Maybe It’s Time To Do A Compensation Study

Price is what you pay; Value is what you get. = Warren Buffett, Chairman, Berkshire-Hathaway

What is value? What is fair? Your key people are underpaid. Your key people are overpaid. Your key people may be looking elsewhere. Or, maybe they are happy. Maybe they feel they are being treated well already. Maybe you don’t know they feel they are underpaid. How can you be sure of anything when it comes to employees and their compensation?

Lots of wondering, lots of maybes.

I’ve always described setting compensation levels as similar to trying to negotiate the purchase of mattress, a diamond or insurance. You have the sense that there is a ballpark range of “fair price” but you always feel that if you’re the buyer (the employer) you’re paying too much, or if you’re selling (the employee) you’re selling yourself short and could probably get the buyer to pay more.

Supply and Demand. In certain industries where employees are in high demand and short supply, for example, people to climb cell towers, work on tall structures, or work in potentially dangerous energy infrastructure, employers must develop a comfort level for paying more than what they perceive to be the “value” of the position, or, market rates. Market can have many variables – not the least of which may be geography. In other roles where supply of talent is commoditized, following the rules of economics and supply and demand, prices fall.

One of the major challenges (and opportunities) is to find the best people your company can afford and pay them fairly so that they want to work hard, develop, bring solutions, innovation and productivity to your company, and stay and be happy and contented. People are an essential ingredient for growth.

In orchestrating many restructurings and turnarounds, and in managing some merger and acquisition “PMI,” (post-merger integration) I’ve witnessed the incredible volatility and inconsistency of compensation levels.

For example, one energy company’s “directors” were compensated in the $150-$180K range, where a direct competitor’s VP’s were in the $120-150 range.

It made for a challenging post-close environment when these two companies merged, where there was great disparity in what people were paid, and thus, what relative value was ascribed to what they do day to day.

In another instance, a company owner had to pay a key salesperson more than the top three executives in the company in order to have that person bring a book of business and generate customer-specific sales.

When geography is a factor, say, a company from Alabama or Florida buying a company from New York, New Jersey, Connecticut, there is sticker shock. The same $42K position in Jacksonville is a $72K position in Jericho.

It’s not an exact science. But, the process of paying people what they are truly worth should be fair, equitable, and sane.

Putting this in the category of “things companies should do but don’t,” many companies need to periodically hire an compensation and benefits expert to conduct a formal comp study, not only to compare how the company’s comp and benefits for each position stack up against competitors, but also to develop a market-based hierarchy for positions.

In small and middle-market privately held companies, there are generally two extreme comp-cultural scenarios.

1. The Culture of Austerity and Benevolence. Owners and senior managers have taken away from themselves in order to keep directors, managers and field/contact employees happy. Many mid level and project management people are overcompensated for fear that they will leave and either damage, or take, valuable customer relationships. Owners keep too many people on the payroll during slow periods, and in extreme cases, write personal checks to keep the employees around, hoping for a rebound.  Employee-centric.
2. The Culture of Excess and Selective Rewards. Employers and senior managers are taking the lion’s share of payroll and SG&A is far too high for the size and scale of the company. The “direct” employees who are most involved in doing the work and generating associated revenue are paid below market. (Think Michael Douglas’ shareholder meeting speech at Teldar Paper in Wall Street.) When things get slow, often these companies make the mistake of cutting direct, revenue generating positions and keeping top heavy senior management teams in place.   In addition, bonuses are often confined to upper levels and generally not tied to anything specific. Management-centric.

A good compensation study can also weigh other important factors such as span of control, and ratios of “overhead” (SG&A = Sales, General and Administrative) employees versus income producing, or “direct” employees such as field technicians, service employees, e.g.  For example, the study may ferret out areas where there are eight people supporting a project that only needs four, or there are 200 people on a second shift that only has enough work to keep 150 busy.

Sales Management and Compensating Salespeople. One of the age-old maxims in business is “never promote your best salesperson to sales management.” That’s sometimes true but not always, and it’s an oversimplification. It assumes that salespeople can’t manage, which is flawed, since a successful salesperson must manage their clients, their time, their employer, and themselves. While it is a different skill set, good people are flexible and can managed a variety of related challenges.

Compensating salespeople is tricky, but should be consistent with what the industry and size company call for, not whether the ownership group thinks that John is making too much, or Mary needs to be paid more so she doesn’t steal the XYZ Widgets account.

Sales managers and sales people should have their compensation be a combination of success and failure. When I say that, I mean that some of their compensation should be at risk, and they should be motivated and incented to behave in certain ways.

Skin In The Game. Ideally the compensation should be structured not only on gross sales, but needs to consider net income. Even gross margin is a flawed basis – see my post on The Gross Margin Trap.

So, the factors affecting comp should be as follows:

• Top line sales
• Bottom line profit
• Customer satisfaction
• New contacts/appointments
• Closed quotes – conversion rate from proposal to purchase order
• Year over year performance
• Developing/cultivating new markets

Likewise, slotting compensation levels for other areas of the company, from mailroom to CEO, need to have some parts of the total comp at risk, or tied to bonus, success marks and milestones, companywide performance and individual growth and development goals.

For example, the company may want to conduct performance evaluations/reviews quarterly instead of once or twice a year, and tie all of the employees’ personal and individual/company goals to collective bonus pools resulting from meeting topline and bottom line results.

A major failure point for companies is keeping employees in the dark with respect to the company’s financial and operating results, including metrics and KPI’s they should have input into, and be able to see. It’s like flying a plane in a nighttime storm without instrumentation. You can’t expect them to be effective pilots or race car drivers if you won’t let them see them the dashboard.

Family Business Issues. With respect to nepotism, often privately held businesses are stacked with employees who are siblings, in-laws, cousins, nephews, relatives by marriage, e.g. and they should be paid what the position is worth, not based on their mortgages, car payments or whether it’s the year to finally build the swimming pool. In addition, certain perquisites should be given to people whose positions warrant them (sales, operations, e.g.)

Some examples:

• Family members who don’t travel driving luxury cars paid by the company while the salespeople who drive 1,000 miles a week get $300 a month car allowances
• a $95K a year manager in a $70K a year position, paid a $25K premium because he’s a relative
• a low level employee/relative given a company vehicle to use exclusively - because he needed a new car
• certain family employees who did not contribute to the cost of their health plans, while others did, depending on family politics/hierarchy

Comp levels and benefits and perks need to be determined by the position and need to be consistent across the company so that employees who are relatives are as fairly treated and accountable to the same expectations as those who aren’t part of the family.

Cultivating Culture. A company attempted to develop its project managers by sending them for PMP training, paying for the training, and having the PM’s “win” by developing new skills, getting out of what I call the three-C zone (comfort/culture/complacency) and realize they don’t know all there is to know. It was met with mixed reviews and levels of interest and delivered mixed results. The most mature and open-minded individuals embraced the opportunity and the most self-assured and insular did not. The initiative was well received once the project management staff realized that there were bonus opportunities for improvement of top line sales and net margins, and that brought understanding and acceptance to the reality that comp levels were being scrutinized by management. In addition, putting performance income at risk makes people work harder to achieve goals and contribute to growth.

Make the Investment. This reinforces the importance of compensation design and why in order to cultivate a continuous improvement/best practices/growth and development kind of culture, there needs to be external validity given to the compensation levels and how employee performance is measured.

Of course, benefits are an important part of the overall package for employees at all levels and there should be a peer review to see what other similar companies (size, industry, margin and profitability) are offering. Sometimes there is a mismatch where benefits are extravagant but compensation is deflated, or comp is higher than market and benefit offerings are weak. Employees have varied opinions on the relative value of the overall package based on their life circumstances.

Compensation studies aren’t cheap but they are investments that pay off exponentially, and for the long term. Your company’s resources (payroll dollars) are precious and they should be optimized by allocating them where they belong. If your company is looking to institute fair and equitable comp and benefits plans, it should make the investment in an objective, industry-specific, market and region-focused study to determine what positions, and the people who currently fill them, are truly worth.

(There are several solid vendors with which to begin the process, but one great firm I would recommend is Compensation Resources, Inc.)