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By Carl Seidman, Principal at Seidman Financial
Getting a good compensation model is a key to attracting and retaining the best talent. But how can companies design the right bonus scheme — so they motivate professionals while protecting profitability? Let's explore the issues.
To attract top talent, companies need to present themselves as market leaders positioned at the front of professional development and innovation. Compensation is part of this. According to the Society for Human Resource Management, it's one of the leading drivers of employee satisfaction.
Companies today are more in tune with the psychology of employee motivation. They've also become more competitive in offering their unique selling points as employers. One form of compensation that has remained a critical motivating mechanism for revenue-generating roles: the variable compensation bonus.
Offering variable compensation to employees has two clear benefits:
Commission-only compensation arrangements in areas like sales largely insulate companies from poor performance. But today, companies with schemes like these are increasingly unable to attract talent.
When combined with a base salary and benefits, variable compensation attracts talent, provides a living or even a premium wage, and aligns compensation with professional achievement toward company goals. It is a win-win-win for all involved.
Frequently, I work with companies on their compensation models and see them looking to comparable market comps to provide indications of salaries at par and then adjusting them up or down to be fairer and more equitable. A similar approach may be taken in constructing a variable compensation program. This is a standard and well-accepted methodology.
However, some companies slip up by:
Companies do not need to create overly complicated compensation models to attract and retain the best talent. There's no need to involve countless metrics, customers, geographies, products, channels, or timeframes. Rather, variable compensation models should be straightforward for the company and its employees.
In my advisory experience, I often encourage organisations that variable compensation programs should be aligned with three key factors:
This is the first parameter of a variable compensation bonus. Employees should have their performance targets examined and reset each quarter or year. It's often helpful to have some degree of personal performance goals set by employees themselves — so the process doesn't create the impression that the company or its leadership dictates 100% of individual performance. Instead, employees set and take greater responsibility and ownership for at least some of their targets. In other words, there's buy-in.
Goals for a personal performance assessment might include measures of:
Overall, personal performance goals might have a hypothetical weighting of 40% of the bonus pool that could be attributed to a compensation model.
A variable compensation bonus should also consider employees' work within groups, departments, or channels — and how much they've contributed to the whole team's achievement. Like individual performance, most of these performance goals will be set by leadership. However, some of these goals should be set by the group's management with individual contributions. Again, this encourages personal and group buy-in.
Goals for group performance to factor into your compensation model might include:
We might apply a hypothetical weighting of 60% of the bonus pool to these group goals. This brings the total to 100% — once you add the individual performance goals we discussed.
Finally, company performance will play the most extensive role in variable compensation. If an organisation fails to perform financially, any shortcomings will be reflected in operating profit, and the bonus pool size will be reduced. If no funds are available, bonuses will not be paid — despite an employee's best efforts.
While HR may be in the position to design the kinds of models we've discussed, teams may not grasp the financial implications. Ensuring there's an appropriate allocation of Selling, General, and Administrative Expenses (SG&A) to meet performance compensation will often be the responsibility of FP&A.
When I've helped develop variable compensation models at more than a dozen companies, the process has required a triangulation between the company's objectives, HR, and the organisation's financial goals.
We've had to ensure the program:
So, let's assume a $75 million company anticipates an allocation of $2.5 million (or 3.33%) of revenue to the variable compensation bonus pool if the sales team exceeds its revenue target. The bonus pool will be distributed to individuals based on individual and group performance objectives.
If the company performs worse than expected, allocations will stay the same based on individual and group performance objectives. However, the $2.5 million allocation will be reduced to a more tenable $2.1 million to safeguard its profitability reasonably. The variable compensation program should flex accordingly.
In rare or exceptional cases, the leadership may choose not to reduce the bonus pool because leaders are so keen to retain sales talent that they might lose. Ultimately, this would lead to a lower operating margin, so leaders must be aware of the implications.
To summarise, HR should be encouraged to structure its variable compensation management model to best align with the company, group, and personal performance. It's vital to allow individuals to have some say in how they will be evaluated and at least some control over the variable portion of their total compensation. Any variable compensation program should also have insight from FP&A to help determine the impact on company profitability.
Failure to take these steps may result in multiple programs that fail. At best, this may result in a confusing set of incentives. At worst, this may result in a lack of alignment between everyday activities and objectives, a feeling of unfairness, employee disengagement and turnover, and margin erosion. In this way, HR and FP&A should be natural partners and allies in developing variable compensation programs.
The article was first published in the D!gitalist Magazine
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