutiny, affordable area, not-for-profit, plentiful supply of desirable employees, and currently paying below median. Considerations to target above the market median include: currently have great employees and recruit only the best, need particular skills short in supply, unstable employment history, less desirable geography, high cost of living area, highly profitable, and currently paying above median.

Base salary has an important role in compensating employees as it provides ongoing job worth and reflects ongoing performance. Design elements include salary range width, how the organizations expects its employees to move through a salary range, the purpose of each segment of the range, and whether differentials or special short-term ranges are to be used.

Annual incentives are meant to reward annual performance. Elements to consider include eligibility, incentive opportunity, performance measures, performance feedback schedule to participants, and payment or holdback schedule.

Long-term incentives, in contrast, are meant to reward a longer performance cycle. Design elements include length of performance period, eligibility, incentive opportunity, performance measures, performance feedback schedule and payment or holdback schedule.

There are several ways that compensation strategy should be used. Your compensation strategy can help in:

  • Designing new programs
  • Evaluating existing programs
  • Communicating programs

Contact Us

Please contact me at nlappley@lappley.com or (847) 864-8979 to discuss any comments or questions you may have regarding the importance and how to develop a compensation strategy.