Of course I’m kidding about not giving raises, but I want you to be very careful about how you increase employee compensation in your business!
As a business owner or leader, your #1 goal is to maximize shareholder value. This is taught from day one. To an employee, or perhaps a new business owner who considers themselves socially conscious and aware, this may seem shallow or selfish, but don’t judge too quickly. Let’s dig farther.
If the business isn’t healthy, nobody in it is safe.
The business must:
- Provide a financial return for its shareholders.
- Have profit enough to organically grow or attract more investors.
- Set aside funds for asset depreciation (old assets must be replaced someday) and contingencies.
- Have sufficient working capital for operations.
Without these financial fundamentals in place, the business will not survive. Then, nobody has jobs! The financial health of the business is vital.
Employees, compensation, and benefits are usually the #1 expense of a business. Unfortunately, this is why layoffs are often the first reaction a company makes in a downturn. Whatever you’re paying that guy, tack on another 25-30% for overhead (payroll taxes, benefits, insurance) for planning purposes. This gets you to start thinking about the cost of hiring someone new, and it’s something most employees don’t consider from the receiving end.
Overall, your goal in hiring is to get the best possible value for the company’s money. Notice I didn’t say lowest pay possible, but the BEST people you can get for the best possible price (pay). The best DEAL, in other words. You may end up deciding to pay $10 an hour over what you had originally budgeted for a person who can accomplish more tasks in your business. That’s a good value, as long as the extra tasks save the company, or create more value, than the $13 per hour the company is paying. (Remember the overhead %?)
This isn’t to say that you should underpay people. People who feel underpaid are unmotivated, unhappy, and unproductive. And they’re looking elsewhere. Eventually they will leave, and turnover is more expensive than you can imagine, with all the hiring, training, and disruption of daily operations. Turnover’s bad. Avoid it.
By the same token, be careful not to go off the other end of the spectrum either, with generous pay that makes you feel (or think you look) like a great person. That’s not good business. Generosity is great – as long as the business is healthy and the basic financial health guidelines I mentioned above are met. We’ll get to that in a moment.
Think of it this way. The company is the customer when it is hiring employees. Employees are expected to provide a service (their talent, thoughts, efforts, and time) for a price (their pay). That makes the company the customer! Just as you wouldn’t expect your customers to pay more than the value they’re receiving, look at your employees as vendors to your company. Different view, right?
All this being said, I have found several concepts on compensation and bonuses that have served me well over the years, ensuring profitability for the business, and long-term employee relationships.
Just like many expenses, employee payroll has two major components – fixed and variable. Fixed compensation is a base salary, and this might go up a few % per year based on inflation, longevity with the company, and increased productivity. Keep these increases to a minimum, or be prepared to raise your prices to your customers by an equal % every year. Tough to do.
Variable expenses are incentives for performance: Commissions, discretionary bonuses, management–by-objective (MBO) bonuses, and so on. These offer the business owner more flexibility to share the wealth when things are good, and to be a little more conservative when times are tight. I LOVE these, and highly recommend them. Remember, the company’s health is more important than any one individual’s job.
Let me give you two specific examples that worked for me. Maybe you can fit them into your business, or they’ll give you ideas for other areas.
#1 – Accounts Receivable Bonus
At one point, since we were selling products and services on Net 30 terms, our receivables over 60 days due grew to a concerning point. First, the farther out they get, the harder they are to collect. Second, they were hogging cash and costing us interest money.
I had an Accounts Receivable clerk who was making approximately $28,000 per year, and I offered her a bonus of $250 per month to reduce and keep our receivables to 95% collected in less than 60 days. While this $250 was much less than the savings for the company on interest expense, it offered her a bonus opportunity which was more than 10% of her annual pay. Win, win, right?
Guess what? It worked! Within several months, she had increased the accuracy and timeliness of her invoicing. She started calling customers to make sure they got the invoice she sent. She’d call again to make sure the invoice was scheduled to be paid. She’d call again to make sure the check went out. And she resolved customer and internal invoicing issues much quicker. Our older receivables got collected, and our newer ones never got to be too old.
The company’s interest expense dropped, and she made an extra 10%. Good deal.
#2 – Senior Management MBO Bonuses
These managers were expected to not only keep the company operating at peak efficiency, but to also innovate and help create new systems as our business changed and grew. Since this was my right-hand team, I wanted them incentivized to achieve growth objectives in line with the company’s. I put 20% of their pay at risk with the following method.
Their salary paychecks were 80% of their total expected compensation package. The other 20% was based on quarterly MBO bonuses. Each quarter, we were executing on a growth strategy, and we’d meet and lay out 3 – 5 clear, measurable objectives that needed to be accomplished in that quarter. Check out ->Stop Snuffing Your Business, Ya Ball Hog!
At the end of the quarter, each manager would self-assess his performance, and I would assess it independently. We would then come together and discuss their results. Most of the time, they achieved 95 – 100% of their objectives, and therefore their bonus money for the quarter. As a side note of this type of performance measurement, if the manager assessed themselves at 95%, and I assessed them at 60%, we had a communication issue we needed to resolve, but this becomes a different topic.
Here are some recommendations about bonuses and performance-based compensation.
- Minimize base pay increases based on time, cost-of-living, and so on, if you can.
- Make sure the bonus objectives are aligned with the company’s strategy.
- The person should have some control over the activities and outcomes.
- The person should understand that part of their pay is at risk.
- It is better to HIRE this way, rather than to change pay structures after a period of time.
- Keep bonuses in line monetarily with the employee’s compensation, NOT relative to the overall value to the company.
- Discretionary bonuses can be fun, temporary, objective-based, and reined in during tough times.
- DON’T give bonuses if the performance is not there.
- Make sure you comply with Human Resources and your government’s Labor Standards.
Being generous as an employer is a great thing, certainly. Just keep in mind that you are also responsible for the financial health of the organization, so don’t over-commit with higher-than-necessary base pay. The company’s survival trumps the individual’s.
Have a question or idea to discuss? Reach out to me directly. As always, I appreciate your shares and comments, so please take a moment and do those if you found great value here!
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