Written by: Jeff Heybruck
Have your employees asked for a raise lately? All over the country people are reevaluating their employment and savvy business owners need to have an answer and a plan. How do you decide how much to pay employees? Is it by gut feeling? In our experience, there are compensation structures that can ensure the employees and the company are on the same page and still be quite rewarding for both during successful periods.
While this can be an uncomfortable conversation for some, trust our many years of experience that having a carefully thought out compensation plan will make it much more manageable.
What is an incentive?
This may seem like a simple question, but it is worth defining the difference between paying someone fairly for their time and incentivizing desired behavior. It can be easy to imagine a full commission-based plan motivating someone, but few outside of sales find that desirable. The goal in any incentive compensation plan is to identify the behaviors we want to promote and match those to the actions the employees can control.
K.I.S.S. Easy to measure, easy to calculate, easy to communicate.
Keep incentives simple. Easy to measure, easy to calculate. Few things can be as demotivating as not understanding what actions affect the outcome. While tying to broader business success can be helpful, getting the metrics too far from the influence of the individual can have adverse effects. For instance, incentivizing sales teams based on gross profits can help them have visibility into the importance of qualified sales. Conversely, basing the incentive on net income is a broader company goal, but the sales team may have little influence on overhead spending. Mistakes or decisions beyond their control may affect their income and disenfranchise the team.
We recommend incorporating benchmarks into the plan. Incremental increases based on performance can yield incremental results, where a “stretch-goal” can often motivate the team to push to a finish line. Successful plans incorporate an element of both.
Pitfalls to avoid
Once the plan is in place, be prepared to act on it. Have results measured in a timely manner and shared broadly. No one wants to play a game when they don’t know the score. Consistency across job descriptions is also a good idea. Don’t be afraid to revisit your plan annually. You may find the need to adjust for factors not realized at the beginning. Feedback from employees is critical, is the business growing? Are the incentives working? Wash, rinse, repeat.
What about benefits and company culture?
It’s true that non-monetary considerations factor in, and for some they can even be more important than salary. That’s why we encourage our clients to define the compensation that best fits the individual role. We have seen the pendulum swing to both sides in terms of salary and work-life balance, it certainly appears to be on the salary side for most employees lately. But for a parent of young children, it may be more important to be home for the bus. Small businesses often need to take these considerations into account on a case-by-case basis to ensure the most talented employees stick around. It does no good to offer additional compensation to a parent who is struggling with child-care logistics; time and flexibility is the currency they need.
It is important to recognize the priorities of employees. Offering “casual Fridays” when employees can’t make ends meet will have the opposite of the desired effect. Inflationary cycles are strong indicators, often forcing everyone to sharpen their pencils and watch where each dollar goes. If your employees are feeling this pressure, it would be wise to recognize that reality and take it into account.
What about ESOP?
We’ve generally found ownership plans to be more complicated than they are worth. While they may be a good fit in some circumstances, we usually advise against them. Ownership is forever, and the required prenuptials are often complex and can get in the way of behavioral incentives. It often sounds good until the employee-now-partner realizes they own a very small percentage of a company and that asset likely won’t be converted to cash until they are much older or the majority owner decides to sell. They quickly realize, “what did I gain by becoming an X% owner?”
A typical sales commission structure we’ve seen might be 3% of revenue from existing clients, and 6% revenue from new business. This is designed to prioritize new business but it has the effect of ignoring existing customers. In this situation, we changed the compensation structure to be based on company gross profit % times each individual sales amount. Until a minimum level is reached, the sales associates get a lower percentage commission. Once they hit their sales goal, that commission percentage jumps to a higher number.
Another client wanted to get away from a 100% discretionary bonus pool to be shared among all of his work crews. In this situation, we identified a target gross profit % to shoot for each month which would result in a flat amount being placed in a bonus pool. Margins higher than the target resulted in a larger amount deposited; margins below the target resulted in less money being added. We also broke it down based on position within the company with certain positions being assigned X percent of the entire pool. Click here for an example to show how the pool is calculated and how it’s allocated.
While this is a simple plan, easily measured and understood, it incentivizes many desired behaviors.
Don’t be afraid to ask for help
Developing incentive plans across the entire business can be a daunting task. This is the perfect time to give Lucrum a call. Our team has decades of experience helping small businesses grow well, and we can bring that experience to bear for your business too. Reach out today.