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Balancing Salaries and Incentive Pay

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Most business leaders know that some portion of their pay construct should be in the form of incentives, but are left struggling to find answers to these kinds of questions: How much of someone’s pay should be variable? And who should have incentive pay as part of their mix? How much of the incentive should be short-term and how much should be based on long-term performance? What type of incentive(s) should it be. If these are questions you struggle with, you will not want to miss this.

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Balancing Salaries and Incentive Pay

  1. 1. “Balancing Salaries and Incentive Pay”
  2. 2. 22 Balancing Guaranteed vs. Variable Pay  What is the right mix of pay between salaries and incentives?  It can be a juggling act  Too much focus on salaries carries a high company cost with no promise of performance  Too much focus on incentives may be perceived as too risky for employees
  3. 3. 33 Balancing Guaranteed vs. Variable Pay  Incentive plans too commonly fail  How should incentives be aligned to your employee demographics to generate a higher return on investment?  How do you maximize your rewards philosophy?
  4. 4. Salary Performance Incentives Sales Incentives Growth Incentives Core Health & Welfare Plans Executive Benefit Plans Qualified Retirement Plans Nonqualified Retirement Plans Salaries Competitive with market standards? Tied to strong performance management process (merit)? Managed within a flexible but effective structure? Performance Incentives Tied to productivity gains? Clear, achievable and meaningful? Self-financing? Sales Incentives Challenging yet achievable? Reinforcing the right behaviors? Differentiating your offering? Growth Incentives Linked to a compelling future? Supporting an ownership mentality? Securing premier talent? Core Benefits Responsive to today’s employee marketplace? Allocating resources where most needed? Evaluated to eliminate unnecessary expense? Executive Benefits Flexible enough to address varying circumstances? Communicating a unique relationship? Reducing employee tax expense? Qualified Retirement Plans Giving employees an opportunity to optimize retirement values? Operated with comprehensive fiduciary accountability? Avoiding conflicts and minimizing expenses? Nonqualified Retirement Plans Optimizing tax-deferral opportunities? Aligning long-term interests of employees with shareholders? Structured to receive best possible P&L impact? An Aligned Compensation Strategy
  5. 5. 55 What is Your Pay Mix?  Most companies aim to pay “at market”  What is “at market” pay?  If everyone paid the exact same way would that give you a competitive advantage in hiring and retaining talent?  What is it about your pay programs that make you unique?  What might be right for you may not be right for others
  6. 6. 66  Lets assume an Accountant should be paid between $45,000 and $47,500  How much of that should be salary and how much should be variable should be decided internally  Are either of these company less “competitive” than any other? Professional Accountant Base Salary Incentives Total Cash Comp Option A 44,000 1,000 45,000 Option B 42,500 4,000 46,500 Option C 40,000 7,500 47,500 Sample Pay Mix
  7. 7. 77 Sample Pay Mix  Option A - Conservative  Has an advantage around base salary  Has higher fixed costs  Option B - Moderate  Middle ground for both salaries and incentives  Option C - Variable  Has a competitive advantage around incentives and Total Cash Comp  Risk when no incentives paid Professional Accountant Base Salary Incentives Total Cash Comp Option A 44,000 1,000 45,000 Professional Accountant Base Salary Incentives Total Cash Comp Option B 42,500 4,000 46,500 Professional Accountant Base Salary Incentives Total Cash Comp Option C 40,000 7,500 47,500
  8. 8. 88 Conservative Pay Profile Profile Base Pay Short-Term Incentives Long-Term Incentives Core Benefits Profile Conservative High Moderate Low Moderate Moderate Provides a high degree of employee security at the expense of variable pay High base salaries and Moderate incentives Generally offers moderate level of core benefits Cash friendly stable organization Generally attractive to a younger employee population Can inhibit the hiring of “high performers” Rewards performance through merit/promotion May have difficulty recruiting executive or key employees
  9. 9. 99 Moderate Pay Profile Profile Base Pay Short-Term Incentives Long-Term Incentives Core Benefits Retirement Moderate Moderate Moderate Moderate Moderate Moderate Provides a middle of the road approach to pay Base salaries at middle of market Some upside incentive potential Performance rewarded moderately Attracts a diverse employee population Rewards performance through multiple facets Tries to provide a balanced approach without any distinguishing element of pay
  10. 10. 1010 Variable Pay Profile Profile Base Pay Short-Term Incentives Long-Term Incentives Core Benefits Retirement Variable Low High High Moderate Moderate Provides a high degree of upside earning potential with higher level of risk Base salaries at low end of the market Rewards tied directly to business performance Entrepreneurial mindset – less cash friendly Attracts high performers, frightens risk averse Rewards performance through incentive pay Promotes high level of value sharing Attracts entrepreneurial leadership through long-term awards
  11. 11. 1111 Pay Mix Considerations Demographics  Younger/Nonexempt employees value predictable pay  Prefer higher salaries and lower total cash compensation  Entrepreneurial/Mature employees want upside pay potential  Will accept lower salaries with higher total cash opportunity  Usually seek both short and long-term incentives  Diverse employee populations may require different focus on pay at different levels  Usually accommodated within compensation structure/salary ranges
  12. 12. 1212 Owner/Shareholder attitudes on pay  Public vs. Privately held companies tend to have different pay mixes  Privately held companies tend to place more pay in variable programs  Public companies have the capital to pay higher salaries  Public companies may offer equity to offset salary or incentive pay  Public companies can be limited to additional shareholder/fiduciary concerns around pay  Nonexempt organizations also share restrictions around pay mix Pay Mix Considerations
  13. 13. 1313 Pay Mix Considerations Capital  High salaries provide ease in hiring talent but carry heavy fixed costs  During poor performance years, high salaries can be a heavy burden  High incentives offers a way of self-funding compensation based on company performance  When performance objectives are not hit and no incentives are paid, this philosophy carries a big turnover risk  Ultimately, your pay mix needs to correspond to your business plan
  14. 14. 1414 How is Your Investment Allocated? What does your total pay mix look like? Does it link employees to your business plan?  Why is your compensation budget allocated the way it is today?  Is your total compensation allocation producing unintended consequences (spiraling compensation expenses, turnover, inability to attract talent, etc.)?  Is there a more cost efficient way to manage your compensation dollars while aligning more tightly with your business objectives?  The mix of incentives is usually the easiest place to start correcting your mix
  15. 15. 1515 Create a Compensation Philosophy  Best practice is to frame up your philosophy into a written statement  All elements of rewards should be identified (Salaries, incentives,  State where pay is targeted We pay salaries __________ a) At the top of market b) At the middle of the market c) Within market, however we do not lead the market Our incentives are ________ a) At the top of market b) At the middle of the market c) Within market, however we do not lead the market
  16. 16. 1616 Why a written statement? 1. Becomes a common narrative 2. Can be shared with existing employees as well as new recruits 3. Gets managers on the same page 4. Identifies your competitive advantage 5. Creates a consistent framework for rewards 6. Your philosophy statement becomes your Constitutional Rewards Charter
  17. 17. 1717 Align Pay to the Philosophy  Salary ranges and incentive targets are commonly set and maintained using market data:  ERI  PayScale  Towers Watson  Mercer  Industry surveys  Ensure you have access to some market data
  18. 18. 1818 Using Market Data  Market data can help create salary ranges  Market data should be interpreted via your philosophy  Conservative, Moderate, Variable 25th 50th 75th Mercer - Accountant Sr 49,837 57,498 63,141 Market Data
  19. 19. 1919 Market Data + Philosophy  Conservative – High Salary  Moderate – Mid Salary  Variable – Low Salary 25th 50th 75th Mercer - Accountant Sr 49,837 57,498 63,141 Market Data 25th 50th 75th Mercer - Accountant Sr 49,837 57,498 63,141 Market Data 25th 50th 75th Mercer - Accountant Sr 49,837 57,498 63,141 Market Data
  20. 20. 2020 Create a Total Compensation Structure Min Mid Max 1 203,531 271,375 339,219 50.0% 100% 50% 50% 5% Yes 5% $11,141 Unlimited Unlimited 15,000 20,000 2 151,167 201,556 251,945 35.0% 75% 50% 50% 5% Yes 5% $11,141 Unlimited Unlimited 10,000 12,500 3 122,065 162,753 203,442 25.0% 50% 100% 0% 5% Yes 5% $11,141 25 5 5,000 8,000 4 104,864 139,818 174,773 20.0% 25% 100% 0% 5% $6,127 25 5 5,000 5 80,952 101,190 121,428 15.0% 5% $6,127 25 5 5,000 6 67,842 84,803 101,763 15.0% 5% $6,127 15 5 7 58,564 73,205 87,846 10.0% 5% $6,127 15 5 8 46,027 57,533 69,040 10.0% 5% $6,127 15 5 9 41,835 49,217 56,600 5.0% 5% $6,127 15 5 10 35,494 41,757 48,021 5.0% 5% $6,127 10 5 11 31,507 37,067 42,627 5.0% 5% $6,127 10 5 12 24,145 28,406 32,667 5.0% 5% $6,127 10 5 13 19,529 22,975 26,421 0.0% 5% $6,127 10 5 14 17,354 20,417 23,479 0.0% 5% $6,127 10 5 Annual Car Allow Grade/ Band Sick Days Salary Range Bonus Target % Phantom Stock AO Supplemental Life Insurance Deferred Comp Eligible Deferred Comp Max Match 401k Match Max % Vacation Days % Phantom Stock FV % Phantom Stock AO Health, Dental, Life
  21. 21. 2121 Who Are You Hiring?  Baby Boomers – Born between 1946 -1964  Generation X – Born between 1965 - 1979  Millennials – Born in the 1980’s and 1990’s Demographic identities are extremely influenced by the world they grew up in Disclaimer: I will be intentionally painting employee demographics with one overly-broad brush. These statements will not hold true for all individuals in these three general classifications. This overgeneralization is intended to provide directional guidance on pay for these subgroups.
  22. 22. 2222 Baby Boomers
  23. 23. 2323 Baby Boomers  Raised by World War II Survivors  Parents worked in manufacturing, agriculture, or retail jobs  Encouraged to attend Universities (premium)  Focused on having fewer/longer term roles within organizations  Dominate senior leadership roles  Understand the increased cost of health care  Typically eyeing retirement  Many retired early and have rejoined the job force
  24. 24. 2424 Generation X
  25. 25. 2525 Generation X  MTV generation/Latchkey generation  Two parents in the workforce  First to have access to home computers  College/university was strongly encouraged  Incorrectly labeled as “slackers” by preceding generations  Strong entrepreneurship mindset  More likely to be 1099 than other gens  Married Later/Fewer kids  Took a few jobs to get comfortable  Professional and Mid-Manager jobs
  26. 26. 2626 Generation Y
  27. 27. 2727 Millennials  Grew up with technology in the house (home computers, internet, cell phones)  Values teamwork, ingenuity, and creativity  Was told that college/university was a necessity  Many struggled to get jobs after graduation  Many prevailing myths  Not all living in Mom’s basement  Starting to have families  More likely to stay in the same job as previously assumed  Values individuality and being recognition
  28. 28. 2828 Pay Strategy Profile Base Pay Short-Term Incentives Long-Term Incentives Core Benefits Profile Conservative Millennial High Moderate Low Moderate Moderate Profile Base Pay Short-Term Incentives Long-Term Incentives Core Benefits Retirement Moderate Gen X Moderate Moderate Moderate Moderate Moderate Profile Base Pay Short-Term Incentives Long-Term Incentives Core Benefits Retirement Variable Boomer Low High High Moderate Moderate
  29. 29. 2929 Theoretical Solution  Structure your rewards around your Compensation Philosophy  Example:  “My business is a regional call center hiring predominately college students and recent college grads.” (Millennials)  “We are a professional investment management firm hiring mostly experienced licensed financial planners.” (Gen X)  “I’m looking to hire extremely experienced legal professionals.” (Boomers)
  30. 30. 3030 In reality…  Rarely, is your workplace demographic so pure  Your senior leadership team is probably in a different demographic than your staff accountant  As a result, their financial goals are probably very different  Maintaining one Compensation Philosophy can be challenging
  31. 31. 3131 In reality… Philosophy Min Mid Max 1 Variable 203,531 271,375 339,219 50.0% 100% 50% 50% 5% Yes 5% $11,141 Unlimited Unlimited 15,000 20,000 2 Variable 151,167 201,556 251,945 35.0% 75% 50% 50% 5% Yes 5% $11,141 Unlimited Unlimited 10,000 12,500 3 Variable 122,065 162,753 203,442 25.0% 50% 100% 0% 5% Yes 5% $11,141 25 5 5,000 8,000 4 Moderate 104,864 139,818 174,773 20.0% 25% 100% 0% 5% $6,127 25 5 5,000 5 Moderate 80,952 101,190 121,428 15.0% 5% $6,127 25 5 5,000 6 Moderate 67,842 84,803 101,763 15.0% 5% $6,127 15 5 7 Moderate 58,564 73,205 87,846 10.0% 5% $6,127 15 5 8 Conservative 46,027 57,533 69,040 10.0% 5% $6,127 15 5 9 Conservative 41,835 49,217 56,600 5.0% 5% $6,127 15 5 10 Conservative 35,494 41,757 48,021 5.0% 5% $6,127 10 5 11 Conservative 31,507 37,067 42,627 5.0% 5% $6,127 10 5 12 Conservative 24,145 28,406 32,667 5.0% 5% $6,127 10 5 13 Conservative 19,529 22,975 26,421 0.0% 5% $6,127 10 5 14 Conservative 17,354 20,417 23,479 0.0% 5% $6,127 10 5 Annual Car Allow Grade/ Band Sick Days Salary Range Bonus Target % Phantom Stock AO Supplemental Life Insurance Deferred Comp Eligible Deferred Comp Max Match 401k Match Max % Vacation Days % Phantom Stock FV % Phantom Stock AO Health, Dental, Life
  32. 32. 3232 Common Trend Profile Base Pay Short-Term Incentives Long-Term Incentives Core Benefits Profile Conservative Millennial High Moderate Low Moderate Moderate Profile Base Pay Short-Term Incentives Long-Term Incentives Core Benefits Retirement Moderate Gen X Moderate Moderate Moderate Moderate Moderate Profile Base Pay Short-Term Incentives Long-Term Incentives Core Benefits Retirement Variable Boomer Low High High Moderate Moderate
  33. 33. 3333 Why Incentives?  All demographics appreciate incentives  Millennials – Partnership  Gen X – Entrepreneurial minded  Boomers – Hoarding cash for retirement  Most incentive plans do not deliver on a level that all demographics can appreciate and relate to
  34. 34. 3434 Market Compensation Trends  Incentive programs are more common than ever  2014 World at Work study showed that 99% of publicly traded companies have incentive plans  Between 2011 and 2013 private companies with incentives plans have grown from 95% to 97% prevalence
  35. 35. 3535 Incentives Are A Good Bet  Good for organization to put emphasis on incentive pay  Performance Requirements  Not Guaranteed  Provides alignment with big picture objectives  When properly structured incentives create a partnership mentality
  36. 36. 3636 Why Do Incentive Plans Fail?  Traditional Incentive plans  They seek to change/set behaviors  They rob employees of their creative input  They reward for completion of small tasks instead of achieving big picture results  They aren’t tied to overall companyresults/lack line of sight  They are either too discretionary or too quantitative BOTTOM LINE: Traditional Incentive plans are philosophically broken. They are not perceived as empowering a partnership mentality
  37. 37. 3737 Merriam-Webster Definitions  Bonus – An extra amount of money that is given to an employee  Commission – An amount of money paid to an employee for selling something  Incentive –Something that incites to determination or action
  38. 38. 3838 Traditional View of Incentives  “If I put a carrot in front of you, you will do what I want you to do”  At its heart, when structured inappropriately, incentive plans are perceived as manipulative  Employees agree to be manipulated for money
  39. 39. 3939 A Better Approach  “We are part of a team. If we all work together we will generate greater success. That success will be shared with everyone in our incentive plan.”  When structured appropriately, incentive programs should be perceived a partnership.
  40. 40. 4040 Partnership  Millennials do not value the traditional “employee” and “employer” relationship  Perceived as a subservience model  “Do what I say and I will pay you”  All demographics prefer a sense of “Partnership,” working together towards a common goal  Partners rewarded differently than employees
  41. 41. 4141 Simplified Plan Design  Simplifying incentive plan design  Incentive plans have historically been very metric driven  Potentially creates conflict of interest  Should I do what’s in the Company’s best interest or should I just worry about performing my goals?  Should I be paid because the company succeeded or because I accomplished a list or tasks?
  42. 42. 4242 Basic Structure  Plan funds at different levels based on achievement of company goals  The incentive pool is then disproportionately shared with employees  Higher level employees receive a higher portion of the incentive pool  Employee performance can “modify” the payout
  43. 43. 4343 Advantages  Easy to understand  All employees are tasked with achieving high level goals  No micromanaging  No conflict of interest  Simple to administer
  44. 44. 4444 Silent Communications  What does your salary philosophy communicate?  Employee Value  What do incentives communicate?  Performance  Don’t assume your employees understand this
  45. 45. 4545 Employee Awareness  How much do your employees know about pay?  How much do you want them to know about pay?  For a long time, employers benefited from keeping pay practices behind closed doors
  46. 46. 4646 Automobile Awareness  How much do you know about your car?  How much should you know about cars?  For a long time, mechanics benefited from keeping automobile maintenance behind closed doors
  47. 47. 4747 Do You Trust Your Mechanic?  Why do people not trust their mechanics?  Because until recently you have had to take their word  Why should your employees trust you around pay?  Compensation is just as important to your employees as transmission fluid  How do you instill trust in your compensation practices: Transparency
  48. 48. 4848 Communications  Communicate your rewards philosophy (Compensation Philosophy Statement)  Communicate your incentive plan goals/metrics regularly  Communicate actual rewards (Total Compensation Statement)
  49. 49. 4949 Perception is Key 2015 PayScale Study • The main predictor of both “satisfaction” and “intent to leave is whether employees feel they are paid fairly. • Even when people’s compensation was in line with their value in the job market, two-thirds believed they were underpaid. Of that huge group, about 60% reported low job satisfaction, and said they plan to look for a new job within six months. • By contrast, the researchers found that, even at companies that pay below-market wages, if employees know why they’re paid less than they could probably earn elsewhere, 82% say they’re “satisfied” with their jobs and plan to stick around. - Fortune Magazine,October 10, 2015, “How PayTransparency Can Keep People from Quitting”
  50. 50. 5050 Return on Investment  Pay is not a cost  Pay is an investment  Every good investment should have an equal or greater return  Proper alignment of salary and incentive programs ensures that you have a desired return 1) Create a Philosophy 2) Align to Market 3) Communicate
  51. 51. 5151 Balancing Salaries and Incentives  Salaries and incentives are the cornerstone of your pay programs  Not an exact science  Identifying your key compensation philosophy, aligning pay accordingly, and communicating effectively is only way to win this balancing act.

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