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Part 2 Incentive Pay and its Significance

A few months ago I wrote a blog post about how disgusted I was by the news of the Postmaster General and his compensation of nearly $1mm in 2008 even when the USPS lost so much money. The primary reason for my frustration in that post was because of TARP and the restrictions that the Government (which is leaning more and more left every day) wanted to place on incentive-based pay for executives at banks.

A couple of very significant things have happened since that blog post (which was written on March 2nd).

The first: GM, after receiving billions of dollars in federal “loans” because they were deemed too significant to fail (by elected politicians who receive massive support from Unions and the Auto Industry), finally went bankrupt. Anyone who didn’t see that coming back in November simply didn’t want to admit to the harsh reality of a company that was ultimately doomed unless it could shed its massive financial obligations and return to a management structure of fiscal prudence and actually providing a product that people wanted to buy.

GM has stayed in the news because they’ve got a massive overhaul to return to significance and it’s going to take a herculean effort by their new CEO to pull it off. What the government hasn’t bothered to really look at, because of its fear that if they have highly compensated executives at an organization like GM their constituents won’t vote for them, is that Incentive-Based pay, with HUGE performance bonuses, is exactly what their CEO needs. At the end of the day, why is he going to be punished for the sins of his predecessors?

Forbes had a brilliant article written at the end of May by Jack Dolmatt-Connell that you can find here. In it, he suggests that the CEO should have a four-pronged compensation structure that is based on:

Cash Compensation that is limited to no more than $500,000 in base pay
Equity Compensation tied directly to increasing the market cap of GM over a long period of time. The argument, if the CEO can turn around a company with a market cap of less than $1B and return it to its former prominence of $18B, they should be justly rewarded.
Severance & Change in Command: if there’s a crisis, the CEO is an At-Will employee. They’re not entitled to a massive golden parachute if they get fired for cause. However, if the CEO can turn the company around and sell it, they should receive a significant bonus on the money that is left over after the taxpayers are repaid.
Stock Grants: give them skin in the game that encourages prudence and gives a sense of ownership.

The second: I met with a long-time mentor of mine: the Honorable Carolyn Gallagher. Carolyn happens to be the Chairman of the Board of Governors for the United States Postal Service. I asked her some very blunt questions about the news surrounding the compensation package that Mr. Potter had received as the Postmaster General.

WOW! I was more than just a little surprised by her answers.

Because she had just returned from testifying in front of Congress, her understanding of the topic was very strong. Her argument for the justification of Mr. Potter’s pay was based on these points:

He’s the CEO of one of the largest Companies (in both revenue and workforce) in America. Add to that, it’s a “quasi for profit” organization that leads all others in the mailing and delivery business.
Over the past 7 years, he has reduced annual costs by more than $1B per year while facing a reduction in business that is unprecendented in the 234 years of the organization’s existence (15% alone in 2008).
The pace with which mail volume has declined in the past 18 months has outpaced their ability to reduce costs because of the operational and financial restrictions that the government places on them.
He’s been responsible for leadership that eliminated 50 million hours of paid labor in 2008 (approximately the equivalent of 25,000 full-time employees). He’s also proposed further cost reductions as well as a contraction of mail delivery from 6 days to 5 (a move that would save nearly $4B per year). That’s quite a bit different from our current government’s perspective of looking at anything but service cutbacks to get our budgets in line.

All of these points were both valid AND significant. They helped me better understand why Mr. Potter was likely under-paid (a mindset I would have never imagined leaving with) in 2008. But none of them had the impact on me that her last point did – and this should both SHOCK and ANGER you as a citizen of America:

“Adding to this unprecedented financial challenge is the requirement passed in the Postal Accountability and Enhancement Act of 2006 that the Postal Service make payments of $5.4 billion or more per year to fund future retiree health care obligations. In fact, if not for this payment, the Postal Service would have earned a profit of $2.8 billion in 2008, an exceptionally challenging year.”

In case you’re wondering, the USPS is the ONLY organization affiliated with the US Government that is required to fund their future retiree health care obligations. While I believe that a model like this is fiscally prudent (though I don’t believe in pensions and retiree health care), it’s ridiculous to think that we could come anywhere close to predicting what the cost of healthcare will be 20 or 30 years from now.

I realized at this point, that our Postmaster General is not only deserving of incentive-based pay, he should be considered as a viable candidate for President of the United States. Not only is he running a massive organization that is profitable during a period of intense market pressures and decline in demand, he’s doing so while having to deal with heavy governmental criticism and oversight that is akin to him having to fight with one hand tied behind his back while at the same time improving customer satisfaction and delivery rates.

To you Mr. Potter and to you Mrs. Gallagher: BRAVO.

For Reference:

You can read the full transcript of the Honorable Carolyn Gallagher’s testimony in front of congress HERE.

Tags: 234 year history, align pay with performance, bankruptcy, barack obama, Carolyn Gallagher, congress, employee retention, fiscal prudence, forbes, fritz henderson, GM, Honorable Carolyn Lewis Gallagher, incentives, Jack dolmatt-connell, Jack Potter, John Potter, pension, performance bonuses, Postal Accountability and Enhancement Act of 2006, postal service, Postmaster General, reduce mail delivery from 6 days to 5, retiree healthcare, stock grant, TARP, testify in front of congress, testimony, united auto workers, United States Post Office, USPS

17 Jun 09 | Compensation, Retention, Taxes | Read on | Comments (0)

Thoughts on Compensation & Incentive Based Pay

This is a blog post that I’ve been working on for a while and I finally got the impetus to complete it after reading a post by Clint Greenleaf, Founder of the Greenleaf Book Group. To view a complete version of his blog entry for Inc Magazine click on this link.

I started working on this blog entry when I heard about the new TARP restriction about caps on incentive based pay for Executives at Banks that had accepted federal bail-out money. Turns out they are restricted from receiving any more than 30% of their base salary in bonuses. The whole idea of the Government trying to put caps on anything really started to frustrate me simply because they have absolutely no place legislating incentive based pay at all.

Before you stop reading now thinking that this is going to be a political rant give me one more moment to justify why I believe the government shouldn’t be involved in compensation conversations at all: last year, the Postmaster General received over $800,000. For those of you keeping track, that’s well within the top 1% of all wage earners in the entire United States and about 40x above the Poverty Level. Honestly, I wouldn’t be upset at all if the pay was justified but when you look at the real numbers, he earned nearly $1m (and 4 other execs earned $250k+) while the US Postal Service: (1) has a government guaranteed monopoly on First Class mail (2) has discussed reducing the delivery of mail by a day to reduce costs and (3) lost more than $3 Billion last year.

Going back to the original premise of being more than a little irritated by the Government’s desire to cap incentive based pay for Bank Execs: aren’t they looking at the wrong data point? Instead of worrying about people making more or the same amount as the Vice President or President Obama, why not reduce base pay by 80% and place absolutely no cap on performance based bonuses that are driven through the execution of behaviors that will drive great results. To let a bank choose to pay a top Executive (who in the case of a company like AIG or Citibank are essentially government employees) $500,000 in base pay is what’s so wrong, in my opinion.

I mentioned Clint Greenleaf’s post at the outset and want to bring that back into the forefront. Clint points out nicely that there are certain roles inside of an organization that make it very easy to incentivize employees. The easiest example is Sales. But even with Salespeople, companies rarely get it right. Here’s a real life example:

Acme Widget Company: Sales Rep – John Doe

Base Pay: $80,00
Average Sales Price: $100,000
Quota: $400,000 per year
Gross Margin: 50%
Net Margin: 30%

John receives his commission from Acme based on Gross Revenue. He’ll receive a 5% commission on his sales for 2009 regardless of if he hits quota or not. Let’s assume he hits exactly his quota and they’re at the target numbers as stated above:

Base Pay: $80,000
Commission: $20,000
John’s Total Compensation: $100,000
Company Gross Profit: $200,000
Company Net Profit: $120,000
Real Company Net Profit: $20,000 (taking out John’s compensation)

It’s rare, however, that salespeople who are incentivized and paid commission on Gross Revenue are ever going to be worried about preserving margins. If you’d like to determine if this is true I’d encourage you talk to anyone you know who’s been a sales manager in their career.

Let’s change around John’s production now and assume that he EXCEEDED his quota by 25%. Instead of selling $400,000, he sold $500,000. What a banner year! Most companies would name him to the President’s Club and reward him with a trip! But instead of selling 5 deals as in the statement above with the target price of $100k, John brought on 7 new clients with an average purchase price of about $71,500. Let’s look at the impact that his Commission Structure had on his wallet and then the Company’s:

John’s Total Compensation:

Base Pay: $80,000
Commission Paid: $25,000 (5% of Gross Sales of $500,000)
Total Compensation $105,000

Company’s Profit on John’s Sales:

Gross Revenue: $500,000
Gross Profit: $150,500 (Gross Profit reduced from 50% to 30% because of price cutting)
Net Profit: $10,500 (Net Profit reduced from 30% to 2% because of price cutting)
Real Net Profit (Loss): ($94,500)

By incentivizing the wrong behavior, John’s employer celebrated his victories and got excited about being able to really bring in lots of revenue. But the real impact on the company is that John is quickly driving them into the ground because of his inability to sell in a competitive environment and maintain pricing.

I find myself talking to CEO’s every day who are grappling with this, especially in this economic environment. They look back on the previous performance of their sales team and they give credit where it simply isn’t due to sales reps who are successful simply because they haven’t quit yet (they’ve inherited the clients of former employees, answered the phones when people called in looking to buy, etc). Even crazier, other prospective employers look at guys like John and see annual awards, a history of beating quota and a guy with lots of industry contacts and start to drool.

Incentive-based pay is one of the greatest levers you can tweak to really drive the kind of behaviors that you’re seeking but unless you’re thinking about it the right way, they can absolutely cause your demise.

Do yourself and our Country a favor, if you have any friends in leadership positions with the Government who would benefit from reading this, forward them the link. It’s not exactly Tea Party-style rebellion but someone needs to say it. We’re incentivizing our Federal and State employees to not do anything to rock the boat, spend money with reckless abandon to ensure re-election of their bosses, and spend at least 100% if not more of their annual budgets to ensure that they don’t get their pay reduced the next year. Anyone else see a problem with this?

Here are some additional resources:

Dave Kurlan on How to Get Salespeople to Perform
Sandler Sales Institute on Why Salespeople Fail
Jack Daly on Understanding the Personality of Salespeople
Dave Kurlan’s Free Salesforce Grader

Tags: AIG, barack obama, Baseline Selling, by the book blog, Citibank, Clint Greenleaf, commission, Compensation, Dave Kurlan, david sandler, federal bail-out, federal employees, government employees, gross revenue, hiring, Inc Magazine, Incentive-based pay, incentivizing salespeople, Kurlan, net profit, OMG, Postmaster General, president's club, talent acquisition, TARP, topgrading methodology, understanding the salesforce, US Postal Service

02 Mar 09 | Compensation, Recruiting, Retention | Read on | Comments (3)

A Dose of Reality on Our Current Labor Market

There was a fantastic article written today in the Wall Street Journal written by Bradley Schiller that did a great job really qualifying the statements that our President has been making recently about the state of the economy and why we need to pass a $1T bail-out to keep us from financial demise.

DISCLAIMER: I’m a staunch fiscal conservative (with a degree in Economics) and I struggle with a bail-out program that is going to “create or save 3.5 million jobs” as I don’t believe any sane Economist will be able to provide you with any effective formula for how to measure “saved” jobs. I’m also a big fan of the WSJ as it’s about the only publication you can read any more without a blatant agenda.

Back to the article. If you’ve spent more than 5 minutes reading the news in the past year you’d truly think that the sky was falling if you didn’t have some kind of statistical baseline on which to compare what’s happened with what really occurred during the 30’s. Here are some important ones:

Unemployment:

1932: 25.2%

1982: 10.8%

2009: 7.6%

Job Loss:

2008: 3.4 million jobs lost or 2.2% of the labor force

1981-2: 2.4 million jobs or 2.2% of the labor force

1930: 4.8%

1931: 6.5%

1932: 7.1%

*No, that is not a rolling total for 1930-32, that was the number of positions lost in each year!

GDP Growth (Contraction):

1930: (-9%)

1931: (-8%)

1932: (-13%)

1982: (-1.9%)

Projected 2009: (-2%)

Bank Failures:

2008: <50

1987-88: >3,000

1933: >10,000

I am not even going to try to summarize these data points as simply quoting what Mr. Schiller said is much more eloquent and concise:

“President Barack Obama has turned fearmongering into an art form. He has repeatedly raised the specter of another Great Depression.

Mr. Obama’s analogies to the Great Depression are not only historically inaccurate, they’re also dangerous. Repeated warnings from the White House about a coming economic apocalypse aren’t likely to raise consumer and investor expectations for the future. In fact, they have contributed to the continuing decline in consumer confidence that is restraining a spending pickup.”

Author’s Note: one additional data point for those looking for a modern day bail-out comparison to The New Deal: from 1934-1940, government spending increased by 45%.

If you’re a history buff you’ll recognize something: in 1940 we were still in The Great Depression.

Tags: 1930's, barack obama, bradley schiller, consumer confidence, contraction, FDR, fearmongerer, fearmongering, GDP Growth, great depression, investor confidence, job loss, new deal, the great depression, unemployment, unemployment reate, wall street journal, wsj

15 Feb 09 | Employment | Read on | Comments (0)

HIRE BETTER™

Delivering the Systems and Expertise You Need to Make Great Hiring Decisions

Part 2 Incentive Pay and its Significance

Thoughts on Compensation & Incentive Based Pay

A Dose of Reality on Our Current Labor Market

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