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How to Build a Small Business Bonus Plan

  1. How to Build a Small Business Bonus Plan
  2. 22 7700 Irvine Center Drive, Suite 930  Irvine, CA 92618  949-852-2288  Today’s Presenter: Tom Miller President (949) 265-5700 2
  3. Vision: Help Businesses Build and Sustain a Performance Culture Accelerate performance capabilities by designing pay strategies that transform employees into growth partners. 3
  4. If you do that… • Quality of talent will improve. • Employee engagement will expand. • Performance will be magnified. • Business growth will be accelerated. • Shareholder value will increase. 4
  5. 55 Today’s Focus Bonus Plan:  Premises:  What makes a plan successful?  Goals  Metrics  Communication 5
  6. 66 If you don’t have a bonus plan . . .  Either you don’t think you’re ready  Or you don’t have the confidence you can do it right 6
  7. 77 Incentive Plan Denial (for companies that do have a plan) Two categories of companies :  Those that know they have bad bonus plans  Those that think they have good plans but actually have bad ones. 7
  8. 88 The Data World at Work 2016 Survey Only 10% of responders indicated they felt their annual incentive plan was effective. These responders were, generally, representatives of larger, successful companies. If large companies can’t get it right (i.e., those with access to high- paid consultants and experienced executive leadership), what chance do smaller companies have?
  9. 99 VisionLink’s Experience  Hundreds of plans  Based on the standards embraced by major industries, consultants, and HR professionals for nearly a century  When examined—not proving effective (not improving productivity) 9
  10. 1010 Why? “…when financial incentives are applied to increase…motivation, intrinsic motivation diminishes. A meta-analysis of 128 independent studies conclusively confirmed this effect.” (“Stop Paying Executives for Performance,” HBR, February 23, 2016) 10
  11. 1111 Hmmm…  Traditional bonus plans aren’t effective  But you have a commitment to your employees  Can you simply raise salaries and compete for talent . . . and create a pay-for- performance culture? So, what are you to conclude? 11
  12. 1212 Resolving the Paradox Cause & Effect: Most bonus plans fail precisely because they attempt to impact behavior. The data are complementary, not contradictory. 12
  13. 1313 What to do? Build a partnership relationship with employees by sharing financial value with those who help create it. 13
  14. 1414 Promoting a Partnership Relationship Key to: 1. Avoiding manipulation 2. Eliminating entitlement 3. Stimulating innovation and stewardship 4. Creating alignment
  15. 1515 Premises, Premises A premise is defined as “a proposition supporting or helping to support a conclusion.” One adopts a premise (believes in a concept or principle) and then acts in accordance with it in the hope of achieving a certain result. However, the desired outcome can only be fulfilled (presumably) if the premise is correct.
  16. 1616 The Wrong Premise (the typical one) Influence Behavior Through Careful Selection of Plan Metrics Reward your employees for achieving results that are as close as possible to their job duties. This typically includes the effort to “select the best metrics” for each employee or at least for every department. Then assume that all the collective mini- improvements will roll up into shareholder value creation. 16
  17. 1717 Metrics Focus 8 Problems 1. Impossible to link every metric to true value creation. 2. Multiple KPIs create confusion and sap motivation. 3. A focus on behavior incentives can lead to the opposite behavior. 4. Difficult to find metrics for every position. 5. Results may be manipulated or loopholes exploited. 6. Impossible to equalize metrics across individuals and departments. 7. Unintended and unanticipated negative consequences. 8. Pursuit of “perfect” metrics is a time waster.
  18. 1818 Results, not Methods "You cannot hold people responsible for results if you supervise their methods.“ (Stephen R. Covey) 18
  19. 1919 The Right Premise Reward employees for achieving the shareholders’ most important financial results and treat them as growth partners.
  20. 2020 Change in Terminology & Mindset Value-sharing instead of paying incentives. 20
  21. 2121 Shareholder’s Most Important Result Sustainable and growing profitability 21
  22. 2222 Central Metric (for funding the plan) Focus on One of These:  Profit  Increase in Profits (% or $)  (Sometimes: Revenue Growth) 22
  23. 2323 Not Just Profit but Productivity Profit Productivity profit is that surplus that can be attributable to the productivity of your people, not just your capital at work.
  24. 2424 Case Study 24
  25. 2525 Keith Williams  Assumed leadership of UL in 2005  Company carrying considerable debt  Losing market share  Low employee morale  UL had become bureaucratic and “siloed” 25
  26. 2626 Core Changes Shift from “Incentives” to “Value Sharing”  Took away local measurements driving management incentive plans—all paid on same metrics  “We live together and we die together”  Aligned everyone behind company success  “I call it ‘pay the company first.’ ” 26
  27. 2727 How do you apply this in a small co?  Identify your most important “profit” metric  Select the threshold amount of that profit that justifies employee bonuses  Begin sharing value above that threshold
  28. 2828 “Basically, up to the company’s operating profit target, all of the profits go to the company; and only after that target is met, do we start funding the incentive pool.” Example: If UL’s target is $80 million--  100% of first $80 in profit goes to company  The next $20 million goes to the incentive pool  From there on, 50/50 between company & incentive pool Pay the Company First
  29. 2929 Pay the Company First Once value creation is defined, compensation can follow a formula for sharing value in a way that aligns key producers with the company’s business plan and priorities. 29
  30. 3030 Setting Payout Thresholds  Base  Target (budget)  Superior 30
  31. 3131 Other Metrics Minimum profit thresholds must be met first. Then…  Department or team metrics  Non-correlated factors (customer retention, customer or client increase, etc.)  Individual performance metrics
  32. 3232 Org Unit Performance  Overall company performance should be primary objective  Org Unit performance can be a secondary objective ▪ Some of the best incentive plans in the world are only tied to company performance ▪ Org units should be utilized when employee line of sight is heavily (if not solely) focused on the org unit
  33. 3333  Allocation to plan participants contingent on:  Company Performance – Employees should have all or a majority portion of their bonus based on company performance  Org Unit Performance – A portion of an employee’s bonus can be allocated based on department, location, division, or business unit Plan Weighting/Allocation
  34. 3434 Plan Weighting/Allocation  Make overall company performance the primary objective (e.g. ~60 - 100%)  Organizational unit success should be secondary objective (e.g. ~40 - 20%)  Weight the overall incentive:
  35. 3535 Individual Performance  Trend is to disconnect performance from incentive pay  Performance Management is still important  Managers more likely to be honest about performance if incentives are not directly correlated to performance rating  If performance is deemed “Unacceptable” discretion should be utilized to eliminate incentive payment 35
  36. 3636 Headlines Performance Management 36
  37. 3737 Plan Discretion What about employees who made special contributions over the course of the year?  Create a discretionary reserve inside of plan funding  Reserved for “exceptional” performers only  Often held at the top of the organization (not cascaded down to individual managers).  Nomination process.  Don’t wait until the end of the year to recognize performance.  Essentially, these are funded “spot” awards
  38. 3838 Is the “Right” Premise Always Right? Exceptions  Sales Compensation  Project Specific Incentives  Time Periods or Projects with no Projected Profits  Revenue Instead of Profits
  39. 3939 Remember the Core Principle The core principle behind the right premise is to avoid trying to micromanage behavior through an incentive program (“do this and you get that”).
  40. 4040 Let’s Restate the Principles behind a Successful Plan  Adopt the Right Premise  Treat employees like partners  Focus on outcomes, not behaviors  Trust and engage  Don’t over-engineer through key performance metrics (a sure indicator of failure)  Build the Funding around Profitability  No payment if Base not achieved  Emphasize Target and Superior  Use Org Units as a Secondary Component (if you use at all)  Use Individual Performance Prudently  Reflect employee performance in the merit program  Allow for some discretion in the value-sharing plan  One last very important thing (see next slide) 40
  41. 4141  Crucial to the success of the plan  Employee communication statements should communicate incentive target opportunity  Regular performance updates during the plan year  “Partners” understand basic company performance  Private companies don’t typically disclose all financial information to all employee “Partners”:  Financial performance in private companies communicated via percentage against target  “After Q1 we are tracking 95% against our ‘Target’ financial performance”
  42. 4242 Reinforce Line of Sight Rewards What’s in it for me? Vision Where? Strategy How ? Roles and Expectations My Contribution? Rewards What’s in it for me? 42
  43. 4343 Market a Future that’s Relevant  Communicate desire for a growth partnership  Demonstrate commitment  To the future business  To key contributors  Promote, don’t just communicate  Be consistent 43
  44. 4444 Market a Future that’s Relevant  Here’s our future  Here’s how we’re going to get there  Here’s the role we picture for you  Here’s how we encourage our people to grow and contribute  Here’s our philosophy about pay and rewards  Here are our specific pay programs  Here’s how our pay programs could work for you if we achieve our plan 44
  45. 4545 Employee Value Statement Year 1 2 3 4 5 Targeted Results 100% 100% 100% 100% 100% Salary $160,000 $166,400 $173,056 $179,878 $187,177 STVS $64,000 $66,560 $69,222 $71,991 74,871 LTVS (EOY) -- $74,000 $186,000 $311,000 $448,000 401(k) @7% $17,120 $36,123 $57,169 $80,428 $106,086 Total Cash $224,000 $232,960 $242,278 $251,970 $262,048 Wealth Accrual $17,120 $110,123 $243,169 $391,428 $554,086 Total Value $241,120 $567,083 $942,407 $1,342,636 $1,767,343 45
  46. 4646 Chronology for Building a Successful STIP 1. Follow the Right Premise by establishing a basic plan approach (scope, funding parameters, company only or departments) 2. Select your participants and organize them by group (tier or level) 3. Create a budget (total value of the pool at various performance thresholds); allocate pool levels by employee tier 4. Assign your metrics (the Key Performance Indicators that produce awards) 5. Allocate employees’ awards between company and business unit results 6. Study, test, and confirm values 46
  47. 4747 Vitals for Operating a Successful Short-term Incentive Plan 1. Communicate the plan details early and often 2. Demonstrate the plan value opportunities on an individual basis 3. Reveal plan progress throughout the year (at least quarterly) 4. Create plan “rules” and live by them 5. Be flexible and recognize special contributions periodically (keep a reserve) 6. Review and renew the plan quickly at the end of the year 47
  48. 4848 How doesVisionLink help? We employ an interactive online tool and teach you how to use it. We show you how to communicate and manage the plan effectively. We build your plan with you (as a DesignTeam). How Does VisionLink Help? 48
  49. 4949 49
  50. 50 What will it do?
  51. 5151 Indicate on survey if you would like more information including a demo.
  52. 5252 Today’s Presenter: Tom Miller President (949) 265-5700 7700 Irvine Center Drive, Suite 930  Irvine, CA 92618  949-852-2288  ThankYou! 7700 Irvine Center Drive, Suite 930  Irvine, CA 92618  949-852-2288  