Schuster-Zingheim and Associates, Inc.- Pay & Rewards Tactics

The SZA Pay & Rewards Bulletin, May 2002

Pay & Rewards Tactics

TACTICAL INCENTIVE SOLUTIONS FOR 2003:
GETTING AHEAD IN THE REWARD GAME!

Patricia K. Zingheim and Jay R. Schuster

2001, and so far in 2002, have turned out to be interesting times for incentives and stock options. We started 2001 with talent capabilities built to match the extended business cycle upturn. But the world finished 2001 having made significant workforce reductions. And we have been riddled with shocks—September 11, Enron, Arthur Andersen. Many companies are now a bit flatter, more streamlined, de-layered, and leaner—shades of reengineering and downsizing of the 1990s. Only now this follows a period of unprecedented growth in shareholder value, workforce strength, and employee trust-building. We have witnessed volatile value reductions and are left with loss of incentive to add value and loss of jobs that were tough to fill only months earlier. All compensation has been impacted—but especially performance-based variable pay—cash incentives and stock options.

Many stock options are underwater, right after we put more stock and stock options in the hands of people at all organizational levels. The 2001/2002 economic slowdown came immediately on the heels of making annual cash incentives available to more people than ever before. Now annual cash incentives aren’t paying off as hoped. It looks like a disaster in the making, just when organizations were beginning to use more creative reward solutions to meaningfully link people with business goals. Imagine—the changing economic scene re-landscaped rewards. But most companies can’t go back to the rewards that characterized the last decade. Those pay solutions added little to creating a positive business atmosphere in which people are rewarded for adding value.

Prescription for Incentives

Is your company stuck with underwater options and incentive plans that didn’t pay off as expected? If the answer is yes, this obviously means your stock is not performing as hoped. It also means you’re missing the financial goals that generate dollars for employee incentives.

Now it’s time to get your incentive design engine into gear so you can do what’s necessary to pull yourself out of a jam. Here are some critical tactics for incentives for the rest of 2002 and for 2003:

Communications—Start the incentive repair process by broadly communicating about what went wrong in 2001 and so far in 2002. What, why, and how goals were missed, and what the company will do about it in 2003 (and maybe for the rest of 2002). Tell people a new incentive solution is in the offing. It’s time to re-state the business case for incentives—why your company has them, how they add value to the business, and what you expect them to do for the remainder of 2002 and in 2003.

Measurement—Business measurements are important for the rest of 2002 and critical for 2003. How will the company judge itself? If the company missed its goals in 2001 and so far in 2002, what are you going to do to achieve the 2003 goals? Does your company need "new goals" for the remainder of 2002? Are new metrics necessary, for example, adding metrics that are closer to the employee’s line of sight? Do we need to not only get the results we want but also rebuild credibility for incentives?

Upside Opportunity—What’s it worth to get the company going again? Are you willing to pay any incentives lost in 2001 and perhaps in 2002 for much improved 2003 performance? It may be well worthwhile to energize incentive participants to help you generate the outcomes you need. How about granting more options if the company meets its performance goals? While re-pricing options is probably out, new options may be possible to help people understand that the company will be on the right track again soon.

Reasonable Thresholds—It’s not good to miss incentive payouts two years in a row. Even if incentives failed for the right reasons, pressure on base pay will increase if total cash (base pay and incentives) falls much below what competition offers for similar jobs. The performance hurdle at which incentives first pay rewards might be adjusted to get people back into the incentive compensation game again. Remember that it’s much cheaper to pay a small incentive than it is to grant a base pay adjustment. You can’t easily get base pay adjustments back if performance slumps again.

Achievable Targets—What are your company performance expectations for 2002? Are you meeting them following 2001? Now remember, you got derailed in 2001 and may again in 2002. If the reason incentives didn’t pay off in 2001 was poor setting of target goals (where business plan is achieved), it’s critical the target is achievable for 2002—and essential for 2003. Goals can be a stretch, but it’s important to tell why the goals are what they are and how they can be achieved. Achieving business plan can’t just be wishful thinking—people with incentives based on goals need to have reasonable expectations of being successful.

Sponsorship—Leadership must be out front showing the way. Incentives need sponsors whose own financial incentives assure others they have some skin in the game. The sponsor should have like incentive metrics compared to everyone else. People at the top need to be the primary champions of the incentives (or new stock options) in 2002. And if you miss 2002, clearly in 2003.

Communications—Again—and again until the message is clear, understood, and accepted. It’s critical to keep the information coming, not only when the incentive plan is kicked off but at least quarterly and ideally monthly all year long. The only reason for incentives is to communicate key goals and directions. This means maintaining two-way information flow—both gathering information from incentive participants and responding back with information that makes it possible for them to achieve goals and earn incentive awards.

The objective is to make incentives work effectively—to accelerate the business process. Incentives can significantly help a company perform better and then share this improved performance with the people who add value to the enterprise. This makes it financially worthwhile for people to help their company thrive.

Diagnosing Your Incentives

We’ve suggested what it takes to repair an incentive solution gone afoul. Now let’s see if you can tell whether your incentive plan is "working." An incentive plan that doesn’t pay awards or a stock option plan that does not generate value for the company or optionees is a symptom of a possible problem. But other problems may arise that suggest a tune up or overhaul may be needed. Some problems with tactics to address them are:

Autopayment—After a time some incentives payments become "the way it’s done here"—not yet entitlements, but repeatedly generated awards with no strategic re-thinking. Goals are not annually reviewed, alignment with business direction is unchecked, and payments continue with little understanding of the business roots on which incentives are based. So the company does not receive benefit from the dollars expended.

Tactic: Start with the business plan and see if incentive metrics and goals cascade from it. Make sure incentive metrics and goals are aligned with new business initiatives.

Measurement Shrinkage—Focusing on past performance only shows you where your company has been—not where it must go. Companies that merely try to outperform their last documented performance sometimes lose out because competitors are doing better.

Tactic: Look beyond your own company’s performance to customers and competitors to see what metrics and performance standards to consider.

Entitlement—People can be conditioned to expect an award every year, either as a result of too-easy goals or because of exceptions that excuse performance and grant an award anyway. Participants view changes as takeaways. So incentives are seen the same as base pay—something people get year after year without concern for results.

Tactic: Communicate that the plan will change because of continuous improvement (of incentive design), learnings, and changes in business goals and directions. Build a clear business case for changing the plan. Provide upside incentive opportunity for exceeding goals and set goals so that exceeding goals does not always happen.

Eroding Shared Goals—Most companies are driven by goals that are shared by a number of people. Few individuals acting alone can impact the performance of a company of any size. Yet many individual incentive solutions have metrics that help erode a sense of collaboration and team commitment. Such situations create internal competition for resources and awards at the expense of overall organizational performance.

Tactic: Ensure that all organizational levels of performance—individual, team, business unit, company—are addressed in some element of total rewards and that the incentive plan optimizes, not suboptimizes, performance at the higher organizational levels.

Hierarchy—In many companies, impact on company performance simply isn’t hierarchical—from top to bottom. Some key performers are not managers, and many managers are not key performers. Incentives are often designed so the opportunity for awards increases from lower in the organization hierarchy to higher. This rewards moving to an administrative management position to become eligible for a larger incentive.

Tactic: Determine incentive opportunity by considering role impact since some nonmanagement jobs may actually be more important from an incentive standpoint than management jobs.

Copycat Designs—When IBM was at the height of mainframe performance, its sales incentive plan was copied by many companies—whether or not it fit their business and selling situation. When IBM’s performance sagged, many immediately moved on to copy the incentive solution of some other successful company. Benchmarking has sometimes transplanted an incentive approach from a company where it might have belonged because it fit to a company where the fit was not right.

Tactic: Use what you learned from benchmarking to build a better plan so that you get a differential advantage over your competitors.

Complexity—Too many metrics, too many goals, and too many rules create "Too many notes, Mr. Mozart," as the film Amadeus suggested. Complex incentive solutions create confusion and misunderstanding. Complexity produces lack of clarity and direction—a deathblow for incentives and the business case for using them.

Tactic: Make sure incentive plans meet criteria of the elevator speech—you can explain the plan to a participant as you ride from the first to the 40th floor.

How many of these dysfunctions do your incentives suffer? Most companies have more than one from time to time.

Many companies—and maybe your company—are challenged to improve their performance in 2002. Incentives should be part of the answer. And the importance of this priority becomes critical for 2003 if this year doesn’t get the results you need. Make sure your incentive designs are helping, not impeding, business results!

Schuster-Zingheim and Associates, Inc. Home Page

FOR FURTHER INFORMATION CONTACT
Schuster-Zingheim and Associates, Inc.
1541 Bel Air Road
Los Angeles, CA 90077-3021
Phone 310-471-4865 FAX 310-471-4859
E-mail: sza@schuster-zingheim.com
Web Site: www.schuster-zingheim.com or www.paypeopleright.com

All material © 2002 Schuster-Zingheim and Associates, Inc.

	*Autopayment—After a time some incentives payments become "the way it’s done here"—not yet entitlements, but repeatedly generated awards with no strategic re-thinking. Goals are not annually reviewed, alignment with business direction is unchecked, and payments continue with little understanding of the business roots on which incentives are based. So the company does not receive benefit from the dollars expended. Tactic:* Start with the business plan and see if incentive metrics and goals cascade from it. Make sure incentive metrics and goals are aligned with new business initiatives.
	*Measurement Shrinkage—Focusing on past performance only shows you where your company has been—not where it must go. Companies that merely try to outperform their last documented performance sometimes lose out because competitors are doing better. Tactic:* Look beyond your own company’s performance to customers and competitors to see what metrics and performance standards to consider.
	*Entitlement—People can be conditioned to expect an award every year, either as a result of too-easy goals or because of exceptions that excuse performance and grant an award anyway. Participants view changes as takeaways. So incentives are seen the same as base pay—something people get year after year without concern for results. Tactic:* Communicate that the plan will change because of continuous improvement (of incentive design), learnings, and changes in business goals and directions. Build a clear business case for changing the plan. Provide upside incentive opportunity for exceeding goals and set goals so that exceeding goals does not always happen.
	*Eroding Shared Goals—Most companies are driven by goals that are shared by a number of people. Few individuals acting alone can impact the performance of a company of any size. Yet many individual incentive solutions have metrics that help erode a sense of collaboration and team commitment. Such situations create internal competition for resources and awards at the expense of overall organizational performance. Tactic:* Ensure that all organizational levels of performance—individual, team, business unit, company—are addressed in some element of total rewards and that the incentive plan optimizes, not suboptimizes, performance at the higher organizational levels.
	*Hierarchy—In many companies, impact on company performance simply isn’t hierarchical—from top to bottom. Some key performers are not managers, and many managers are not key performers. Incentives are often designed so the opportunity for awards increases from lower in the organization hierarchy to higher. This rewards moving to an administrative management position to become eligible for a larger incentive. Tactic:* Determine incentive opportunity by considering role impact since some nonmanagement jobs may actually be more important from an incentive standpoint than management jobs.
	*Copycat Designs—When IBM was at the height of mainframe performance, its sales incentive plan was copied by many companies—whether or not it fit their business and selling situation. When IBM’s performance sagged, many immediately moved on to copy the incentive solution of some other successful company. Benchmarking has sometimes transplanted an incentive approach from a company where it might have belonged because it fit to a company where the fit was not right. Tactic:* Use what you learned from benchmarking to build a better plan so that you get a differential advantage over your competitors.
	*Complexity—Too many metrics, too many goals, and too many rules create "Too many notes, Mr. Mozart," as the film Amadeus suggested. Complex incentive solutions create confusion and misunderstanding. Complexity produces lack of clarity and direction—a deathblow for incentives and the business case for using them. Tactic:* Make sure incentive plans meet criteria of the elevator speech—you can explain the plan to a participant as you ride from the first to the 40th floor.

	Communications—Start the incentive repair process by broadly communicating about what went wrong in 2001 and so far in 2002. What, why, and how goals were missed, and what the company will do about it in 2003 (and maybe for the rest of 2002). Tell people a new incentive solution is in the offing. It’s time to re-state the business case for incentives—why your company has them, how they add value to the business, and what you expect them to do for the remainder of 2002 and in 2003.
	*Measurement*—Business measurements are important for the rest of 2002 and critical for 2003. How will the company judge itself? If the company missed its goals in 2001 and so far in 2002, what are you going to do to achieve the 2003 goals? Does your company need "new goals" for the remainder of 2002? Are new metrics necessary, for example, adding metrics that are closer to the employee’s line of sight? Do we need to not only get the results we want but also rebuild credibility for incentives?
	*Upside Opportunity*—What’s it worth to get the company going again? Are you willing to pay any incentives lost in 2001 and perhaps in 2002 for much improved 2003 performance? It may be well worthwhile to energize incentive participants to help you generate the outcomes you need. How about granting more options if the company meets its performance goals? While re-pricing options is probably out, new options may be possible to help people understand that the company will be on the right track again soon.
	*Reasonable Thresholds*—It’s not good to miss incentive payouts two years in a row. Even if incentives failed for the right reasons, pressure on base pay will increase if total cash (base pay and incentives) falls much below what competition offers for similar jobs. The performance hurdle at which incentives first pay rewards might be adjusted to get people back into the incentive compensation game again. Remember that it’s much cheaper to pay a small incentive than it is to grant a base pay adjustment. You can’t easily get base pay adjustments back if performance slumps again.
	*Achievable Targets*—What are your company performance expectations for 2002? Are you meeting them following 2001? Now remember, you got derailed in 2001 and may again in 2002. If the reason incentives didn’t pay off in 2001 was poor setting of target goals (where business plan is achieved), it’s critical the target is achievable for 2002—and essential for 2003. Goals can be a stretch, but it’s important to tell why the goals are what they are and how they can be achieved. Achieving business plan can’t just be wishful thinking—people with incentives based on goals need to have reasonable expectations of being successful.
	*Sponsorship*—Leadership must be out front showing the way. Incentives need sponsors whose own financial incentives assure others they have some skin in the game. The sponsor should have like incentive metrics compared to everyone else. People at the top need to be the primary champions of the incentives (or new stock options) in 2002. And if you miss 2002, clearly in 2003.
	*Communications*—Again—and again until the message is clear, understood, and accepted. It’s critical to keep the information coming, not only when the incentive plan is kicked off but at least quarterly and ideally monthly all year long. The only reason for incentives is to communicate key goals and directions. This means maintaining two-way information flow—both gathering information from incentive participants and responding back with information that makes it possible for them to achieve goals and earn incentive awards.