The Art And Science Of Incentive Plan Design

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    The Art And Science Of Incentive Plan Design - Presentation Transcript

    1. The Art and Science of Incentive Plan Design David Neilly Managing Director PeopleCOMP, Inc. HRPA 2009 Annual Conference January 28, 2009 This presentation is the property of PeopleCOMP Inc. and may not be reproduced or distributed without written consent (PeopleCOMP Inc. 2008)
    2. Objectives Provide you with ideas and perspectives to evaluate   the effectiveness of your current annual incentive plan Make you a stronger advocate of the “right” annual   incentive plan for your organization Provide you with ideas and examples that you can   apply to your organization Make you a more effective change agent regarding   incentive plan implementation 2
    3. The art and science of incentive plan design Art Strategy alignment Modeling Communication Analysis Training Surveys Values alignment Budgeting Change leadership Differentiation 3
    4. Enterprise Software Company- 
 Is anybody happy with the incentive plan? An enterprise software company sold $million software requiring annual service implementations worth tens to hundreds of thousands of dollars per year. It was imperative that the company operate as a team between sales, service and engineering to balance new product introductions, new features, new software sales and maintenance sales. Teamwork was essential all around. But it didn't happen, and it turns out much of the problem was rooted in misaligned incentive plans. The services team was compensated on margin while the sales team was compensated on software sales. And just to add a nasty twist, the head of engineering was also being compensated on new sales. What happened? The services team component of sales quotations would come in too high (because they wanted the margins) so in order to secure the sale, the sales team got quotes from engineering for the services component at very low margins. Engineering then delivered the service and was late delivering features for future releases. Much friction ensued and it was estimated that close to $2M was lost in revenue while customer satisfaction dropped. 4
    5. Assessing your existing annual incentive plan Cannot articulate strategic goals   Little differentiation   Perceptions of “unfair payouts”   Counter-productive behaviour   Too complex   So vague that employees suspect the plan is designed   to keep them from earning the bonus Your goals are too high and employees feel “ripped off”   Your goals are too low and the company overpays for   mediocre performance 5
    6. The benefits and risks of a performance- based incentive plan The benefits:   A variable cost is better than a fixed cost   Send a powerful message about whatʼs important   Deliver competitive cash compensation   The risks:   Resentment   Gamesmanship   Disengagement   Counter-productive behaviour   6
    7. An effective incentive plan operates within a broader “performance” culture Align The belief that organizations must Measure Differentiate continuously adapt and strive for higher performance Performance Culture The belief that Reward Improve planning, alignment, measurement and rewards promote Hold Coach higher performance Accountable 7
    8. How much business impact do you want your incentive plan to deliver? Minimal Significant BUSINESS IMPACT 8
    9. Successful incentive plans are… •  Grabs attention, sends strong messages about expectations and Motivating priorities, rewards for winning and going the extra mile •  “Rules of the game” applied consistently across the company •  Link between executive, management and production employee Fair incentives •  Perception that goals are achievable and have consistent stretch Challenging components •  Performance measures focus employees on key drivers of business Linked to the business performance •  Employees “own” the plan Internalized •  Plan is tweaked year over year to address business shifts and to learn Evolving from experience •  Drives business performance Value-producing •  Business infrastructure Supported •  Training and communication 9
    10. Considerations for incentive plan review or design Culture Shareholder Best Expectations Practices Incentive Plan Industry Competitive Design Economics Practice Business Business Drivers Strategy 10
    11. Designing an Incentive Plan Competitive Governance & Number of Plans Objectives Business Drivers Assessment & Planning Practices Involvement Individual, Team, Eligibility Funding Measures Formula High level design Company Performance Payout Range Target Setting Thresholds What-if Modeling Detailed design Range Documentation Business Systems Training Communication Implementation & “Fine Print” Updates 11
    12. Incentive plan- main ingredients Target Annual Max Annual Employee Incentive as % Incentive as % Category of Base Salary of Base Salary ( ) Corporate Individual Incentive Bonus Base Performance + Performance x Target x Salary Director 15% 30% Award = Factor Factor Manager 10% 20% Professional 5% 10% Individual Individual Incentive Performance Performance Factor Exceeds 150-200% Expectations Fully Meets 100-150% Expectations Minimally Meets 50-100% Expectations Falls Short Of 0-50% Expectations 12
    13. Eligibility What are some valid reasons to make all staff eligible   for an annual incentive aware? What are some valid reasons to limit eligibility to senior   managers and executives? 13
    14. What do think are the pros and cons of building a team component into your annual incentive plan? ABC Company Individual Team Company 14
    15. Illustrative incentive formulae What messages Corporate Incentive Bonus Base Performance x Target x Salary does each formula Award = Factor send? ( ) Which formula Corporate Individual Incentive Bonus Base would you prefer as Performance + Performance x Target x Salary Award = Factor Factor a participant and why? Corporate Individual Which formula Incentive Bonus Base Performance x Performance x Target x Salary Award = would you prefer as Factor Factor a shareholder and why? 15
    16. Illustrative payout curves 200% Performance Factor What messages does Corporate each payout curve 100% send? 50% Which payout curve 0% would you prefer as a 50% 80% 100% 120% participant and why? EBITDA as % of Target 200% Which payout curve Performance Factor would you prefer as a Corporate shareholder and why? 100% 50% 0% 50% 80% 100% 120% EBITDA as % of Target 16
    17. Benefit and practicality of customized incentive plan High Accountability and measurability Sales Manufacturing of business results Call Centre Customer Service Marketing Finance, IT, Legal, Corp. Affairs, HR R&D Low High Low Direct impact on business results 17
    18. Customized plans must have pay components which are appropriate to the functional area Scope of Measure Mechanics Measure Bonus New Team product paid over R&D Engineer revenue 3 years Customer Team & Quarterly retention & Call Center Rep individual bonus satisfaction Monthly   Revenue Individual commis- Sales Rep   Profit sion $0 $50,000 $100,000 $150,000 $200,000 Annual Compensation Base salary Target annual incentive Maximum annual incentive 18
    19. Your business planning and performance management process is critical Set Organizational Goals Set Team Goals Set Individual Goals Provide Rewards Provide and Feedback Coaching Evaluate Performance 19
    20. Summary of design trade-offs Simple More Complex Company performance only Company, teams, individuals Typical Single plan Customized plans for functions design Single or few measures Multiple measures features Simple payout curve Complex payout curve Easy to communicate Customized value drivers Pros Easy to measure Participants have stronger sense of Easy to administer control over measures Participants are more remote from Significant communication and Cons measures and probably less engaged administration with the program Many moving parts More of a pay delivery vehicle and less Lots can go wrong of a value driver Higher risk of counter-productive behaviours 20
    21. Example 1-
 Media and Entertainment Company •  One team culture Background •  History of profit sharing and reluctance to differentiate payouts to individuals •  Strong focus and tools for performance assessments, not as strong for goal setting •  Stronger incentive to achieve stretch financial Objectives objectives •  Transition to performance-based individual payouts •  More transparency to employees 21
    22. Bonus payout curve “Elite” - Strongest performer 205% Bonus Payout “Meets Expectations” performer 100% *If greater than 110% of 50% EBITDA is achieved further bonus payments will be discretionary and subject to approval by the Board 90% 100% 110% Actual EBITDA vs. Target 22
    23. Budget implication $1.95M Bonus Payout $1.3M $0.65M $0.00M 90% 100% 110% EBITDA vs. Target 23
    24. Example 2-
 Telecommunications & IT Outsourcing •  Almost all individual bonus arrangements- Background administrative nightmare •  Inconsistent bonus targets by level •  Pure focus on short term business results •  Shift to strategic initiatives requiring multi-year effort •  Focus team on both near-term business and Objectives longer term strategic initiatives •  Create alignment from owners, executives management and between business units/ divisions •  Create excitement to achieve and exceed goals •  Balanced focus on company, team and individual performance 24
    25. Incentive formula (simplified) [( ) ( )] ( ) Bonus = Company X Company Team Team Individual Individual Bonus Base + Weighting X Performance + X Performance X Target X Salary Performance Weighting Weighting Key messages from the incentive formula: 1.  The individual portion of the incentive is fully budgeted and fixed, while the corporate/team portion of the 2.  incentive is funded by free cash flow performance in excess of a threshold There is a portion of incentive available to every eligible employee based only on individual performance 3.  (i.e. no matter what happens at the corporate or team level, an incentive payout is possible) If the Company does not achieve a minimum financial performance threshold, the Company and Team 4.  incentive components are zero (as well as the variable portion of executive individual incentive component) Company, Team and Individual weightings vary by employee level, but generally the higher your 5.  management level, the more weight is placed on corporate performance Incentive targets are the same for all employees at the same organizational level 6.  25
    26. Bonus program features Corporate Team Individual How funded Variable (funded by Excess Free Cash Flow) Budgeted and Fixed 0-200% of target Award range $0 to unlimited $0 to unlimited (Zero-sum) Strategic or continuous Performance metric Excess Free Cash Flow Varies by team improvement goals Allocation to Management allocation individuals at end of Formula Formula based on performance year 26
    27. Bonus weightings CEO Execs Sr. Mgrs Mgrs Prof Corporate performance weighting 50% 50% 40% 30-40% 30% Team performance weighting 0% 0% 40% 40% 20-40% Individual performance weighting 50% 50% 20% 20-30% 30-50% 27
    28. Bonus payout scenarios Bonus = [( ) ( )] ( ) Company Company Team Team Individual Individual Bonus Base Performance X + Weighting X Performance + X Performance X X Weighting Weighting Target Salary Scenario Corp. Team Indiv. Bonus Bonus Bonus Total Assume: Perf Perf Perf from from from Bonus Base salary = $50,000 per   Corp. Team Indiv. (30%) (30%) (40%) year 1 100% 100% 100% $1,500 $1,500 $2,000 $5,000 Bonus target 
   = 10% of base salary
 2 50% 100% 100% $750 $750 $2,000 $3,500 = $5,000 3 200% 100% 100% $3,000 $3,000 $2,000 $8,000 Bonus weightings:   4 0% 100% 100% $0 $0 $2,000 $2,000 30% Company   30% team   5 100% 0% 100% $1,500 $0 $2,000 $3,500 40% individual   6 100% 100% 0% $1,500 $1,500 $0 $3,000 28
    29. Total spending vs. excess free cash flow Uncapped Target 29
    30. Project governance Large Organization, Critical to Business, Small Organization, Minor Significant Program Change, Vocal Group Change, Cooperative Group Steering Steering Committee Committee (Leadership) (Leadership) Organizational Cross- Technology Design Team Change Functional Implementation (Design & Implementation Design Team Team Implementation) Team (Design) (Technology) (Communication) Challenge Team (Involvement) 30
    31. Implementing an annual incentive plan Use challenge teams to test design and communication materials   Involve Finance early and often   Allow plenty of time for target setting and modeling   Sequence the roll-out from the top-down   Give executives and influential managers responsibility to explain and lend   support to changes Provide a document to each employee explaining the program and ask   employees to sign the plan indicating their understanding Make plan document and details available on company intranet   Communicate, educate and motivate through detailed plan documents and   earnings calculators for incumbents to model plan payouts under different performance scenarios Post quarterly performance reports   31
    32. Enterprise software company re-visited- 
 What would you do differently? An enterprise software company sold $million software requiring annual service implementations worth tens to hundreds of thousands of dollars per year. It was imperative that the company operate as a team between sales, service and engineering to balance new product introductions, new features, new software sales and maintenance sales. Teamwork was essential all around. But it didn't happen, and it turns out much of the problem was rooted in misaligned incentive plans. The services team was compensated on margin while the sales team was compensated on software sales. And just to add a nasty twist, the head of engineering was also being compensated on new sales. What happened? The services team component of sales quotations would come in too high (because they wanted the margins) so in order to secure the sale, the sales team got quotes from engineering for the services component at very low margins. Engineering then delivered the service and was late delivering features for future releases. Much friction ensued and it was estimated that close to $2M was lost in revenue while customer satisfaction dropped. 32
    33. Key messages You get out of an incentive program what you put into it   Most incentive programs are low effort, low risk, low return   Incentive plans should be designed and operated to create   value, not just to deliver pay There are best practices in incentive programs, but no two   are identical Successful incentive programs have as much to do with   change management, communication and training as with analysis and design High ROI incentive programs are highly dependent upon a   sound corporate planning and performance management process 33
    34. When you get back to the office… How much value is your current annual incentive plan   creating? Start a conversation with HR and business leaders   about how to drive stronger business results with an annual incentive plan Are there elements of this presentation that might   strengthen your organizationʼs approach to annual incentives? 34
    35. Questions? 35
    36. About PeopleCOMP The issues we address:   Employee engagement:   •  Measure employee engagement and workplace effectiveness •  Identify opportunities for improvement •  Assist with workplace Improvements Compensation:   David Neilly Link pay to performance •  Managing Director Design and implement incentive plans •  PeopleCOMP Inc. Design sales compensation •  david.neilly@peoplecomp.ca Design executive compensation •  Our approach: 905-829-4572   Drive business performance   Strategy + design + implementation   Why you can trust us with these important issues:   23 years of HR experience   Sensitivity to your business model and culture   Specialization and focus   36

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