Rethink Compensation for Better Results

TL;DR - Pay your people based on their market value when it comes to salary. Use variable bonuses to incentivize performance, not salary adjustments

We get asked a lot if Ohos "maps" (or "integrates" to use a current buzzword) to compensation. And the answer is yes and no.

Yes, in that knowing who is driving your results in key areas more than others can help you create a better picture of their impact (and thereby value) to your organization.

And No, in that we believe you should NEVER use one measurement to direct compensation, even one as great as Ohos ;-)

But the fact is, the whole paradigm for company compensation models is broken or at least obsolete; at least in relation to today's work environment. The existing model is a modified version of a traditional tenure-based paradigm...with set salaries based on either tenure, performance, or a mixture of the two. It relies on salaries that are essentially guaranteed regardless of performance. It is an up or out system that encourages people to do better to get a raise, but then when someone fails to meet the expectation, we don't think about adjusting compensation to match performance - instead we fire them. It's a bad paradigm and ends in a slippery slope of unmet expectations.  So how do we fix it? How do we get better performance, better retention, and improve employees' satisfaction with pay. The simple answer: Transparency and flexibility when it comes to compensation.

Problems with a fixed mindset in a variable environment

The prevalent mindset around compensation is based on the fixed model of inflation, or overall economic growth...or the average. This model makes it easy to budget, but not very effective when it comes to motivation or actual talent needs for different businesses and roles. Basing a system on average growth assumes that supply and demand stay constant. When it comes to talent, they don't anymore. The fixed mindset of compensation says that once a year (maybe twice) we give you a raise to recognize you for your contributions.

Additionally, raises are often artificially capped based on the "average" raise people can get. Often cited is the idea of "internal equity" which is a short-handed way of saying "we can't give you that big of a raise because then others will expect it as well."  With a fixed mindset, an employee is limited to how big their salary can get (within a role) based on how well they negotiated their starting salary. It has nothing to do with market value and even less to do with variable contribution.

This old model presents a few obstacles:

  1. it does not account for people who RAPIDLY outpace their colleagues in terms of development, it assumes everyone develops at the same rate and can actually dis-incentivizes people from growing faster since there is no possible reward for doing so
  2. It can unfairly punish women and others who do not negotiate salary (women are 3x less likely to negotiate salary and even when they do, they are less likely to be successful.  
  3. It encourages a culture of disloyalty and turnover. When you pay external candidates based on market value, but only pay your internal people based on their previous salary (and the "allowable" raise %) - people start to realize that staying with you is hurting their earnings potential. 

What you should be doing is focusing on market value. Don't focus on the % of the raise, talk about salary equity (not raise equity.) A person is worth what the market will pay them, not your salary band. Salaries are as dictated by supply and demand as anything else, and smart employees know it. Basing salary on market data not only allows you more flexibility but also rectifies any unintended gender disparity when it comes to salary. Several companies - including Facebook - use a predetermined formula based on competitive market data to calculate salary...and there is very little room for negotiation (since that only rewards people for negotiation skills...which very few roles actually need.) Read more about their approach here.

The old way is out. Start doing more research, pay people fairly, and whether you post salary info about your people or not you should be able to defend it if and when salary differences becomes known. (And keep in mind it is ILLEGAL to forbid people to share their salary data....yes, ILLEGAL.)

Surprise people if you want surprising performance

When it comes to actually motivating better performance, managers need much more flexibility, education, and coaching on properly recognizing people. Annual bonuses are nice in regards to company performance but are too far removed from someone's actual contribution. Some companies do hybrid individual/company performance bonus calculations but the periodic and predictable cadence of those types of bonuses only serve to diminish any kind of link to recognition for behavior and therefore incentive to provide additional effort.

The ultimate challenge is most bonuses are often linked to financial planning, not individual performance and therefore are being run like any other fairly predictable line item on the budget. They are planned, calculated, and controlled by people in charge of maintaining the company's financial health. Financial health is great to work towards. As is brand reputation, product development, and sales growth. But would you put marketing or sales in charge of culture? How about engineering in charge of succession planning? Why then do we often put Finance in control of employee recognition? As a place to start, yes, put payroll with finance (see above) but put control of bonuses with the manager/director/VP/etc. of the respective employees. 

I remember working with an Account Manager who paid me out of his pocket $100 for me helping him make his quarter. It was not expected, It was not his responsibility, and it was not tied to the company performance. It was tied to mine and it was surprising. That was 12 years ago and it was one of the best examples of leadership and motivation I have ever learned.

Performance is variable and not guaranteed. The minute you lump bonuses in with salary, you just removed any link to motivation and created an expectation. People EXPECT to get their annual bonuses...whether they did anything exemplary or not. Stop doing that and take control of your bonuses. If someone saves the company $200k - they deserve a bonus as soon as that change goes into effect. How much? I don't know but it should be enough to surprise them. If you just make them "satisfied" then you will get "satisfactory" work from them. If you want them to surprise you with great performance, you need to surprise them with great bonuses.


Dave NeedhamComment