Scaling Up Compensation, 5 Design Principles for Turning Your Largest Expense into a Strategic Advantage by Verne Harnish and Sebastian Ross
Recommendation
Ideally, you would reward people according to the value they bring to your company. But pay, benefits and incentives trigger emotions, making their design complex. Employees will think disproportionately about it unless they believe their pay is fair. Verne Harnish and Sebastian Ross urge you to build your compensation system to remove pay as a distracter. Through case examples, the authors show how a “total rewards” strategy aligns worker behaviors, decisions and actions with corporate values and culture.
Take-Aways
- To get compensation out of sight and out of mind, design it strategically from the beginning.
- Connect pay to your company culture and values.
- Focus on what employees do, not how much they cost.
- Compensate people equitably, not equally.
- Design incentives to attract, retain and motivate the right people.
- Include games and gainsharing in compensation.
- Use profit shares to incentivize employees to act like owners.
Scaling Up Compensation Book Summary
To get compensation out of sight and out of mind, design it strategically from the beginning.
For most firms, salaries, bonuses and other compensation represent a huge expense. Salary may not affect people’s motivation to work harder over the long term, but getting your compensation system right matters enormously.
Like every component of people management, compensation management delivers the greatest returns when leveraged strategically. This means structuring pay not equally but equitably, by recognizing differences in performance, skills and the value people bring to the firm.
Strategic compensation includes the extras beyond base salary – bonuses, commissions and other rewards. Tread carefully when designing “total rewards,” including incentive programs. People act and behave according to the incentives you give them.
“When money is at stake, people act more like a homo psychologicus than economicus.”
People react emotionally to pay. More than two-thirds of employees believe their firms pay them unfairly; three-quarters of employers believe the opposite – a clear disconnect.
Connect pay to your company culture and values.
Don’t borrow another firm’s compensation strategy; it won’t work in your firm. Every culture differs and your values differ, too. Leverage compensation to support your strategy, culture and values.
“Compensation is one of your largest expenses and, therefore, one of your most important strategic decisions. It requires careful thought.”
Consider Lincoln Electric in Cleveland, Ohio for example, where workers make welding products. They receive no paid sick days and can’t count on full-time hours. They get paid for what they produce, and if their product has flaws, they pay for the fixes. Lincoln attracts and keeps some of the best talent in the business. Why? Because top talent can earn more there than at rival firms – $80,000 annually on average. Lincoln values quantity of work and quality of product; it differentiates in these ways and has for decades.
Customers turn to Lincoln for reliability. Lincoln’s people processes link directly to customer satisfaction. Its approach to compensation reinforces its value chain, as it should. Its methods probably repel most talent. That’s worked well for Lincoln, because it wants independently minded, competitive, high performers.
To align your compensation strategy and other people processes with your values, define your culture. The Container Store, for example, built its culture around excellence in customer service and defines high performance accordingly. It’s hiring, training and rewards practices support the culture. Founders Kip Tindell and Garrett Boone pay about twice market rate. Top performers can earn multiples more. On average, The Container Store associates outperform their equivalents in other firms by 300%.
Focus on what employees do, not how much they cost.
Pursue a balanced hiring, onboarding and training strategy in designing your people systems and compensation methods. Spain’s TMC – a teleradiology firm – for example, emphasizes mutual respect, a team mind-set, knowledge-sharing and continuous learning to drive its values, which emphasize collaboration and quality. It requires specialized radiologists to audition for two days before hiring them, then they participate in a two-week onboarding process, followed by job shadowing. In support of TMC’s focus on quality and teamwork, physician pay varies only slightly depending on volume and location, and everyone knows how much their colleagues earn.
Higher than average pay, derived from contribution, coupled with other people practices that reflect an appreciation for talent as investments rather than costs, should drive strategy and success. Mercadona in Spain has nearly 100,000 employees across 1,600 supermarkets. It pays twice the minimum wage, hires selectively, and spends $5,000 training each new associate. Wages compound by 11% in each of the first four years and everyone gets six weeks paid vacation.
Mercadona spends more on its people than its competitors, but, after 40 years, remains three times as profitable as Walmart. Like The Container Store, Costco, Netflix, and others who pay above-market rates and treat employees well, Mercadona competes on productivity. One Mercadona employee equals three elsewhere.
Higher salaries don’t automatically generate higher productivity. They combine with elements of a broader, aligned people strategy that sets the conditions for high performance. Dan Price, CEO of Gravity Payments, for example, boosted minimum wages at his firm to $70,000 in 2014. Most observers were sure he would fail and his brother/co-founder sued Price for what he considered malpractice.
A few high-salaried officers quit, but Price’s employees responded with so much extra effort that the company tripled revenues between 2014 and 2019 – from $15 million to $50 million. Profits doubled, dwarfing Price’s extra payroll costs of $2 million.
Compensate people equitably, not equally.
Pay can demotivate, but not always motivate. Start-ups typically pay people what they can afford. But when your firm grows to a few hundred employees, design a structured and fair compensation system. Implement a pay structure early in your company’s life to avert problems later on.
“Management debt is incurred when you make an expedient, short-term management decision with an expensive, long-term consequence.”
Stay flexible, make exceptions when you must, but structure your system according to:
- Competencies – Set pay on skills levels and grant raises based on new competencies acquired. Don’t pay for years of service; pay for the skills and abilities you need now and in the future.
- Performance – Average out performance over years, not weeks or months. Pay more for consistently high performance over long periods of time.
- Market value – Most firms benchmark compensation and rewards against what others pay for similar talent. Cisco, for example, aims to pay in the top 25% of the market.
Determine a pay structure for managers/leaders and another for individual contributors/non-managers. Each should have several stages of pay and three bands within them – low, medium and high. You may, for example, have five pay levels in your leadership track, coordinator to CEO. You might have seven levels for non-managers, novice to master. Bands should overlap; the high range in one matching the low range for the next. Your senior non-managers should earn pay equivalent to mid-level managers, or you run the risk of pushing non-leaders into management.
Whatever your compensation philosophy, aim for fairness, including a living wage for your lowest-paid employees. Your best performers can easily triple the output of your average performers, so pay accordingly.
“Structure should produce Fairness, but not Sameness.”
Paying people the same only seems fair in the aggregate; your best performers will find that punitive and unfair; they’ll leave.
Design incentives to attract, retain and motivate the right people.
Fully 90% of US firms use rewards beyond base pay to motivate employees and influence their behaviors, decisions and actions. Though this amounts to only about 5% of total compensation, it can have an enormous impact – positive or negative. Design incentives to attract and keep the right people, to signal the firm’s priorities, and to encourage extra effort. Incentives work, but poorly-designed rewards can backfire and/or build extrinsic motivation at the expense of more powerful intrinsic motivation.
“A wealth of research has shown that financial rewards can have a positive effect on performance. Large meta-studies show strong correlations between financial incentives and the results of people’s work.”
Financial incentives drive your culture and values, and support your corporate strategy. Keep them simple and comprehensible to the employees you seek to motivate. Make sure employees can’t game or cheat your program. Use incentives when you have crystal clear goals and can easily measure the performance or behaviors you seek to encourage.
Under the right conditions, incentives work well, especially for sales teams. In Los Angeles, Dan Caulfield, CEO of a home automation firm, for example, wanted to stand out in the high-end market where people spend half a million dollars or more on their home technology platforms. The firm offered detailed home automation plans at $1 per square foot. Caulfield rewarded his salespeople 50% of that fee. Homes in the target market range over 10,000 square feet, so the commissions were thousands for each plan sold. Salespeople sell lots of plans, and homeowners almost always give the installation work to the firm afterward. These projects average $1 million.
Make bonuses and commissions significant and tailor them to your best performers, placing no cap on what they can earn.
Include games and gainsharing in compensation.
Moving firms pay insurance companies to cover them against breakage. At MiniMovers in Australia, for example, founder Mike O’Hagan wondered why he should give money to an insurance firm when he could use it to reward his movers for not breaking things. O’Hagan’s simple but genius scheme has worked brilliantly for the past 25 years, making him, workers and customers happy. This gainsharing gives movers every incentive to teach new employees how to avoid breaking things. Other than gearing the hiring system toward careful movers, O’Hagan doesn’t have to do a thing; his incentives align his workforce and his interests.
Back at the LA-based home automation firm, Caulfield lets customers keep the final 10% of their bill if they don’t like anything about their installations. If they pay, Caulfield shares that 10% equally among everyone in the service chain. On a $1,000,000 installation, for example, $100,000 puts a fat check in everyone’s pocket, even if 20 people share in it. This aligns incentives with Caulfield’s highest priority – happy customers.
Team-based rewards means peer pressure keeps people honest and hard-working. At Hilcorp, an oil and gas firm in Texas, for example, CEO Jeff Hildebrand offered every worker a $50,000 car voucher if reserves doubled in four years. They did, and he paid. Next, he offered $100,000 to everyone if they could do it again in five years. He paid again, happily. In Hilcorp’s culture, teams and collaboration matter most, so everyone got the same $50,000 and $100,000 regardless of position or rank.
Gamify rewards by making incentives smaller, novel, more frequent and surprising. Include entertainment, dining, travel and other non-cash rewards to add emotional impact and memorability.
“Research indicates that non-monetary rewards have a more substantial impact on performance than monetary rewards of equivalent value.”
A well-selected gift touches most people more than cash. Frequent, irregular and surprising rewards trigger more dopamine spikes than other types of rewards. At the Home Shopping Network, for example, call center reps who make sales get to go to the center of the floor and spin a big wheel. Where it lands determines their prizes – from movie tickets to flat-screen TVs. This increased sales by 250%.
Use profit shares to incentivize employees to act like owners.
When Outback Steakhouse wanted to grow quickly, it recruited managers willing to front $25,000 of their own money invested over four years. In that time, Outback poured resources into training and supporting those managers. After five years, those who remained and met their performance goals received $100,000. If they remained another five years, they received another $500,000. Eighty percent stayed for a decade versus an average industry turnover of six months. Outback’s parent company grew into the third-largest restaurant chain in the country and one of its highest performers.
Don’t expect workers to work harder for stock options or profit shares; those rewards arrive too far after the action. Profit shares signal what’s important, impacting behaviors, decisions and actions, and aligning worker interests with those of owners. Stocks and the promise of year-end profit shares boost retention. Align what you do with your values and culture, and aim for fairness in distributing options and profits.
About the Authors
Verne Harnish founded Scaling Up and the 16,000-member Entrepreneurs Organization (EO). Sebastian Ross is the Director of the School of Founders Program at IESE Business School.
