A Better Approach to the Bonus Question by Mike Higgins, Sr.

A Better Approach to the Bonus Question

Growing businesses need unique yardsticks to determine which employees get how much extra at the end of the year

Entrepreneurs intent on building successful companies are largely committed to rewarding
exceptional performance, but too oftentimes, the basis for reward is misguided, resulting in significant expense being wasted. For example, 97% of all business managers are rewarded to maximize annual earnings.  If management teams did what they were rewarded to do, they would not invest in people, systems, products, facilities, and improved service, because those investments do not improve first-year earnings. Rather, those are investments for earnings over the long term and at the expense of annual profit, so it would result in reducing their bonus.

Welcome to the downside of the traditional performance-based method of compensation: the bonus. Two decades ago, when I was CEO of a community bank, I began to realize that the traditional bonus did not align with creating long-term owner value. Instead, it rewarded short-term annual profit at the expense of long-term owner value.

WINNING DISCIPLES. The day-to-day challenge of operating the bank prevented me from doing much about it at that time.  However, when I started my consulting firm in 1983, I had become so frustrated about traditional reward programs that I spent two uninterrupted weeks devising an entirely new concept. In that process I identified 14 differences that had to be introduced to create a system that was relevant to creating long-term owner value.

Initially, it was difficult to interest my clients in this unique approach we now call "Stakeholders." After applying the concepts to our company successfully, we tested various elements of it in eight client companies for over five years. Their overwhelming success convinced the marketplace it was the right thing to do. To date, we have transferred it to more than 500 small entrepreneurial companies.

Simply put, the Stakeholders concept requires a shift in thinking on the part of the entrepreneur. All participants have significant untapped potential -- 50% to 85%, according to human behaviorists' studies. All who contribute to the enterprise must be respected as
having a significant stake in their work, literally a personal stake.  Employees who learn to think, work, and achieve like owners deserve to be rewarded like owners.

KEEPING SCORE. With that philosophy as the backdrop, the issues raised above can be addressed from a wholly different perspective -- that the traditional bonus-based reward system is misguided. If the management team is to assume that all are owners working toward a mutual goal -- to create value over the long term -- it must first convey that thinking throughout the organization and educate those who don't understand. One statistic suggests 92% of all business employees do not know what a profit margin is, much less how they contribute to it. If the players don't know how the team keeps score, it is impossible to even begin to think in terms of maximizing their potential much less the company's potential.

The matter of maximizing value over the long term means that management must set goals, not only for sales, but also for the organization's three other vital signs: profit margin, quality and efficiency. When people are rewarded for balancing these four vital signs, everyone will
demand that sales result in the most efficient delivery of a quality product at an acceptable margin because that creates the biggest bonus.  (And, by the way, it creates the greatest long-term value for the owner).

In addition, the goals need to be examined according to a mathematically weighted formula of Key Performance Indicators. Rewarding for the various levels of achievement of balancing multiple quantifiable goals enables the organization to eliminate entitlement, favoritism, and the cult of the superstar.

FREE HAND. The Stakeholders concept goes a long way toward correcting the glitches in the traditional bonus system, and is especially applicable to entrepreneurial organizations, which, by definition, must get results fast if they are to survive, let alone thrive. What's more, independent-minded owners who needn't answer to layers of management can more easily and comfortably adopt the program.  In short, it is a more effective method of compensating for performance. What follows is a look at its major components:

Philosophy, Participation, Literacy. All of the company's constituencies are owners -- indeed, stakeholders -- whose ultimate goal is to maximize company value and satisfy customers. All will clearly understand how their individual work contributes to this end.

Balance. The four vital signs that determine the type of growth that leads to reinforce long-term value -- sales, profit margin, quality and efficiency -- are in balance when goals are set.  All constituents aim, for example, to increase sales without sacrificing margins, quality or efficiency.

Standards. A baseline level of performance that reflects the four vital signs is first established. Baseline represents a level of performance to justify base salaries and benefits.
Performance-based compensation is tied to results achieved over baseline at every level: the company, each business unit or department, and individual.

Integrity. Arbitrary goals have no place in the program. Instead, goals are determined by mathematically based metrics, enabling the elimination of entitlement and favoritism. Technology eliminates the administrative burden required to facilitate the metrics.

Limits. There aren't any, because rewards aren't capped. If the business experiences especially fast growth, all who have enabled that growth are compensated accordingly. However, all participate in penalties to the reward pool for achievement below baseline in any of the four vital signs.

Alignment. Just as sales goals are aligned with the ultimate objective of increasing corporate value, various level of sales are benchmarked against relative expense control rather than a single expense quota -- and thus, are in sync with reality.

Even in a tight labor market, entrepreneurs must get fledgling companies off the ground and drive growth with the talents of high-performing people. Everyone can perform to the fullest extent of their capabilities if they understand they have a stake in their workplace, and if they are taught to think, and therefore work, like owners.

Adapting a performance-based compensation program that aligns talent with the company's ultimate need to create long-term value -- and that compensates accordingly -- is its most effective motivational strategy. The Stakeholders approach empowers!

Michael T. Higgins founded Mike Higgins & Associates, Inc. in l983 and now has offices in Lincoln, Nebraska, Kansas City and Orange County, California.