Creating Effective Incentive Compensation Programs
Compensation systems have three components ― base salary, benefits and bonus compensation ― that must be competitive in order to successfully recruit talented employees.
Of the three, the bonus or incentive compensation has the most potential for retaining superior producers and rewarding employees for what they actually accomplish. They have potential to be great reward systems and excellent management tools.
This article will discuss in detail the process of creating a successful incentive compensation system that rewards employees for what they produce and ties together employee goals and company performance benchmarks.
Base Salary and Benefits Should Be Competitive
The base salary and the benefits package offered to employees must be, at least, competitive. They must be on the high side of average for the position. The base salary preferably should be a range that allows you to recruit both experienced and raw talent.
The prime determinant of what base salary to offer a potential recruit is the salary he or she currently is earning. Candidates must feel that they are making a positive move based upon base salary and benefits when they first learn of the company.
Components of an Incentive Compensation System
The following procedures and strategies are important components of incentive compensation systems:
- Company benchmarks are established for measurable company goals.
- Quantity measurements are compared to benchmarked performance standards.
- Reporting systems are developed to provide consistent feedback on performance as compared to benchmark.
- Performance is measured on a quarterly basis.
- Growth reviews are part of the measurement process.
- Rewards are available to be earned on a sliding scale — the better the performance, the higher the incentive. Rewards should not be an all-or-nothing proposition.
Benchmarks Should Be Quantifiable Measures of Performance
Benchmarks are quantifiable measures of performance. Examples include time of construction (also known as cycle time), number of sales, customer satisfaction ratios, percentage of profit, etc. As “quantifiable” measures, they can be reduced to an easily understood and measured number or percentage.
There are four things that can be measured and used as part of the benchmarking process:
Of these, time and quantity are the easiest to measure. Cost is the most volatile and quality is the most difficult criterion to measure.
Time can be measured in number of days, hours, etc. Quantity is the number or percentage of something. Cost is the dollars spent or earned during a buying or selling procedure. Quality measurements can be based upon performance benchmarks from the points-of-view of the customer, manager or general public.
Suggested Benchmarks for Specific Postions
Some positions (like sales and construction management functions, for example) lend themselves to easier and more plentiful performance benchmarks. Other positions, like receptionist and administrative positions, have fewer opportunities to measure quantifiable performance.
Some specific performance benchmark examples are listed below.
- Time of construction
- Variance percentage from budget
- Customer satisfaction
- Job site quality
Sales position measures:
- Number of sales
- Percentage of traffic units registered
- Closing ratio
- Customer satisfaction ratings
- Number of follow-up appointments scheduled during the period
- Projected profit percentage of sales
- Improvement on direct costs as a percentage of sales price
- Reduction in direct costs as a square footage dollar amount
Division/department manager measures:
- Profit percentages
- Employee turnover
- Productivity ratio
- Number of closings
- Number of starts
Receptionist and administrative employee measures:
- Number of times management calls in and gets the proper phone greeting from employee
- Number of transactions handled during the period
- Number of closings coordinated
- Customer satisfaction ratings
Who are the customers for the administrative staff? Often, they are the customers themselves. Sometimes they are fellow employees and sometimes they are vendors and trade contractors. Each of these groups can give you measurable feedback if you develop a system to gather the measurements.
Gathering Performance Measurements
Some data is gathered through the normal home building back office and accounting software systems. These data normally include profit and dollar figures measured by small- to moderate-volume builders’ operational systems and side spreadsheets.
Other data are measured by surveys, special management reporting systems or inventory counts. These systems are developed internally for the specific performance benchmarks established by the builder.
Data from a builder’s reporting systems should be measured consistently. They should be used regularly in management team meetings to stay abreast of performance in the field and sales and back offices.
These are the benchmarks on which employees should pattern their daily behavior. These performance benchmarks should be emphasized in the builder’s business plan. They are the measures that tell you when you are winning and when you are losing.
The popularity of sporting events generally is well accepted throughout the world. Sporting events generally appeal to the public because we all love to know who is winning. And, when we understand the rules of the game, it’s easy to determine who is winning and who is losing. Games that always result in ties or draws diminish the satisfaction of the fans. Similarly, people are less likely to attend and follow a game if they don’t understand its rules.
The same concept describes job satisfaction and your employees’ ability to enjoy teamwork within an organization. If employees understand the ground rules and have easily understood measures of success, they will know when they are winning or losing. They will be more apt to recognize unacceptable behavior and will be self-motivated to do something about it. Finally, they will understand their roles and those of their teammates and will be more willing to sacrifice for the team when they share mutual goals and celebrate victories together.
Reporting sources include:
- Financial statements
- Gross profit reports
- Sales starts and closing reports
- Customer satisfaction surveys and databases of results
- Job cost variance reports
- Quality and Conditions (Q&C) forms and resulting database
- Spec home inventory reports
- Traffic reports
- Prospecting actions item reports
- Model home conditions checklists
- Transaction registers
- Phone logs
- Additional simple forms designed to gather data for future reporting
Trends and Averages Are Better Than One-Job Measurements
Averages and trend measurements are better applied to incentive compensation systems than single-event or single-job measures. Rewarding an employee for performance on individual homes may cause the employee to “pad” one home for a reward and ignore another home where the reward may be more difficult to earn. This is counter-productive.
We want employees to concentrate their efforts on the hard-to-solve issues. Including each home or single-event measure in the overall employee performance average keeps the employee concentrating on doing the best possible job on each home or measurable event.
The good and the poor performances are averaged together and can be monitored over a given period to determine the incentive (quarterly is ideal). They also can be used as cumulative measurements on a rolling 12-month or calendar-year basis.
Rewards should be based upon a sliding scale, with better performance measurement results yielding a higher incentive. All-or-nothing programs can be very discouraging once the reward is in doubt. Compensation incentives based on a sliding scale enables as many employees as possible to benefit from the incentive program. This motivates them to improve performance during the ensuing measurement periods.
Budgeting for Incentive Compensation
The development of an incentive program should start with the question, “How much am I willing to pay (in total dollars or per employee or department) in incentive compensation this budget period?”
It’s best to predetermine this amount and then develop the compensation rewards around it based on the projected level of closings or revenue dollars.
The incentive is generally not fully earned ― as employee performance is rarely perfect and the best programs reward on a sliding scale. However, more than 100% of the incentive can be earned if the closings or revenue volume greatly exceeds the amount projected in the budget.
This, then, would make the incentive a variable amount based on volume. Any incentive program budget overruns would be more than offset by the revenue exceeding projected amounts.
The ideal reward limits are tied to variables like revenue and closing volume. These make the company’s potential compensation liability easily measurable. Rewards can be pooled, and unearned monies can be carried over into future periods to increase the potential rewards and therefore stimulate even more intense performance awareness.
Incentive programs must be well designed and simple to administer. They should also be simple to understand. Remember, employees want to know and understand the rules of the game. This motivates them to participate to the fullest extent possible in the game — or, in this case — the program.
Benchmarks must be measurable via quantity, quality, time or cost. They must be consistently measured and reported in consistent formats at regular intervals.
When in doubt, the incentive program and its measurements should err on the side of the employee. You never want the program to be demoralizing. The programs can be altered from year to year to emphasize new measures or to improve employee response to the incentives.
Incentives can be paid quarterly, or a percentage of the earnings can be held until the end of the year or full measurement period to help employees manage their money.
Bob Whitten is vice president of SMA Consulting, which offers operational and financial management consulting services to home builders. For more information, contact SMA Consulting at 909-420-0200 or by e-mail at email@example.com.
- Motivated, productive employees can boost your bottom line. If you need a hand with the “people side” of your business, visit the Human Resource Management Tools section of NAHB’s online Business Management Tools (www.nahb.org/biztools), available to NAHB members only. Members can access a collection of resources that can help you manage your workforce and stay on top of human resource management issues that are unique to the home building industry.
- "Managing Your Employees: Human Resources Guide for Builders," available through BuilderBooks.com, contains a model personnel policies and employee handbook that you can customize for your company; and a section on legal and regulatory authorities that affect personnel policies, and suggested systems and processes for managing your workforce. It also contains a CD of forms and checklists for managing human resources policies and programs. To order online, click here, or call 800-223-2665.
- "Job Descriptions for the Home Building Industry,Third Edition," available through BuilderBooks.com, contains 40 job descriptions for home building industry employees, plus sample company organization charts, job description forms, electronic documents on CD and other tools. To order online, click here, or call 800-223-2665.
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