Getting It Right—Paying for Performance
Through Variable Pay
Ken Abosch
Marilu Malague
Your Presenter(s)
„
Ken Abosch, Lincolnshire Office
847.442.3580
ken.abosch@hewitt.com
„
Marilu Malague, Woodlands Office
281.882.6268
marilu.malague@hewitt.com
Bottom Line on Top
„
Variable pay has become the primary
mechanism to pay for performance today
„
There are sub-optimal practices that
are inhibiting the effectiveness of
variable pay plans
„
Now is the time to Get it Right!
Road Map for Today’s Discussion
„
Variable Pay’s Role in Pay for
Performance Today
„
Learning From Our Mistakes
„
Getting it Right:
Criteria and Tools
„
Your Questions!
Sources of Information
„
Variable Compensation
Measurement™
„
Hewitt Salary Increase
Survey
„
Broad-based plans
„
Created in 1976
„
Created in 1996
„
Fortune 1000 companies
„
1,156 companies in 2009
„
Merit/overall salary
increases
„
Salary structure movement
„
Variable compensation
„
Special topics
„
„
More than 380 cash
variable pay plans
„
300 companies
„
1.9M employees
Plan characteristic driven
database
„
Prevalence
„
Effectiveness
Variable Pay’s Role in
Pay for Performance Today
Use of Variable Pay
Percent of Companies With a Variable Pay Plan
100%
88%
90%
70%
80%
70%
60%
47%
50%
40%
30%
20%
10%
0%
20 Years Ago
Source: Hewitt Salary Increase Survey 1990–2009
10 Years Ago
Today
Participation in Variable Compensation
Prevalence in Variable Pay Plans By Employee Group
100%
90%
80%
81%
74%
70%
60%
50%
52%
41%
40%
30%
20%
10%
0%
10 Years Ago
Today
Salaried Exempt
Source: Hewitt Salary Increase Survey 1990–2009
Salaried Nonexempt
Increasing Line of Sight
Focus of Variable Pay Plans Based on Plan Type
100%
90%
80%
64%
70%
53%
60%
45%
50%
40%
35%
35%
28%
30%
20%
38%
20%
13%
18%
10%
10%
0%
20 Years Ago
10 Years Ago
Individual Performance Plans
Cash Profit Sharing
Source: Hewitt Salary Increase Survey 1990–2009
Today
Business Incentives
Gainsharing
Growing Role of Individual Performance
Inclusion of Individual Performance in Variable Pay Metrics
100%
90%
80%
70%
60%
36%
50%
40%
30%
17%
20%
10%
0%
10 Years Ago
Today
Source: Hewitt Variable Compensation Measurement™ (VCM™) database 2000–2009
Budgeted Spending: Base Salary Increases
in Decline
Percent of Payroll
10%
9%
8%
7%
6%
5.5% 5.4%
4.2% 3.9%
5%
4%
2.5% 2.5%
3%
2%
1%
0%
20 Years Ago
10 Years Ago
Salaried Exempt
Source: Hewitt Salary Increase Survey 1990–2009
Today
Salaried Nonexempt
Budgeted Spending: Variable Compensation
on the Rise
Percent of Payroll
10%
12.0%
9.6%
9%
8%
6.5%
7%
5.0%
6%
5%
4%
4.0%
3.0%
3%
2%
1%
0%
20 Years Ago
10 Years Ago
Salaried Exempt
Source: Hewitt Salary Increase Survey 1990–2009
Today
Salaried Nonexempt
Projecting Future Budgeting
Percent of Payroll
20%
16.0%
18%
16%
11.8%
14%
12%
10%
8%
6%
4%
2.5%
2.0%
2%
0%
Today
10 Years From Now
Base Salary Increase Budget
Source: Hewitt Salary Increase Survey 2009–2010
Variable Pay Budget
Focus on Total Cash to Attract/Retain Talent
Compensation
Total Cash
Talent Risk Zone
Base Salary
$50,000
$100,000
Salary Level
$250,000
Variable Pay Has Become a Global
Phenomenon
United States
Canada
Venezuela
Puerto Rico
Mexico
Chile
Brazil
Argentina
United Kingdom
Switzerland
Sweden
Spain
Netherlands
Italy
Hungary
Germany
Belgium
Austria
Thailand
Taiwan
Singapore
Philippines
Malaysia
Korea
Japan
India
Hong Kong
China
Australia
0
20
Source: Hewitt Salary Increase Survey 2007–2008
40
60
80
100
Why the Dramatic Shift to Variable Pay
„ Fixed
vs. variable costs
„ Need
to focus and drive behaviors
„ Need
to create alignment
„ Perceived
control
„ Shareholders/analysts
value it
Learning From Our Mistakes
Learning From Our Mistakes
Plan Weights
Corporate
Employee With
$50,000 Salary
(5% Bonus Target)
50%
■
Net Income
25%
$625
■
Revenue
25%
$625
10%
$250
5%
$125
Business Unit
20%
■
Cash Flow
■
Revenue
■
Quality
2.5%
$62.50
■
On-Time Delivery
2.5%
$62.50
Department
20%
■
Safety
10%
$125
■
Attendance
10%
$125
Individual
10%
■
Attendance
2%
$50
■
Project Completion
3%
$75
■
Idea Creation
5%
$125
100%
$2,500
Learning From Our Mistakes
Executives
Directors
Managers
High-Level
Exempt
Other Exempt
Nonexempt
Salary
Increases
Annual
Bonus
X
X
X
X
X
Special
Recognition
X
X
X
X
X
X
X
Learning From Our Mistakes
Maximum
Funding Gap
Target
Threshold
$1.0M
$1.5M
$3.0M
$6.5M
Funding
Funding Required by Plan
Actual Available Funding
Learning From Our Mistakes
Corporate
Results
X
X
X
X
X
Business
Unit Results
Department
Results
Individual
Results
X
Nonexempts
Entry
Exempts
Managers
Directors
Executives
Learning From Our Mistakes
>1
35
%
-1
00
%
10
0%
-1
05
%
10
5%
-1
10
%
11
0%
-1
15
%
11
5%
-1
20
%
12
0%
-1
25
%
12
5%
-1
30
%
13
0%
-1
35
%
95
%
-9
5%
90
%
-9
0%
85
%
-8
5%
80
%
-8
0%
75
%
-7
5%
70
%
-7
0%
70
60
50
40
30
20
10
0
0%
# of Incumbents
Distribution of Total Payout as % of Target
Total Payout as % of Target
Company Perf as % of Goal
Learning From Our Mistakes
Business Performance
Bonus Payout
2001
2002
2003
2004
2005
2006
2007
2008
2009
Learning From Our Mistakes
% of Target Incentive
Percent of Goal vs Percent of Total Target Incentive
R2 = 0.1331
190%
170%
150%
130%
110%
90%
70%
50%
70%
90%
110%
130%
150%
% of Goal
170%
190%
210%
230%
250%
Learning From Our Mistakes
$10,000
$5,000
Grade
Midpoint
$5,000
–
Employee
Salary
Salary to Midpoint Comparison
Calculated
Bonus
Payment
$5,000
=
Less
Salary
Over
Midpoint
Actual
Bonus
Paid
Bonus Payout Calculation
Learning From Our Mistakes
Participation Requirements
No formal requirements to participate
Communication
Year-end pay statement left on desk
Plan Administration
Payout 5 months after close of year
Create focus
on required
results
Improve
performance
The
Role of
Variable
Pay
Share in
successes
and failures
Motivate
desirable
behaviors
Facilitate
ideas
and
improvements
Getting it Right:
Criteria and Tools
Getting It Right!
„
It has never been more critical to get variable pay
right
„
Role in pay for performance
„
Increasing investments
„
Management expectations
„
External scrutiny
Getting It Right: Diagnosis and Ongoing
Plan Validation
„ Common
Alignment
Measures
goals with clear linkages
„ Controllable
„ Relevant to the Business
„ As few as possible
„ As
Line of Sight
Funding
Eligibility
Targets
much direct influence on outcomes as possible
„ Accrued
„ Reflective of
„ Increasing
„ Be
actual results
as inclusive as possible
„ Competitive
„ Appropriate pay
„ Minimal
Participation Requirements
Plan Mechanics
Communication
Plan Administration
at risk given line of sight and role
performance standards
„ Reflective of pay philosophy and culture
„ Balanced between realistic and challenging
„ Understandable and communicated
„ Goals shared before plan starts
„ Progress reports
„
„
goals
Not overly burdensome
Should include assessment of continuous
improvement
Getting it Right: Performance Measures
„
Problem
„
„
The current STI was not effectively rewarding for business and
individual performance
Before Program Redesign
Corporate
Results
Assigned Target
+
Individual
10% of Base
=
Annual
STI
Award
„
Eligibility limited to Directors and above
„
Program only paid for corporate results—no consideration for Business
Unit performance
„
Individual component (10% of base) was not aligned to an appropriate
target, ill defined, subjective, and traditionally always paid
„
Company’s recommendation was to have 4 to 5 measures weighted
at 2.5% to 2%
Getting it Right: Performance Measures
Many
Many alternative
alternative design
design approaches
approaches and
and performance
performance measures
measures considered
considered
Award Pools
Additive
Opportunities
(Funding = % of Profit)
(Funding = Sum of Required Payments)
Participant A
Participant C
+
Participant D
Measure
A
Modifiers
Earned
Award
+
Measure
A
Measure
B
X
(Funding = Sum of Required Payments)
Earned
Award
Participant B
(Funding = Sum of Required Payments)
Multiplicative
Models
+
Measure
B
Earned
Award
=
Measure
C
Discretionary
Plans
(No Specific Funding Mechanism)
X
X
Measure
A
Measure
B
Measure
C
Hybrids
(Funding = Sum of Required
Payments Modified by Pool Size)
=
Measure
C
=
+
Measure
A
Measure
B
+
Measure
C
Earned
Award
=
Getting it Right: Performance Measures
„
Recommendations
„
Expanded plan eligibility deeper in the organization (all exempt
employees)
„
Aligned the incentive plan and employees to the business goals
Corporate
Results
+
Business
Unit
Results
X
Individual
Modifier
=
Annual
STI
Award
Incentive Weighting
Job Level
Incentive Target
Corporate
Business Unit
Individual Modifier
Executives/
Sr. Vice Presidents
40%
100%
N/A
N/A
Vice Presidents
30%
70%
30%
+/- 15%
Directors
20%
50%
50%
+/- 25%
Managers
10%
40%
60%
+/- 25%
Professionals/
Specialty Roles
5%
30%
70%
+/- 35%
Diagnosis and Ongoing Plan Validation:
How One Plan Measured Up
Measures
Corporate, 50%
Individual, 50%
„ Performance measured at Corporate and individual levels
„ Measures aligned with Plan Objectives
„
„
Eligibility
„
„
Funding
„
„
Alignment
„
„
Line of Sight
„
Plan Mechanics
„
Exempt Employees >$60,000 – 85%
Exempt Employees <$60,000 – 78%
Performance trigger
High eligibility and high spend
Consistency in the pay out of awards across all employee levels
Common measure or measures across all eligible employee groups
Primary focus on Corporate Measure
„ Measures are balanced across all levels (i.e., not too much on Corporate)
Relationship between amount of stretch in goal setting and formula parameters is reasonable
Pay out is below target if objectives are not met
„ Thresholds and maximums are reasonable
„ Pay outs for key contributors relative to average is 175%
„
Targets
„
„
Participation
Requirements
„
Communications
„
Plan Administration
„
Pay out targets +/- 10% to 15% of market targets
Degree of stretch built into performance target: moderately low stretch
Gate for individual performance
„ Part-time employees are eligible
„ Must be employed on the last day of the measurement period
Direct and indirect
„ Only payout targets and maximum are communicated
„ Frequency: Quarterly
„
No process in place to evaluate the plan
Takes 24 person weeks to administer
Incentive Plan Scorecard:
How One Plan Measured Up
Variable Pay Index™ Scorecard
Overall Score
Effective Zone
Score
Maximum
Score
696
1,000
Score
Maximum
Score
100
150
1.
Measures
Effective Zone
2.
Eligibility
Highly Effective Zone
75
100
3.
Funding
Highly Effective Zone
75
100
4.
Alignment
Highly Effective Zone
75
100
5. Line of Sight
Effective Zone
50
100
6. Plan Mechanics
Effective Zone
62.5
100
7. Targets
Highly Effective Zone
75
100
8.
Highly Effective Zone
100
100
9. Communication
Highly Effective Zone
83.5
100
10. Plan Administration
Ineffective Zone
0
50
Participation Requirements
Diagnosis and Ongoing Plan Validation
VPI™ Scorecard
Participation
Requirements
1
Highly Effective
Zone
Communication
Eligibility
0.75
Funding
Alignment
Targets
Effective
Zone
Plan
Mechanics
Measures
Line
of
Sight
0.5
Partially
Effective Zone
0.25
Plan
Administration
Ineffective
Zone
0
-2
-1
0
1
2
3
4
5
6
7
Measures
Eligibility
Funding
Alignment
Line of Sight
Plan Mechanics
Targets
Participation Requirements
Communication
Plan Administration
8
9
10
Incentive Plan Scorecard
The analysis details each design characteristic through “speedometers” that
compares to both best practice, our normative VCM Database, or a selected
peer group
Overall Score
XYZ Company
Ineffective Zone
Partially Effective
Effective Zone
Highly Effective
Company’s Score
0–249
250–499
500–749
750–1000
696
Partially Effective Zone
Ineffective Zone
0
Effective Zone
Highly Effective Zone
1000
Getting It Right:
Answering Critical Questions…
How does our
annual incentive
plan compare to
best practices?
How does our
annual incentive
plan compare to
those in my
industry?
How can we
change our annual
incentive plan to
make it more
effective?
How can we demonstrate to
our leaders how our plan
supports business
objectives?
What characteristics have
the greatest impact on plan
effectiveness?
Your Questions
Your Presenter(s)
„
Ken Abosch, Lincolnshire Office
847.442.3580
ken.abosch@hewitt.com
„
Marilu Malague, Woodlands Office
281.882.6268
marilu.malague@hewitt.com