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Saturday, August 11, 2012

Variable Compensation Drives Performance

Guess which company was the world’s most innovative company in 2011? Yes, it is Apple, as determined by BusinessWeek and the Boston Consulting Group. Regardless of the measures considered, Apple and Google have consistently been at the top of the list of the most successful companies in the world. What are the secrets of their success? Among other factors, a performance based culture is the key driver for their accomplishments and common in both companies. Like most high performing companies, Apple and Google offer their people the opportunity to share in the success those people help create through variable compensation.

A few examples would illustrate the importance of variable compensation in high performing companies.  Steve Jobs, the late CEO of Apple, drew an annual salary of $1 for 13 years. Wait, that $1 is not all! He earned billions of dollars through gains in stocks – he owned 5.5 million shares of Apple and share price of Apple skyrocketed with its superior performance. If Apple did not perform well and share price went down, he would have made just $1 annually. Next, Tim Cook, Apple’s current CEO, had a total compensation of $378 million in 2011 – only $900K of that (less than 0.25% of total) in cash salary and the rest in stock grant.   Similarly, Eric Schmidt, the CEO of Google, had a fixed salary of $1 from 2004 through 2010; He is one of the few people to become billionaires based on stock options received as an employee. We can go on and on, but let us stop here. These few examples illustrate that top executives of the most successful companies are predominantly paid in the form of variable compensation – when performance of their companies rock, so do their personal worth. So far, we just established a correlation that the most successful companies have variable compensation pay structure, but the real question is, how does this pay structure help corporations drive performance? 

Linking variable compensation of employees to the performance of the organization encourages certain behavior from employees that reinforces corporate objective. Among all different responsibilities, an employee is likely to devote more attention on the projects driving his/her target achievement. When employees are aligned with corporate objectives and are motivated to work hard, execution becomes easier & more efficient and financial benefits must follow.

Variable compensation also encourages employees to take responsibilities of their action – the characteristics of an owner. They understand that if they can deliver superior performance driving success for the company, they would be rewarded too. When employees take ownership of their projects, they take results personally and ‘walk the extra mile’ to ensure that targets are achieved.

Variable pay structure not only motivates employees because of the monetary value, but it also creates a sense of accomplishment which creates hunger among them for more success. Once employees get the taste of wining, they want to win more and work harder to continue the momentum – somewhat similar to winning games such as Cricket.

A well designed compensation structure attracts certain kinds of talent that is desirable by companies. Clear communication regarding compensation structure to the potential candidates allows for ‘self-selection’ by the applicants – this in turn, increase retention rate which reduces Human Resources costs related to training, recruiting etc. An example would illustrate the concept of ‘self-selection.’ Consider three compensation schemes - option 1: 100,000 (BDT) monthly salary with up to 15% bonus opportunity; option 2: 90,000 (BDT) per month with up to 40% bonus opportunity and option 3: 105,000 (BDT) per month with no bonus opportunity. As evident, if an individual is high achiever and prefers risk, he/she would prefer option 2, which offers less fixed salary, but has potential of the highest payoff (136,000 BDT). On the other hand, if an individual is looking for certainty and do not prefer risk at all, he/she would choose option 3, which offers the highest fixed salary (105,000), but no bonus and therefore no risks. Offering the right combination of fixed and variable compensation, a company can attract employee with right attitudes. When employees ‘self select’ the organization to work in, they are more likely to be culturally aligned and therefore low chances of turnover.

Variable compensation is prevalent in most companies across the globe. According to a survey by Hewitt Associates (now Aon), a global Human Capital consulting firm, more than 80% of the companies worldwide offered variable compensation in 2010. In Bangladesh, while most companies offer bonuses for religious festivals, only a handful has a variable compensation pay structure. Even in these companies, variable pay plans are not planned/implemented well - achievements are often discretionary to supervisor’s ratings and bonus do not vary as much with individual’s performance/efforts. To be competitive in the global marketplace, Bangladeshi firms need to integrate variable compensations structures – not because top successful companies have it, but because of the benefits it provides.

Variable compensation has been a great tool for most high performing companies to create a performance driven culture and therefore drive success. However, many companies also failed to reap the full potential of this pay structure due to poor implementation. It needs to be carefully designed, complemented by right organizational structure and aligned with corporate strategy. Different types of variable rewards needs to be offered at different level of management to balance long term strategic visions and short term objectives. Since this concept is not well understood and rather nonexistent in the corporate Bangladesh, the firms that want to pioneer should seek help from experts in this field. We hope that most companies of Bangladesh will recognize the benefits of pay for performance concept and implement it appropriately to become more efficient, successful and competitive in the global marketplace.

3 comments:

Anonymous said...

It was a nice read. I did not know that many renowned people of big companies drew only $1 as salary.

You gave an example of three different compensation in BDT. Just wanted to know if the application of variable compensation is possible in Bangladesh or not.

Thanks

Russel Ahsan

All About Bangladesh said...

Good post :)

Mohasin Mithu said...

Mr. Ahsan,

Thanks for your comment. To your question, variable compensation can surely be implemented in Bangladeshi companies as well. However, there are many implications of such change and I recommend seeking advice from experts.