How to develop a new pay plan

Care to step onto a business-version of a land mine? Try to make sense of the economically sensitive and emotionally loaded topic of pay.

Pay is a subject loaded with emotion because it communicates an individual's value to an organization and describes a cornpany's commitment to its employees. Employees' attitudes about the fairness of pay affect their motivation and productivity. Yet businesses trying to compete in the marketplace and provide profitable returns to shareholders are under constant pressure to keep pay in line.

The ability to attract and retain quality employees who add to your bottom line depends on your ability to craft an attractive compensation package. The traditional "salary-plus-bonus, seniority-based' pay strategy is on its last legs. Fortunately, a variety of "new pay" options are offering business owners a wide array of new choices.

Since the 1980's a new paradigm of pay determination has emerged to reflect business trends including leaner flatter organizational structures, customer focus, quality improvement, re-occuring and team-based work structures. Companies have struggled for years to develop individual merit pay programs, but many have come to realize that employee evaluations are to subjective and bear little relationship to how well the company is doing in achieving its financial goals. Many executives have found that while their employees may he rated above average on individual performance and may have earned corresponding merit increases, the company is actually losing market share profits, or both. The challenge, then, is how to link individual and company performance in a way that will meet business goals.

Sharing the risks and rewards

The principal concept behind "new pay" is that individual performance and overall organizational success are, in fact. inexorably linked. What follows is that salaries and pay increases. which are derived from company revenues must be tied a least in part to productivity and performance improvement. New pay options shift a certain amount of bottom line responsibility onto the employees who also collect a greater share of the rewards of outstanding performance. But new pay strategies cannot be expected to succeed in a vacuum. Instead, pay determination should flow directly from a company's business plan. When the business plan changes, companies need to review their pay strategies, too.

A trend toward nontraditional pay programs, particularly among small and growing companies, has emerged over the past five to eight years.

Among the army of new pay strategies evolving within companies. the most prevalent right now are skill-based pay, team pay, and gainsharing.

Paying for playing

Skill-based pay systems reward employees according to the competencies they learn and use in the work setting. The highest value is placed on cross-trained employees who can perform multiple functions.

This compensation system parallels traditional merit pay in that employees are evaluated individually instead of as a team; however. raises are not automatic. Raises are granted only when the skills an employee learns and displays enable the company to avoid additional hires or realize other tangible benefits, such as better use of existing employees.

Skill-based pay systems work best in an environment where on-the-job training is emphasized: where he company's business goals are communicated among all employees: and where an effort is being made to promote a strong sense of ownership rather than entitlement. The critical task of human resources in a skill-based pay scenario is to establish pay levels that not only match identifiable skills across all job descriptions. but also reflect the button of an employees learned skills to the achievement of company goals.

Paying for winning

Team-pay systems place a premium on achieving specific, measurable goals, rather than on having employees display certain skills that may be used to achieve those outcomes. For instance, in a team pay system, groups of up to 10 employees work together to solve specific problems or to achieve benchmark improvements such as increased customer satisfaction. Bonuses then are awarded to individuals based on the performance of the group-providing that the team meets its objectives. A key difference between team pay and traditional merit pay is that with team pay, one employee's word affects another person's compensation. This underscores the importance or having every function within an organization contribute to the company's success in a measurable way.

Paying for playing nicely

Gainsharing systems encourage employees and managers to work together to solve problems of cost, quality, safety, or efficiency that lead to a monetary gain for the company. The company then shares the gain with employees, typically retaining 50 percent of the monetary gain and distributing the other half among members of the employee-management team. In a manufacturing environment for example, payouts for a specified gain would be distributed not only among the line workers involved, but also among employees within business units linked to production, such as purchasing, sales, shipping, and accounts receivable.

Compared with a traditional salary-plus-bonus pay structure, gainsharing over time tends to provide larger financial rewards to provide employees at a lower cost to the company. (Gainsharing systems have produced an average of 8 percent pay increases for employees, with companies realizing an equivalent benefit to their P&Ls.) Further, because employee payouts must be earned from year to year, gainsharing systems do not add to the fixed cost of employee base salaries, but instead are considered a variable expense.

Revamping your pay plans

As new economic pressures and social patterns add complexity to compensation issues, more companies, even small businesses, are looking to outside council for help. Before doing this however, ask yourself the following questions:

• What is your business plan?
  Unless the company mission and goals are clearly articulated, it will be difficult to develop a compensation strategy to support them. Companies also need to understand what kinds of workers they will have in determining the companies future.
• How do we want to pay in comparison to our competitors?
  Knowing what your competitors pay their employees will better position your company to develop a strong recruiting message, regardless of how it pays in comparison. Companies that cannot afford to pay at or above the market average for base salaries may be able to offer rapid advancement, access to training. or bonuses and long term incentives instead. In fact, a growing number of highly skilled managers are leaving large corporations and substantial salaries behind in favor of the hands-on challenges and ownership potential offered by small companies.
• What activity do we want to reward?

  If your company's business plan calls for an empowered, customer-focused workforce organized into self-directed teams, its compensation program should reinforce that goal by asking employees to help determine their own performance targets and how they will be paid for achieving them.

• How much pay should be maintained as fixed cost, and how much placed at risk?

  The amount of pay at risk(pay that is tied to team or company performance) will vary depending upon an employee's position within the organization. Employees at lower end of the pay scale cannot afford to place much pay at risk, but more substantial incentive pay helps motivate those with greater bottom-line responsibility.

• What percentage of total pay should be distributed annually versus long term?

  More companies are adopting long-term employee stock ownership plans (ESOPs)or, in companies that are not publicly traded, phantom share plans, that reward employees for increasing shareholder value. The value of shares awarded to employees generally ranges from one half of base salary for lower level support staff to four or five times base salary for top executives. However, if the company cannot afford to pay competitive base salaries or annual bonuses, those multiples should be increased to reflect business conditions.

Finally, when developing a new compensation plan, seek input from participating employees. This proposition may be uncomfortable to think about, but asking employees how they would like to be paid can unearth some surprisingly creative - and often workable- solutions. For example, in 1993 I was approached by president of a medium-sized, heavy equipment dealer here in the Midwest. He said that his five departments were not working together. Each department was meeting its goals but company profits were not increasing. A meeting was held with the president and the five department heads. We learned that since their bonus plans were tied only to department performance, there was no reward for interdepartmental teamwork, nor were their performance goals attached to company profitability.

After several more meetings, we scrapped the old bonus plan entirely, disposing of all department targets, and instead, we crafted a new plan that rewarded sales volume and profits company-wide with bonuses payable only after the owners had received at least a 5 percent return on invested capital. By the end of the first year, the company had exceeded its sales targets by 30 percent and its profit targets by 50 percent. The executives doubled their bonuses.

Clearly, pay systems that require individual and team contributions to overall company performance are here to stay. For companies, new pay systems offer greater control over costs and profits, along with more ways to attract and retain top-notch employees. For employees, new pay means more responsibility for personal income, along with monetary and psychological rewards gained by contributing to the company's success. -CRV

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