Article from Leading Compensation Consultant to Motivate and Retain Top Employees with Executive Compensation Packages That Work

Today's compensation approaches, like the rest of the business world, are changing rapidly. As a result, the bridge that connects compensation strategy to the overall business strategy may have been weakened by the frequent shifts that characterize business today. Consider the following scenario: Seeing its competitors and peer companies implementing skill-based pay, one company decided to implement a similar system in its own operations-without giving sufficient thought to how the change will help or hinder the company's ability to execute its business strategy. Or consider the opposite scenario: A company reformulates its business strategy without making the necessary changes to its compensation systems. Situations like these are not unique. The pace of change in both business strategy and compensation design are leading many companies to consider and implement changes to one side of the bridge without making changes to align it with the other side of the bridge. As a result, the bridge becomes weaker and is more likely to undermine the overall success of the business.

This article will discuss how companies can periodically examine the alignment of the bridge between business strategy and compensation strategy and then make the necessary changes to address any weaknesses in that alignment. This process encompasses the following key steps:

Articulating the company's long- and short-term business strategies and making sure they are aligned with current compensation approaches.
Choosing the compensation approach that will best reward and reinforce the company's articulated strategic goals.
Periodically evaluating the compensation approach against the business strategy to see if goals have been met and make necessary adjustments.

To align compensation with the business strategy, a company must first be able to articulate what that business strategy is. After all, in the continuum of the strategic planning process, compensation systems design comes at the end. See Exhibit 1. The reason is this: compensation systems must be designed last to ensure that they are rewarding the types of performance and behaviors that will ultimately allow the company to realize its strategy.

Exhibit 1.

The Strategic Planning Process

Step 1. Using the results to a situation analysis (which identifies the strengths and weaknesses of the company's business processes, organizational behavior, and other systems), as well as the company's mission and philosophy statements, develop a corporate strategy.

Step 2. Using an approach similar to that in Step 1, begin to operationalize the corporate strategy by developing a business strategy plan for business units and departments.

Step 3. Establish job accountabilities and individual assignments so that each employee knows what to do to support the strategy.

Step 4. Develop supporting reward systems.

Step 5. Monitor and measure progress against the articulated strategy and goals.

While identifying and articulating the business strategy seems self evident, many companies have lost sight of their strategy or find that a strategy is in place but not explicitly recognized or communicated. And in this era of constant change, companies can't assume that they are pursuing their official business strategy. In other words, a company whose business strategy is obsolete may have adopted a more relevant strategy without taking the time to explicitly articulate that strategy.

The business strategy should include specific financial and non-financial objectives for the company over three to five years that, in turn, can be translated into short-, intermediate-, and long-term initiatives necessary to help execute that strategy. Financial goals like increasing profit margin and net income can be translated into objectives that are relevant to people lower in the organization but still help achieve those higher level goals. For example, manufacturing teams have, at best, indirect influence on the company's overall profit margin. Therefore, these teams would instead be measured against goals, like operating and maintenance cost management and the results of customer satisfaction surveys that contribute to the company's profit margin.

Because the goal of a compensation strategy is to deliver the right amount of pay necessary to motivate the types of performance necessary to achieve the business strategy, it is much more difficult to identify and design appropriate reward programs without an articulated business strategy. In fact, in the absence of an articulated strategy, compensation professionals must often gather the planning information necessary to develop reward systems themselves. In these cases, compensation professionals should find out where the organization is headed, the goals and objectives for each level in the organization, and what behaviors are to be reinforced through the rewards system.

One manufacturer planned to shift from simply providing machinery, which has a long sales cycle, to providing more in-depth technical knowledge and customer support that required more consultative selling skills. This strategic shift to a service center required the current staff to refocus on the new direction and to become more sensitive to customer service. At the same time, altering the direction of the company also required a new hiring approach that would bring in the types of people necessary for the company to achieve its overall goal of moving up from ninth place in the industry to third place within five years.

To accomplish this strategic shift, the company's human resources and compensation professionals needed certain critical information:

Could the company re-educate the affected employees in time to have the desired results within the immediate and intermediate time frames?
How many new people needed to be hired?
What are the desired background and experience required to do the job?
Were the new roles clearly defined and articulated to the employees and the customers?
How many of the new roles required team work versus individual contribution?
How will the company know when it is attaining its goals?
And will cash be the only or the primary means of recognizing the attainment of individual and company goals?

Without answers to these questions, the company's HR and compensation professionals would be unable to develop the people systems, particularly compensation systems that would support the achievement of the company's strategic goals.

Once compensation professionals have a strong grasp of the business strategy and its associated goals and objectives, the next step in this process is to design reward systems that will support and reinforce that strategy, goals, and objectives. This is where companies seem to be swayed away from choosing the most appropriate compensation approach in favor of the most popular or trendy compensation approach. Does it make sense to change the compensation system to a broad banded approach, to use team incentives, or to link financial goals to external measures? Each one of these plan design features have a great following in the business press, but do they make sense for the individual company?

On the one hand, a precision manufacturer of optics or a specialty tool company may need to move slowly before changing the specifications of jobs to fit one of these compensation approaches because of the specialized nature of the jobs. On the other hand, it may be easier for a manufacturer of heat transfer equipment to modify pay without potentially affecting quality. In either case, the job structure must meet the needs of the current and constantly evolving nature of the company's product and services cycle. And the compensation system must support the achievement of the company's strategic objectives.

The need for care in changing compensation approaches became clear to one company that used earnings per share as the primary financial measure of performance in both the short- and long-term incentive plans. Although this measure was easy to communicate to both internal and external audiences, existing accounting procedures made it difficult to maintain enthusiasm among individuals working in business units with operating problems. Only after each business unit had its own operating performance indicators under the short-term incentive plan was the company able to rejuvenate itself.

As this company's experience suggests, choosing the right compensation approach is a matter of determining what a given employee or group of employees can control and what impact their performance has on overall company success. By determining what an individual or group can control, the compensation professional has a list of potential goals and objectives to be rewarded. And by determining what impact an individual or group has on company performance, the level of reward can be established.

In one financial product company, management shifted its strategic focus from growing primarily by adding new customers to a strategy focused on product penetration of existing clients and geographic areas. This shift required a change from cold selling to improved account management and product enhancement. This, in turn, required the management and marketing staff to listen more closely and respond more carefully to their existing customer bases. The company did not neglect the cold call selling but now balanced it with this new overall strategy. As a result of this shift, recruiting emphasized customer servicing skills and the organization emphasized team work and coordination. There was also a shift in pay practices from rewarding only new dollar sales to a balance of rewards for retention sales, account management, service quality, and new sales both inside and outside of the current customer base.

The process of aligning business and compensation strategy also requires determining what level of pay should be at risk. With various forms of incentives making their way to the lowest levels of many organizations, simply limiting pay at risk to the highest levels of the organization may no longer be an option. For example, the now-deregulated utility industry is facing increased competition and a struggle to increase margins to sustain competitive rates of shareholder returns. To generate those returns, many of these companies are extending variable pay practices deep in the organization as a means to focus employee attention on operating margins, return on investment, cash flow, and customer service. One such company went a step further by holding base salaries at the competitive market level, using lump sum merit increases for salaries above the competitive level, and making all employees eligible for variable pay. The variable pay was conditioned on achieving a certain level of shareholder returns before any incentive payouts would be made. In other words, only after the shareholder was taken care of would each business unit receive incentive monies to reward individuals for achieving corporate and business unit goals. As a result of this approach, communications about what is important to the organization's success have improved and people are speaking the same language of success.

Part of this process also includes taking stock of existing compensation programs to see how they reward employees and what kinds of performance and behaviors they reward. After all, just because the company's strategy may change does not mean that existing reward programs must change wholesale. Rather, reward programs often simply need refurbishing to accommodate the new goals objectives and direction of the company. For example, one company in the apparel industry simply had to tweak its reward programs by paying more attention to the communication program. The company already had variable pay and what it considered reliable measurements. But the employees who were supposed to be enjoying the fruits of their labor did not have a clear understanding of how it all made sense. Therefore, the company embarked on a revised and sustained communication program aimed at all employees.

By periodically reviewing the linkage between the business strategy and the compensation approach, companies can ensure that the two are still in alignment. This also allows companies to judge the effectiveness of the compensation approach. In other words, if the company is closer to its strategic objectives than it was at the beginning of the strategic planning process, the strategy and compensation approaches are most likely aligned and working synergistically. On the other hand, if it has not seen expected results or moved forward as quickly as expected, the company should undertake more analysis and a more thorough strategic planning process.

If compensation is indeed the reason why the company has not achieved its strategic objectives, two common pitfalls may be at the root of the problem. The first pitfall, the Moving Target Syndrome may be difficult to discern because these companies often appear to have everything in sync with processes in place for planning and goal setting. However, a closer look reveals that managers frequently change goals, targets, and objectives throughout the performance period, causing employees to change direction constantly. Companies that undergo frequent reorganizations are particularly at risk for the Moving Target Syndrome.

The Moving Target Syndrome also manifests itself in other ways. Managers change performance target just as employees are about to achieve them, often with the rationale that the targets were set too low or were not realistic. Or managers lower targets if the original targets will not be reached. But however it plays out, the Moving Target Syndrome can be devastating to a company's efforts because employees become confused and frustrated without clear and steadfast performance objectives to guide them. The second common pitfall is making accelerate payments for long-term performance before that performance has actually been realized. For example, under management incentive plans with three- to five-year time periods for goals, some companies will make incremental payments under the plan to reward them for projected future performance. Unfortunately, past performance doesn't guarantee future performance will be at the same level so companies can get burned if performance drops and payouts against that performance have already been paid. Accelerated payments also reward and reinforce short-term thinking among these managers.

At the same time, however, companies should resist the impulse to make compensation the scapegoat for unsatisfying results. After all, compensation is but one portion of the strategic planning and implementation process. It solves nothing to change compensation when the overall strategy or some other organization system is flawed. For example, a bank holding company wanted to install a short-term incentive plan for all management and increase the level of long-term incentives for senior management. The reason for the change? Because other companies were doing it and pressure was building to stay competitive. Moreover, the operating analysis seemed to indicate future operating performance might support such action. However, a retrospective and more detailed analysis of performance indicated a different level of company performance that would not support the projected baseline for future performance. Therefore, the challenge became for the company to fix itself before attempting to move ahead by restructuring and hiring key executives to bring the company up to the level it thought had already achieved. For the short term, the company chose not to establish a new compensation plan but planned to rely on the current plan with more hands on management by the executive team.

Compensation remains an important tool for helping a company achieve its strategic objectives. However, companies must recognize that compensation does not operate in a vacuum. It is merely one step in a very dynamic strategic planning and implementation process. But by ensuring that compensation is aligned with their strategic objectives, companies stand a better chance of achieving those objectives and maintaining a competitive edge over their competitors .

Donald G. McDermott is President of D.G. McDermott Associates, LLC, founded in 1985, a Red Bank, N.J. -based management consulting firm specializing in the integration of human resources and compensation programs with business strategy.

Reinforcing the Bridge between Business Strategy and Compensation Strategy