Planning Effective Compensation Programs -- Introduction

May 2006

Planning Effective Compensation Programs -- Introduction

As you read the following discussion papers think about what your company may yet need to do to ensure it has an effective, total compensation program.

Keep in mind that total compensation programs consist of many interrelated parts, which must work well together. Because of this it is important when doing a market analysis even for the development of a Base Compensation Plan to collect sufficient data to address other aspects of a total plan at a later time. Appropriate data collection on the front end will preclude the costs or re-work and lost time later.

Every company is unique with regards to the need for compensation program design. This makes it unlikely that all of the following elements of a total plan will need to be addressed all at once. Most often it is a matter of updating one aspect of a program while possibly introducing a new element if conditions have changed significantly enough to warrant it.

If you have specific questions regarding your current or proposed compensation program, give us a call at 925-867-4400.

Rod Hanna

Principal



May 2006

Effective Compensation Program -- Base Compensation Plan

The foundation for any company's approach to paying employees and the guidelines that ensure consistency and fairness are all part of the company's Base Compensation Plan.

In order to determine how best to reward current employees it is important to know how employees in similar businesses and same "market space" are paid. This information, developed as part of the Base Compensation Plan, helps prevent paying more than the market requires and guards against paying too little to attract the kinds of employees, skills and talent needed to be competitive.

Another key element of a base plan is a documented review and comparison of jobs within the company based on job, skills, knowledge requirements and relative importance to the company's core product or business. This review helps ensure the values placed on specific jobs across the company are in balance.

Equally important is evaluating how individuals perform in their jobs, compared to what is expected of them. An annual or periodic review (for salary and performance purposes) is key to determining fair pay treatment for individuals and helps to prevent underpayment of top performers and overpayment to those not contributing what is expected. This is important to managing the costs of compensation as well as motivating and retaining important contributors.

Once completed the Base Compensation Plan gives the company and its managers specific comparative information about how all employees are paid compared to their industry and market. It also provides the confidence that pay levels for individuals and groups are fair within the company and in the competitive market.

With this information managers are able to make better business decisions, contribute more meaningfully to planning and the allocation of resources, and be more effective leaders capable of explaining the company's pay philosophy and approach in positive and confident terms.

The Base Compensation Plan truly is the foundation for all other types of pay and benefits offerings. If the foundation is not strong and clear in its purpose, the effectiveness of all that comes later can be diminished. The attraction, motivation and retention of people will be weakened and the budget outlay for the results attained may be totally unjustified.

Base Compensation Plans may include the following:

• Market Analysis -- provides market data against which to compare core positions
• Individual Salary Analysis -- shows how the salary of each company employee compares to the market for that position
• Market Reference Ranges -- establishes salary ranges calibrated to market data for specific positions
• Salary Administration Guidelines -- offers guidance for salary related decisions
• "Compensation 101" Manager Workshop -- instruction on how to effectively utilize the guidelines

May 2006

Effective Compensation Program -- Incentive Program

Once a company begins to grow and a more specialized workforce is recruited, incentive award programs often are needed. These help direct behaviors and performance toward expected business outcomes, such as meeting specific company goals, working together as teams or achieving new product development milestones.

Programs of this type are most effectively implemented after first answering questions that help frame and focus the types of incentives that should be designed.

To begin with, a company should determine where it is today in its life cycle. The most successful and desired behaviors at any given time in a company vary as the company develops. Getting product designed and out-the-door may be desired in a start-up, while effective hiring and adaptability to the use of new technology is important to a fast-growth company. Increased sales and solid account management may be important to a mature business, while one in the stage of renewal may need to reward new ideas and concepts that redefine the business. Consequently the incentives that drive these behaviors need to be designed differently.

Determining what the company is trying to achieve and what its business goals are, assessing the market conditions affecting the company and taking a look at appropriate industry trends are basic research steps that will help reveal the feasibility and necessity for an incentive program. It is essential to know what the competition is doing, and it is important to periodically review current, short- and long-range business targets and financial capabilities.

Further, a look across your entire business for the relationships desired between individual jobs, teams and even departments or groups, will help prevent incenting conflicting behaviors and poor outcomes as a result of designing incentive programs for some or all of the groups. Individual contributors being rewarded where team contribution is desired is an example of conflict that frequently exists. An imbalanced focus on sales with little reward for service has led to declining sales because of poor service offered in many businesses.

A company may have a variety of incentive plans in place, but the key is that they individually and collectively support the company's goals, intentions and capabilities. This only comes through research and advanced planning.

Development of Incentive Programs should include:

• An Incentive Program Feasibility Report -- helps define when incentive or variable pay should be part of the total compensation mix
• The actual Incentive Program Document -- (which includes participant guidelines) describes how the plan works, special definitions and conditions, eligibility standards, frequency and method of pay-out and more
• Individual Program Descriptions -- specific to driving certain behaviors to produce specific results such as sales -- revenue generation -- development -- market share, etc.

May 2006

Effective Compensation Program -- Stock Program

One of the most competitive and at the same time one of the most misunderstood areas of total compensation planning can be the area of stock. In a market where both public and private companies are competing for the same talent, expectations about what and how much to offer and what to expect can be confusing from both the company and the employee's point of view.

Before prematurely jumping to offering stock, because "everyone else is", a company needs the answers to a few "old questions". From the start-up phase to the mature stage of a company's development, and depending on the industry and what the current market and competitive trends happen to be, the role that equity compensation plays in the total compensation package can change dramatically.

Assessing your company's relative stage of development will help determine the appropriateness of granting stock. Once again a market analysis will help determine, for specific types of jobs, what levels and types of grants are most appropriate keeping in mind what the company is trying to achieve in its short-term and long-range plans.

As with any other part of an effective total compensation program, when stock is offered, to whom, in what amounts, and how frequently -- must be determined based on what the market says is appropriate, the company's goals, and of course its financial capabilities.

Stock guidelines are essential to give stock option programs consistency and credibility. Equity compensation is a more volatile component of an individual's total compensation because of what potentially can be gained or lost, based on the company's performance. The results can lead to dramatic impacts on performance and morale in either a positive or negative way. Inappropriate awards of stock can have a negative impact on the business as it grows or its financial position changes. Stock guidelines can help avoid some of these situations while capitalizing on others.

Private companies can compete with publicly traded firms in the areas of equity-like deferred pay that is based on the company's performance, but the programs may look very different. Clear guidelines and comprehensive communications about such plans are essential if managers and employees are to feel such plans are competitive and fair when compared to what other companies are offering.

Stock Programs should be based on:

• The company's stage of growth or development -- to become clear on the appropriateness and type of stock program to design
• A market analysis and specifically a competitive review -- to determine the timing, amount and frequency of awards at specific job levels
• A review of the business plan -- to be clear on what the company is trying to accomplish and its financial ability to afford stock grants
• The development of specific Stock Program Guidelines -- that summarize all the details of timing, structure and eligibility

May 2006

Effective Compensation Program -- Life-style Approach to Benefits

Never before have the relationships of cash compensation and benefits programs held greater potential for allowing companies to remain competitive, even in a tight labor market. The current workforce wants balance between the imperatives of work, family, skills and personal development, in addition to achieving financial success.

Put another way -- it is not all about cash any longer. And the traditional health and welfare benefits that have come in "one size fits all" are no longer effective. The alternative should be a well-meshed, balanced combination of cash and non-cash programs that make up an effective total compensation approach.

Enter -- life-style benefits -- and an approach to providing for the diverse needs of many different kinds of employees in a customized, flexible manner. When it comes to costs, many of the tailored programs that companies offer today are less expensive than the traditional ones. Not everyone needs the same coverages nor uses the same amounts or even types of services. Singles, families, older and younger employees all have different needs and they want to be able to exercise choices in satisfying those needs. Developing the kinds of alternatives that employees want and staying competitive with those alternatives as the market and social needs change, can dramatically differentiate employers in today's marketplace. The key is how a company goes about it.

To get started there is no substitute for going back to the basics and finding out the answers to a few questions. First, a company should look at what kinds of benefits it is providing today to meet employees' needs. Then it should look at what other companies in its specific market space are doing today -- particularly the competition. Perhaps the most important question is -- What do employees want? - (Specifically the types of employees you need to attract in order to remain competitive).

Some of the answers to these questions lie inside the company and some outside. It is important to look in both places to get the full picture. It is extremely important that employees are surveyed periodically to validate the appropriateness of current benefits offerings. Salary / benefits surveys can provide much of the external information needed to determine what is being done today in other companies within the industry. This alone however may not reflect what needs to be changed. Benefits and insurance experts who are chartered to respond to emerging needs are the best resource for helping plan lifestyle approaches that will have the best fit.

None of this is without its cost and therefore life-style benefits, while proven to be very effective, must be planned along with the cash program elements of total compensation packages and in alignment with the company's ability to afford them both.

Developing an approach to offering Life-style Benefits should include:

• Analysis of current benefits offered -- to quantify the types of programs, their costs, participation, etc.
• Market analysis -- to determine what the industry, market and competitors are doing
• Surveying current employees -- and listening to the feedback, with particular emphasis on the types of employees the company wants to attract
• Seeking expertise -- insight to the future to be able to stay out in front with a quickly changing aspect of total compensation planning

May 2006

Effective Compensation Plan -- Compensation and Benefits Communications

"Without communications, value is lost and the wrong perceptions take over." Sound a little strong? In truth it really is that simple when it comes to the importance of explaining compensation and benefits programs to employees.

From an investment standpoint not insuring the company's physical assets or not trying to improve its ROI is a demonstration of fiscal irresponsibility. Not communicating with employees frequently and clearly about the company's compensation and benefits programs is just as irresponsible in light of the total dollars spent on these programs to attract, retain and motivate critical talent.

The responsibility for this starts with leadership and management and it cascades down throughout the organization. Competitive compensation and benefits plans represent a considerable value to employees. If the plans are not understood or if questions arise that managers cannot answer the value of the programs can be lost and employees can be left distracted with possibly a false perception of the truth.

Too often employees hear more from friends, relatives and acquaintances about the pay and benefits at other companies than they hear about their own from their leadership. Preventing this requires getting back to basics with communications.

If employees are solicited for their input when plans are designed or changed, it is vital that they be told what the company did with their input. Next, do not make the mistake of believing that if the company announced something once last Spring that everyone now knows. Changes should be announced creatively in a number of ways. On-going communications in different formats should be used in meetings and other internal media the year around to insure the value of the company's compensation and benefits programs are understood.

Effective communications not only means reminding employees that they have the programs but more importantly, with regards to benefits, how they work and how to access their benefits when they need them.

The backbone of effective communications about both compensation and benefits programs is confident, well-informed leaders and managers who can consistently and positively answer questions. They are the first lines of insurance on the investments the company has already made.

Employees of a company are as much the customers of its compensation and benefits plans as its clients are of its products and services. In the same way, compensation and benefits programs need to be marketed to employees so that they realize the value being provided.

Development of Compensation and Benefits Communications should involve:

• Training managers and supervisors -- to prepare them to confidently respond to employees questions
• Considering getting help with communications -- for materials development and designing an ongoing schedule for delivering information or updates
• Establishing periodic or annual employee surveys -- to gain input for new program development