Production: Note that this week’s column has two authors, two mugs
Pat Byrnes and Steve Acosta
When faced with flat revenues and declining profits, business owners can lay off employees, reduce the services they offer, increase the price of products or services, or decrease prices in an effort to raise revenues.
But many business owners have found another answer: reward employees according to performance. Increasingly, employee compensation is linked to bottom-line results, enabling an organization to offer attractive pay packages without taking unnecessary risks. It also gives employees a powerful incentive by offering them a chance to earn significant financial rewards for performance that truly contributes to the goals of the company.
Indeed, a performance-based compensation system can be the catalyst that drives companies to new levels of success.
Consider the case of a local business that experienced rapid revenue and profit growth during its early years. As it matured, however, revenues became flat, expenses increased, and profits declined. Tough competition necessitated that fees charged to clients remain unchanged, even though overhead costs exceeded revenue generated by new clients.
In addition, employee salaries continued to increase with cost-of-living adjustments, despite the fact that revenues were not growing at the same pace. Consequently, a review of profits over the previous 10 years produced a near-perfect bell curve.
The company president was naturally quite concerned and wanted to cut costs. But he also realized that his firm’s greatest resource was its staff. Any lasting solution to the problems would have to be employee-centered. So he developed a plan for implementing a performance-based compensation system that included a bonus program tied to company profitability.
The plan involved several goals. The first was to educate employees about ways to affect profitability. The second was to instill a desire to make the firm profitable. The third was to share profits in a manner that recognized individual performance, and the fourth was to develop teamwork.
To implement the system, the company established an employee education program that focused on the results of operations. Employees were introduced to budgets, income statements and key financial indicators.
The company also developed performance criteria upon which each employee had a direct impact. For the first time, workers were able to understand the correlation between their performance and the economic health of the firm.
Next, the company established a bonus pool and distribution process to provide monetary incentives to employees. The pool was based solely on profitability. As profits increased, the bonus pool increased commensurately.
Bonuses were paid based on performance and a staff member’s position in the company. Again, the education program was key to effectiveness. In the end, the employees actually took on some of the risk and reaped some of the rewards for company performance. The results of this compensation solution speak for themselves. Overall profits increased by 36 percent with the payment of employee bonuses.
Meanwhile, revenue-per-employee increased 16 percent, and by the end of the first year, employee bonuses increased tenfold. Three years after implementation of a performance-based plan, profits had increased 140 percent while revenues increased 37 percent.
In addition, profit-per-employee increased 175 percent, revenue-per-employee increased 20 percent, and employee bonuses were 23 times higher than before. Obviously, the company was able to reverse its decline.
Once the connection between performance and compensation is established, morale soars. Employees become more involved in operations, and their commitment is solidified. In effect, employees begin to think like owners.
As a result, some believe that traditional pay structures are rapidly becoming relics. As organizations strive to achieve a competitive advantage, they often find that their reward system needs to be philosophically different from previous plans.
Effective compensation systems are becoming increasingly sophisticated in order to incorporate a wider array of benefits and rewards. One of the best ways to determine if your system is providing the maximum benefit to you and your employees is to obtain an independent third-party analysis of key executive compensation in your industry.
That information should help you recognize that there has been a fundamental change in the employee marketplace. Firms primarily competed for customers in the past. Today, they also find themselves competing for talented employees.
Performance-based compensation systems are becoming the pay structure of choice for achievement-oriented business leaders because they encourage teamwork and employee involvement. Such a system will enable your company to attract and retain the most talented and career-oriented employees available while increasing your profits and providing you with a powerful advantage over your competition.
Pat Byrnes and Steve Acosta are principals with CCi, a compensation consulting firm.
Entrepreneur’s Notebook is a regular column contributed by EC2, The Annenberg Incubator Project, a center for multimedia and electronic communications at the University of Southern California. Contact James Klein at (213) 743-1759 with feedback and topic suggestions.
