How to Build a Small Business Bonus Plan

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7700 Irvine Center Drive, Suite 930 Irvine, CA 92618 949-852-2288

www.VLadvisors.com www.PhantomStockOnline.com

Today’s Presenter:

Tom MillerPresident

(949) 265-5700tmiller@vladvisors.com

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Vision: Help Businesses Build and Sustain a Performance Culture

Accelerate performance capabilities by designing pay strategies that transform employees into growth partners.

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If you do that…

• Quality of talent will improve.• Employee engagement will expand.• Performance will be magnified.• Business growth will be accelerated.• Shareholder value will increase.

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Today’s Focus

Bonus Plan: Premises:

What makes a plan successful?

Goals Metrics Communication

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If you don’t have a bonus plan . . .

Either you don’t think you’re ready

Or you don’t have the confidence you can do it right

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Incentive Plan Denial (for companies that do have a plan)

Two categories of companies : Those that know they have bad bonus

plans Those that think they have good plans

but actually have bad ones.

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The Data

World at Work 2016 Survey

Only 10% of responders indicated they felt their annual incentive plan was effective.

These responders were, generally, representatives of larger, successful companies. If large companies can’t get it right (i.e., those with access to high-paid consultants and experienced executive leadership), what chance do smaller companies have?

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VisionLink’s Experience

Hundreds of plans Based on the standards embraced by major industries,

consultants, and HR professionals for nearly a century When examined—not proving effective (not improving

productivity)

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Why?

“…when financial incentives are applied to increase…motivation, intrinsic motivation diminishes. A meta-analysis of 128 independent studies conclusively confirmed this effect.”

(“Stop Paying Executives for Performance,” HBR, February 23, 2016)

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Hmmm…

Traditional bonus plans aren’t effective

But you have a commitment to your employees

Can you simply raise salaries and compete for talent . . . and create a pay-for-performance culture?

So, what are you to conclude?

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Resolving the Paradox

Cause & Effect: Most bonus plans fail precisely because they attempt to impact behavior. The data are complementary, not contradictory.

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What to do?

Build a partnership relationship with employees by sharing financial value with those who help create it.

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Promoting a Partnership Relationship

Key to:1. Avoiding manipulation2. Eliminating entitlement 3. Stimulating innovation and

stewardship4. Creating alignment

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Premises, Premises

A premise is defined as “a proposition supporting or helping to support a conclusion.”

One adopts a premise (believes in a concept or principle) and then acts in accordance with it in the hope of achieving a certain result. However, the desired outcome can only be fulfilled (presumably) if the premise is correct.

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The Wrong Premise (the typical one)

Influence Behavior Through Careful Selection of Plan Metrics

Reward your employees for achieving results that are as close as possible to their job duties. This typically includes the effort to “select the best metrics” for each employee or at least for every department. Then assume that all the collective mini-improvements will roll up into shareholder value creation.

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Metrics Focus

8 Problems1. Impossible to link every metric to true

value creation.2. Multiple KPIs create confusion and sap

motivation.3. A focus on behavior incentives can lead

to the opposite behavior. 4. Difficult to find metrics for every

position.5. Results may be manipulated or

loopholes exploited.6. Impossible to equalize metrics across

individuals and departments.7. Unintended and unanticipated negative

consequences.8. Pursuit of “perfect” metrics is a time

waster.

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Results, not Methods

"You cannot hold people responsible for results if you supervise their methods.“ (Stephen R. Covey)

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The Right Premise

Reward employees for achieving the shareholders’ most important financial results and treat them as growth partners.

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Change in Terminology & Mindset

Value-sharing instead of paying incentives.

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Shareholder’s Most Important Result

Sustainable and growing profitability

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Central Metric (for funding the plan)

Focus on One of These: Profit Increase in Profits (% or $) (Sometimes: Revenue Growth)

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Not Just Profit but Productivity Profit

Productivity profit is that surplus that can be attributable to the productivity of your people, not just your capital at work.

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Case Study

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Keith Williams Assumed leadership of UL in 2005

Company carrying considerable debt

Losing market share

Low employee morale

UL had become bureaucratic and “siloed”

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Core Changes Shift from “Incentives” to “Value Sharing”

Took away local measurements driving management incentive plans—all paid on same metrics

“We live together and we die together”

Aligned everyone behind company success

“I call it ‘pay the company first.’ ”

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How do you apply this in a small co?

Identify your most important “profit” metric

Select the threshold amount of that profit that justifies employee bonuses

Begin sharing value above that threshold

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“Basically, up to the company’s operating profit target, all of the profits go to the company; and only after that target is met, do we start funding the incentive pool.”

Example: If UL’s target is $80 million-- 100% of first $80 in

profit goes to company The next $20 million

goes to the incentive pool

From there on, 50/50 between company & incentive pool

Pay the Company First

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Pay the Company First

Once value creation is defined, compensation can follow a formula for sharing value in a way that aligns key producers with the company’s business plan and priorities.

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Setting Payout Thresholds

Base

Target (budget)

Superior

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Other Metrics

Minimum profit thresholds must be met first. Then…

Department or team metrics

Non-correlated factors (customer retention, customer or client increase, etc.)

Individual performance metrics

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Org Unit Performance

Overall company performance should be primary objective

Org Unit performance can be a secondary objective

▪ Some of the best incentive plans in the world are only tied to company performance

▪ Org units should be utilized when employee line of sight is heavily (if not solely) focused on the org unit

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Allocation to plan participants contingent on:

Company Performance – Employees should have all or a majority portion of their bonus based on company performance

Org Unit Performance – A portion of an employee’s bonus can be allocated based on department, location, division, or business unit

Plan Weighting/Allocation

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Plan Weighting/Allocation

Make overall company performance the primary objective (e.g. ~60 - 100%)

Organizational unit success should be secondary objective (e.g. ~40 - 20%)

Weight the overall incentive:

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Individual Performance

Trend is to disconnect performance from incentive pay

Performance Management is still important

Managers more likely to be honest about performance if incentives are not directly correlated to performance rating

If performance is deemed “Unacceptable” discretion should be utilized to eliminate incentive payment

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Headlines

Performance Management

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Plan Discretion

What about employees who made special contributions over the course of the year?

Create a discretionary reserve inside of plan funding

Reserved for “exceptional” performers only

Often held at the top of the organization (not cascaded down to individual managers).

Nomination process.

Don’t wait until the end of the year to recognize performance.

Essentially, these are funded “spot” awards

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Is the “Right” Premise Always Right?

Exceptions

Sales Compensation

Project Specific Incentives

Time Periods or Projects with no Projected Profits

Revenue Instead of Profits

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Remember the Core Principle

The core principle behind the right premise is to avoid trying to micromanage behavior through an incentive program (“do this and you get that”).

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Let’s Restate the Principles behind a Successful Plan

Adopt the Right Premise

Treat employees like partners

Focus on outcomes, not behaviors

Trust and engage

Don’t over-engineer through key performance metrics (a sure indicator of failure)

Build the Funding around Profitability

No payment if Base not achieved

Emphasize Target and Superior

Use Org Units as a Secondary Component (if you use at all)

Use Individual Performance Prudently

Reflect employee performance in the merit program

Allow for some discretion in the value-sharing plan

One last very important thing (see next slide)40

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Crucial to the success of the plan

Employee communication statements should communicate incentive target opportunity

Regular performance updates during the plan year

“Partners” understand basic company performance

Private companies don’t typically disclose all financial information to all employee “Partners”:

Financial performance in private companies communicated via percentage against target

“After Q1 we are tracking 95% against our ‘Target’ financial performance”

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Reinforce Line of Sight

Rewards

What’s in it for

me?

VisionWhere?

Strategy How ?

Roles and Expectations

My Contribution?

Rewards

What’s in it for me?

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Market a Future that’s Relevant

Communicate desire for a growth partnership

Demonstrate commitment

To the future business

To key contributors

Promote, don’t just communicate Be consistent

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Market a Future that’s Relevant

Here’s our future Here’s how we’re going to get

there Here’s the role we picture for

you Here’s how we encourage our

people to grow and contribute

Here’s our philosophy about pay and rewards

Here are our specific pay programs

Here’s how our pay programs could work for you if we achieve our plan

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Employee Value Statement

Year 1 2 3 4 5

TargetedResults

100% 100% 100% 100% 100%

Salary $160,000 $166,400 $173,056 $179,878 $187,177

STVS $64,000 $66,560 $69,222 $71,991 74,871

LTVS(EOY)

-- $74,000 $186,000 $311,000 $448,000

401(k)@7%

$17,120 $36,123 $57,169 $80,428 $106,086

Total Cash

$224,000 $232,960 $242,278 $251,970 $262,048

WealthAccrual

$17,120 $110,123 $243,169 $391,428 $554,086

TotalValue

$241,120 $567,083 $942,407 $1,342,636 $1,767,343

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Chronology for Building a Successful STIP

1. Follow the Right Premise by establishing a basic plan approach

(scope, funding parameters, company only or departments)

2. Select your participants and organize them by group (tier or level)

3. Create a budget (total value of the pool at various performance

thresholds); allocate pool levels by employee tier

4. Assign your metrics (the Key Performance Indicators that produce

awards)

5. Allocate employees’ awards between company and business unit

results

6. Study, test, and confirm values

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Vitals for Operating a Successful Short-term Incentive Plan

1. Communicate the plan details early and often2. Demonstrate the plan value opportunities on an individual basis3. Reveal plan progress throughout the year (at least quarterly)4. Create plan “rules” and live by them5. Be flexible and recognize special contributions periodically (keep a

reserve)6. Review and renew the plan quickly at the end of the year

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How does VisionLink help?We employ an

interactive online tool and teach you

how to use it.

We show you how to communicate and manage the plan effectively.

We build your plan with you

(as a Design Team).

How Does VisionLink Help?

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www.BonusRight.comwww.BonusRight.com

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What will it do?

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Indicate on survey if you would like more information including a demo.

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Today’s Presenter:

Tom MillerPresident

(949) 265-5700tmiller@vladvisors.com

7700 Irvine Center Drive, Suite 930 Irvine, CA 92618 949-852-2288

www.VLadvisors.com www.PhantomStockOnline.com

Thank You!7700 Irvine Center Drive, Suite 930 Irvine, CA 92618 949-852-2288

www.VLadvisors.com www.PhantomStockOnline.com www.BonusRight.com