"STAKEHOLDERS": Reinventing Entrepreneurial Performance Compensation
Michael T. Higgins, Founder and President, Mike Higgins and Associates, Inc.
Entrepreneurs intent on building successful companies are largely committed to rewarding exceptional performance, but often the basis for reward is misguided, resulting in significant expense being wasted. For example, 97 percent of all 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 one-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 bonuses.
Welcome to the downside of the traditional performance-based method of compensation: the bonus. Over two decades ago, when I was CEO of a community bank, I realized the traditional bonus did not align with long-term owner value. Instead, it rewarded short-term annual profit at the expense of long-term owner value.
The day-to-day challenge of operating the bank prevented me from doing much about it. However, when I started my consulting firm in 1983, I spent two uninterrupted weeks devising an entirely new reward concept. In that process I identified fourteen differences that had to be introduced to create a system 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 600 small entrepreneurial companies.
Simply put, "STAKEHOLDERS" requires a shift in thinking on the part of the entrepreneur. All participants have significant untapped potential, 50-85 percent, 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.
With that philosophy as the backdrop, the issues raised above can be addressed from a wholly different perspective—the traditional bonus-based reward system is misguided. If the management team is to assume that all are owners working toward a mutual goal—creating 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 percent of all business employees do not know what a profit margin is, much less how they contribute to it. If the players do not 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.
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.
The "STAKEHOLDERS" concept goes a long way toward correcting the glitches in the traditional bonus system, especially in entrepreneurial organizations, which 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, "STAKEHOLDERS" 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.
The four vital signs that determine the type of growth that leads to reinforces 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.
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.
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.
There aren't because rewards aren't capped. If the company 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.
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 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 performance-based compensation program that aligns talent with the company's ultimate need to create long-term value—and that compensates accordingly—is that company's most effective motivational strategy. "STAKEHOLDERS" empowers!