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Improving Profits Through Higher Employee Compensation

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If you were to ask most business owners or executives how they feel about compensation paid to employees, for the most part they will answer, "part of the cost of doing business" or "my biggest expense," or even "the cost I fear the most."

There is, however, a group of owners or executives who, while agreeing with the importance of compensation, have instead viewed it as a catalyst to improve profitability—i.e., as an opportunity cost as opposed to a lost cost.

My first exposure to this new vision came almost 20 years ago upon my entry into the turnaround business. I became the president and chief operating officer of a fast-growing, almost bankrupt corporate travel and fulfillment company.

It was clear from the outset that the basic core business was sound, but labor costs, which made up more than 50 percent of operating expenses, seemed uncontrollable. I immediately keyed in on this area and began to question how we could stabilize these costs, improve productivity and at the same time enhance the net profits. Over the years, I had read many stories of successful companies that rewarded employees with all types of stock options in the hope that one day a big payoff would come. However, we were a small $50M service provider, entrepreneurially owned, trying to create a market niche and enterprise value at the same time.

As we examined our employee profile, I concluded that the most important issue for our employees was cash. In fact, the average employee in any company, even with two wage-earners, struggles on a monthly basis to make the car and house payments, put braces on Sally's teeth and save a little for a rainy day, college or retirement. Options or equity-kickers are long-term issues and do nothing to improve the current quality of life or cash flow.

After careful analysis, I concluded that the best thing we could do was to find a way to incentivize the employees so that through their efforts, if our bottom line improved in excess of our expectations, we would repatriate back to them on an ongoing basis a portion of the excess earned. In effect, we were creating a "gain sharing" relationship between the owners and employees.

Prior to that time, like all of us, I had seen many annual bonus plans that were discretionary or were tied to the famous "Christmas bonus" concept, where each year everyone waits with baited breath to find out how many weeks or day's pay he or she was going to get. I knew that in order to be successful, a plan had to be achievable, quantitative, meaningful and, in my view most important of all, distributable with some degree of frequency.

Our plan had three key components: fair, frequent and formal.

Fairness

My previous experience had shown me many companies where bonus plans were set out with the bar so high that it was almost impossible to reach or, if achieved, it came at the end of the year and there was little or no value. These plans, while well-intentioned, generally create a negative attitude and are discounted by the employees before their first dollar of revenue is earned.

I decided to make sure that even under only the most modest of levels of success there would be some value of gain for the employee group. I therefore looked at our anticipated and budgeted goals, taking into consideration our reasonable expectations based on the current wages we were paying, and then adjusted it downward less than 10 percent so that somewhere in the 90 percent range of achievement, a small amount of bonus could be earned. There is some treachery here in that you could pay for results that are less than satisfactory, but I submit that any good owner, executive or turnaround specialist could set the minimal bar at a level that would encourage rather than discourage commitment to improvement.

Frequency

This is the area where many of the arguments against gain-sharing plans start to kick in. How many times have you heard, "We have to finish the year before we can calculate this year's bonus." Really—why is that? A well-managed business certainly has budgets and/or projections on a monthly or at least quarterly basis. Why can't the measurement period be less than a year? Why not set shorter-term goals and reward as those goals are achieved? Give the employees the sense that their efforts are improving profits today and that they don't have to wait until Christmas to get rewarded. The more frequent the distribution, the more important the bonus becomes to the employee group. The fruits of their labors are rewarded as they accomplish the goals that have been set, and their reward is current.

Each month we set our parameters, monitored our accomplishments on a daily basis, transmitted where we stood on a daily basis and created a daily focus for that month to be a winning month. By the last day of the month we generally knew what that month's bonus pool would be, and by the next check the cash was in the hands of those who had earned it.

There are many who challenge the frequency concept. There are all types of arguments, including, "Why would I reward for only one month that exceeded expectations?" That's a reasonable argument, except that I believed that the more they saw of the cash, the harder they worked toward improving our performance. I was willing to run the risk that they would get passive, and it just never happened.

Formality

Here is where the rubber meets the road. There is nothing worse than a plan that is discretionary and left up to the goodwill and whim of owners or executives. A good plan should be well thought-out based on what a company may be looking to drive. Profits are not the only criteria.

I knew what we were looking to accomplish and understood our key drivers. Since we were essentially in the ticket-sale business, our profits were directly correlated to the number of airline tickets sold in a given month. I also knew what the average ticket sale was and our related commission. Carefully building a fixed- and variable-cost model, I knew at each ticket-sale level what our profits would be, then, using the fairness criteria, set our bonus on the number of tickets sold in a given month, seasonally adjusted and modifiable if the average sales price changed.

Through the use of lighted message boards and daily memos in our reservation centers, I posted the number of cumulative tickets sold and where we stood in relation to our goal for the month. I controlled the baseline on a monthly basis, and our employees understood that if costs went up via raises or other matters, including carelessness, that I would adjust the monthly standard to provide ownership the minimum return we deemed acceptable.

The data we shared with our employees was general yet specific enough for them to understand how I arrived at the bonus amount. To further incentivize the employee base, I implemented a "put and take" pool as well. For example, since Mondays and Fridays were our most important days, I put a fixed dollar amount into the pool for every Monday and Friday that everyone who was supposed to be there was there. I was amazed. People literally crawled to work so that they would not be the one who prevented the additional pool contribution. I had other additive factors based on letters received from customers and other events.

On the negative side, I had takeaways as well. Here is where we really got creative. Since everyone (except owners) in the company participated in the pool (sharing was based on a numerical measurement for each level of employee), I had the employees elect one person from each level to form a team of evaluators. They were the ones who evaluated problem situations and made the determination how much the pool lost. They were far harsher than I would have been.

We deemed it critical that everyone in the company should participate at some level; the team spirit created when everyone pulls in the same direction produces extraordinary results.

The results of our plan were a dramatic change in attitude, productivity and profits. The amount paid out during the period of our ownership resulted in a geometric gain in profitability, which in turn established an enterprise value that resulted in a sale two years later that was far in excess of expectations.

Over the years, I have used similar plans in numerous turnaround situations, and I believe that in each case the improvement in performance and enhancement of value can in part be directly linked to the vision of compensation and its use as a tool to improve corporate performance. A successful turnaround is difficult to achieve. It requires the implementation of sound business practices and nimble and creative techniques.

I encourage each executive, owner and turnaround professional to consider the success that I have discussed and think about how they too can get creative and improve performance and enhance enterprise through the use of creative and innovative compensation schemes.

Journal Date: 
Saturday, September 1, 2001

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