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Can You Pass the Bonus Test?

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Business Management

Can You Pass the Bonus Test?

Profit-based compensation systems have the proven potential to motivate employees while increasing their focus on critical business issues such as revenue, cost control, profit, and customer satisfaction

By Scott Sedam April 30, 2004
Incentive compensation systems in home building
Can you really get employees to act more like owners? Sure you can! Profit-based compensation systems have the proven potential to motivate employees. | Image: mohamed hassan / Pxhere
This article first appeared in the PB May 2004 issue of Pro Builder.

I have been asked countless times, "How do I get my people to act like owners, not merely employees?" So let's play "You Be the Consultant!"

How would you answer the ownership question?

A) Have frequent meetings where you talk about the bottom line and how critical it is - but keep the details of how you calculate the bottom line close to your vest, where they belong.

B) Launch an "accountability crusade." Owners are accountable, so let's make everyone accountable. Repeat the A-word in every memo, meeting and conference call. Declare it "a condition of employment."

C) For each department and individual, create incentive plans that, while not tied directly to profitability, are based on what experience tells you are the most critical success factors in your company.

D) Implement an open-book, profit-based incentive system in which every employee has a direct financial stake in the company's success.

E) None of the above.

Ownership Behavior

OK, my turn. Choices A and B simply cannot produce "ownership behavior" because they don't tie most employees directly to the company's financial success. You can talk about the bottom line and accountability every day, but without a direct financial link, you won't maintain your employees' focus for long. With the unprecedented 12-year boom in home building, the old "you get to keep your job" speech no longer inspires. Of course, it's not only about the money, yet the power of a financial incentive to grab and keep people's attention is undeniable.

You can talk about the bottom line and accountability every day, but without a direct financial link, you won't maintain your employees' focus for long.

With choice C, we add the bonus, but it's not tied directly to profitability — a fatal flaw. These plans are notorious for fostering "suboptimization," whereby individuals and departments succeed and get the payoff without the whole company succeeding.

Choice E generally means you do nothing — other than lament your frustration about unengaged associates. It's the old refrain: doing the same things the way you've always done them and expecting different results. Einstein called this insanity.

All that's left, then, is choice D, which is definitely the road less traveled. It takes guts, it takes trust, and it means going places you haven't gone before. But provided you can build a company culture that fully supports it, there is one other thing about choice D — it works.

Compensation Incentives and Results

I won't suggest that this is easy. In fact, I once knew a doctoral candidate in organizational behavior who needed a good dissertation topic to dramatically illustrate the impact of systems on human behavior. I suggested she study incentive compensation systems in the home building industry. I know countless horror stories, and so do you.

So let's be honest. Stare your incentives straight in the face and ask, "Are these incentives truly generating the results they were intended to produce?" While it's a good bet that every incentive plan, including yours, was conceived by well-intentioned managers who genuinely believed that the plan would help the company, it's an even better bet that most of you are less than thrilled with the results.

How Do You Get Employees to Act More Like Owners?

So, can we really get employees to act more like owners? Sure we can. Profit-based compensation systems have the proven potential to motivate employees while increasing their focus on critical business issues such as revenue, cost control, efficiency, profit, growth, product development and even customer satisfaction.

These are enticing goals for everyone, but take a deep breath and a word of caution. A profit-based incentive system isn't for sissies. Over the years that I have worked on such systems, I have developed 10 key criteria to judge the soundness of an existing plan or the odds for success of a new one. These should be treated like test questions, and this is pass/fail grading with an unfortunate catch. To pass, you must pass all 10. Fail one, and you fail the whole thing.

1) Strategic relevance: The incentive plan must be clearly in line with the company's strategic goals and thus contribute to long-term success. Plans that enable employees, especially senior managers, to engage in short-term suboptimization to increase bonuses at the expense of long-term company health will blow up in time.

2) Operational connection: Bonus plan success must be tied to the company's current operating goals - monthly, quarterly and yearly. Thus, you don't pay bonuses merely because you made money. You pay bonuses if you made money and ensured the company's strength the next year and the years after that.

3) Personal and departmental links: People must see their daily work as connected to company success, strategically and especially operationally. This means involving everyone in yearly planning at some level and having mechanisms to keep everyone tuned in throughout the year.

4) Fair and equitable: Participants must perceive the plan as a "fair game." This requires clear communication of the rules of the game and no messing with it during the year. If ownership judges the plan as fair but the employees are unconvinced, you still have work to do. Meaningful involvement by representative employees during the design of the system will go a long way toward solving this problem.

5) System transparency: The plan must be completely open in terms of the sources and calculation of the inputs into the system. It cannot be viewed as a mysterious "black box" that takes financial and operating inputs and magically spits out an answer.

6) Simple calculation: All participants must understand the plan or it won't be trusted. An open system can pass No. 5 but still be too complicated to be understood. When in comes to compensation, simple is not just better, it's mandatory.

7) Trust of the stewards: Without trust, the plan will not merely fail, it will make things worse. The participants must trust the people in charge of the system and the company. Facing this one takes unusually strong fortitude, and getting the answer you don't want to hear is painful. Yet if this is an issue, you have more problems than just your incentive plan, so you'd better deal with them now.

8) Significance of potential bonus: All parties must consider the amount of incentive compensation to be significant, with the potential to make a material difference in their income. I have seen system after system fail because senior management couldn't bear to give up "that much," even when it meant the top level would make more money than ever before.

9) Complete participation: Plan participation should be universal. This includes permanent part-time employees and anyone else who has been with the company more than 90 days. Or do you not want these people acting like owners? Don't expect to succeed if you have one plan for those at the top and a different one for those on the firing line.

10) Ownership and responsibility: Such plans require a culture that supports profit-based incentives as the way you do business. Employees must own the plan and the results, good or bad. They must participate in the system daily and drive the results, not sit at the back end of the system and hope it spits out numbers they like as if it were some kind of benevolent slot machine. Done right, the plan is never perceived as an entitlement; participants understand the risk of no bonus should the company fail to meet its goals.

You might wonder why I did not address employee stock ownership programs and other approaches to employee equity participation as routes to creating "ownership behavior." I used to be pretty high on them. Yet because of tax and business laws at the state and federal levels, they are a complete nightmare that few are ready to address. Trust me on this. Go with what we know works and requires little or no time with attorneys (always a good sign). Bring your people in on the best part of your business, your favorite part - participation in the profits. But do it with your eyes wide open. Take the test. The scary thing is that passing means you likely will give away more money. Imagine the implications of that.


Written By

Scott Sedam is president of TrueNorth Development, a consulting and training firm that works with builders to improve products, process, and profits. A senior contributing editor to Pro Builder, Scott writes about all aspects of the home building business and won the 2015 Jesse H. Neal Award, business journalism's most prestigious prize, for his commentary in Pro Builder. Scott invites you to join TrueNorth's Lean Building Group on LinkedIn and welcomes your feedback at scott@truen.com or 248.446.1275.

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