Incentive plans


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Recently published article on Employee Incentive plans - How to attract, retain and motivate employees - by Craig West, CEO & Founder of Succession Plus.

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Incentive plans

  1. 1. FINANCE FINANCE “The incentive plan is meant to improve the financial performance of the company, and to shape The most important element of an incentive plan is that it must be self-funding – employee behaviour accordingly.” it must pay for itself. If an incentive plan does not pay for itself, then what you’ve created is simply a new expense. You’ve also created an entitlement (a new form of welfare, some enthusiasm about creating one. I suggest you incentive plan is meant to improve the might say). If employees are going to have look at it this way instead – by implementing financial performance of the company, and the opportunity to participate in an incentive the ‘Ownership Thinking’ way of doing to shape employee behaviour accordingly. plan, then in my view it is their obligation and business, your profitability will increase from Incentives should never be paid if financial responsibility to fund it. It follows, however, X to Y, and Y should be substantially greater performance does not warrant them. Having that it is the obligation of ownership and/or than X. The organisation now has additional said that, many short-term incentive plans leadership to teach them how and to provide profit dollars that are represented by the gap are ineffective. In fact, many incentive plans employees with the education, measures, between X and Y, and the incentive will be a actually damage the organisation. Here are information and tools to ensure they find the portion of that gap. some design elements that typically render money to fund the plan. Given this, the incentive is not only self- them ineffective and/or damaging. I have found that many (if not most) funded, but it will also drive the profitability • The plan is not self-funded (most critical). business owners and leaders look at of the organisation higher, even after the • The plan is too complicated, and is tied incentives as if they were a budgeted incentive payout is made. Everyone must to operational metrics rather than expense, so clearly there might not be a lot of understand this simple premise – the financial results. An important thingSELF-FUNDED INCENTIVE PLANS:HOW THEY CAN WORK FOR YOU W hen considering business exit andBusiness succession planning succession strategies, a large part of the conversation is increasingexpert Craig West explains how the value of the business prior to exiting – most commonly in order to fund retirement.self-funded incentive plans work There has recently been an increase in interest in the use of employee shareand how they can drive the value ownership plans and other incentive plans to improve engagement and performance ofof your business to ensure it’s in a the workforce, which ultimately leads to an improvement in the value of the business.healthy financial state when you’re Several recent examples of the use of ‘Ownership Thinking’ when combined withready to hand over the reins. a self-funded incentive plan, and in some cases an employee share plan, show that these models can dramatically improve the performance of any business. Let’s look at some real examples and why they work.36 AUGUST 2012 37
  2. 2. FINANCE “To keep the plan simple and understandable, tie the incentive payout to only one measure” may be at the expense of another area. • Some departments may receive payouts, yet the company may lose money, which makes no sense. In order to avoid the problems noted above, follow the following guidelines when designing your plan: • To keep the plan simple and understandable, tie the incentive payout to only one measure: Profit Before Tax (PBT). • If a second key indicator is utilised to fund the plan, I suggest that it be a balance sheet indicator that drives cash flow, such as average collection days or inventory turns. I generally don’t C recommend this, however if cash flow has M been an issue, it may be a good idea – it’s Y not a great outcome to have an incentive payout due to your employees, and no CM cash to pay for it! MY • Ensure that the plan is self-funding. CY To do this, identify those requirements the business has that must be satisfied CMY Meet with anyone in high definition. before any incentive may be paid. K Welcome to GoToMeeting — the extremely simple, These requirements will include (among extraordinarily powerful way to collaborate face to to note on this issue is that if employees incentive payouts (or lack of payouts). It other things): return on investment for face in high-definition video. When inspiration don’t understand their incentive plan, is gratifying when an employee receives ownership, capital for debt repayment, they do not trust it. an incentive, however it does not change and capital for improvements or strikes and your business demands action, you can• If the plan is tied to financial results (as their behaviour because the link between investments (as in equipment). By instantly work together to turn ideas into reality. it should be), employers don’t teach the incentive and their work is not clear. analysing these factors, a minimum employees about finance, nor do they • Since this link is not established, the acceptable (or threshold) PBT can be provide employees with the education incentive simply becomes part of their identified before which no incentive and tools they need to be active compensation, i.e. an entitlement. should be paid. participants in funding the plan. • Ultimately there will be a quarter • The plan should be broad based,• Employers don’t regularly communicate (assuming this is a quarterly plan) meaning everybody should participate. TRY IT FREE TODAY organisational performance relative to the where there has been poor business I suggest that the incentive pool be GOTOMEETING.COM.AU incentive plan. performance, and therefore no incentive distributed in one of two fashions: PHONE 1800 451 485• The plan is tied to individual or payout. Since the plan has become an 1) equally among all employees, or departmental performance rather than entitlement, the employee simply feels 2) based on wages. Equally among all company-wide results (multiple plans). that they have been cheated, therefore employees is generally the best choice• Wins are not celebrated. damaging morale. in small, flat companies (few levels of Given the above components • If incentives are tied to individual or management), whereas distribution basedof ineffective plans, here are the departmental performance, one or more on wages is more common in larger,typical outcomes: of the following may occur: more complex organisations.• Due to the lack of training and • Questions of fairness will arise, negatively • Pay the incentive quarterly as opposed engagement as it relates to funding the impacting morale and performance. to annually. Annual plans are too far plan, there is actually a very weak link • Employees will focus only on their own removed from activity. The way to shape between employee performance and objectives and incentive plan, and this behaviour is to keep the reward close38 AUGUST 2012
  3. 3. FINANCE FINANCE CASE STUDY: Succession plan success for engineering company C-Mac Industries GM Steve Grylak was presented with the to it. Having said this, it is important to Short term, cash incentives, as described are active participants in driving the financial national award for Best Employee Share Plan for SMEs/ withhold some of the incentive for each of here, can be helpful in engaging your performance of your organisation. The Succession at the inaugural Employee Ownership Conference the first three quarters in order to protect employees toward driving the financial benefits of this combination are cultural as and awards dinner at The Sofitel in Melbourne in May. A locally the company in the event of a downturn. performance of the company. In saying that, well as financial, which is made clear from grown and owned engineering plant from Western Sydney, I suggest paying 50 per cent of the it is important to point out that the incentive the fact that statistically, companies who C-Mac has bucked the growing national SME trend to wind up incentive in quarters one through three, plan itself is unlikely to change behaviour. It practice this methodology retain employees on owner retirement with the introduction of an employee owned then calculating the final quarter payout must be tied to the other key activities which at a 200 per cent better rate than companies share plan (ESOP) offered to all its employees. The engagement based on how the company finishes make up part of the ‘Ownership Thinking’ that do not. In a tight labour market, when of employees as owners has already seen an 18 per cent hike in the year. Not only will this protect the incentive planning process, namely: trying to grow business value (one thing productivity at the plant. company’s cash flow, it will also act as a • Teaching business and financial acumen that make buyers very cautious is high More than 80 per cent of Australian SME owners aged over retention tool. to employees; and staff turnover) this could be the difference 55 are trapped in their businesses – struggling to work out how • If possible, the plan should allow for • Identifying Key Performance Indicators, between funding your retirement or having to escape and at the same time extract their wealth from the roughly 10 per cent of payroll as a payout and creating an environment of high to keep working. companies they have worked so hard to create. Recent surveys at a stretch PBT goal. If your company visibility and accountability around driving by a number of the big four banks and several accounting firms has been unprofitable or marginally them through the use of scoreboards and Craig West is CEO and Founder identified succession planning as the number one issue among have directions and targets from the elected board and I profitable in the three to five years prior to Rapid Improvement Plans. of Succession Plus, which advises business owners as they approach the end of their careers. But like have all the support I need from all staff. Our meetings are plan design, this may not be possible. Let These three things combined will create business owners on successful exit so many management “buzz words” coined to capture complex open for discussion, with great ideas from all staff to improve the numbers make the decision for you. a true culture of Ownership Thinkers, who strategies for their business. trends in simple phrases, “succession planning” fails to address so efficiency. As a manager with job security and a share in the many of the problems SMEs owners are grappling with. business, it’s a great pleasure to manage a team who want you For example, those in the manufacturing sector find to lead with ideas.” themselves looking for a viable exit from their businesses Matt Connolly, technical officer for C-Mac’s sheet metal at a time when markets for their products and services are department, was elected by the employees as one of two disappearing offshore. Unable to find buyers prepared to pay representatives to sit on the board of directors and has fully a fair price for the value they have created, or family members embraced the plan. willing to take over the reins, more and more face the terrible “Being a board member has definitely given me a much alternative of simply turning out the lights and walking away. different perspective on the way the business runs,” he says. “I The Australian Employee Buyout Centre facilitated the now have a lot more respect for the decision makers and have ESOP implementation and funded all the advisors costs for found that a lot of the day to day issues aren’t as clear cut as they C-Mac Industries. The funding was provided through a Federal seem. Being on the board has also given me some newfound Government Grant under the now completed Jobs That We confidence in the business. Now I see all the measures and Own program. processes that are set up to make sure the business doesn’t fail. This plan has been a great example of the combination I’ve found it quite interesting. of enthusiastic employees (who have now elected two “I get a slightly more positive vibe in terms of the way the employees to represent the new group of owners on the company is viewed by the employees. It has definitely made company board) and owners who can see the benefits of people think about their futures with the company and not just the increased participation and who are prepared to create a win- next week or day. Most people understand it is a long-term process win environment for all stakeholders. and aren’t expecting to get rich quick or anything like that.” C-Mac Manufacturing Manager Steve Grlyak says that since the The company’s founding family are still the principal introduction of the employee share plan, employees are now saying shareholders, but they see the benefits of a gradual sale of shares “us” instead of “me” and asking, “What do you want us to do?”. to employees based on profit share as well as the increased “Job security is a key motivator at C-Mac and we do not want involvement of key staff within the management team. Margaret to lose employees with skills,” Grlyak explains. “There are now McMaster, widow of company founder Cliff McMaster, who passed charts in the lunch room so everyone can see how the business away in 2008, supported the plan as she saw how it would benefit, is doing. The change has been truly unbelievable from all staff. I long-term and faithful employees as much as the family.40 AUGUST 2012 41