How to Structure Compensation in Recessionary Times to Ensure Ongoing Performance

How to Structure Compensation in Recessionary Times to Ensure Ongoing Performance

The Strategic Question

In his book, The Well-Timed Strategy, Peter Navarro poses a question that any business serious about its growth plans should consider.

"How can the modern executive team strategically and tactically manage through the various recessionary and expansionary phases of the business cycle to gain a competitive advantage over rivals?"

Learning to deal strategically with the various timing issues that press upon a business in the constantly fluid economic environment of the 21st century is what will ultimately determine whether a business thrives or fails. Seldom do you find high performance companies shrinking in the face of competition, internal struggles or the relentless waves of a fickle economy. Rather, winners find a window of opportunity in virtually every business cycle they experience and assume an offensive rather than defensive posture during difficult times.

The proactive approach taken by these winning organizations includes a proper view and understanding of how compensation can be used as a strategic tool to help them get ahead when others are falling behind.

The "Bright" Side of a "Dark" Economy

One of the key characteristics of organizations that move ahead when others are falling behind is their ability to identify and capitalize on opportunities when others are seeing only obstacles.

All businesses have certain key functional areas that must be anticipated and planned for regardless of current external or internal conditions: marketing and pricing, production and inventory control, human resource management, risk management, capital expenditure programs, and the tactical timing of acquisitions and divestitures. A careful examination of the interdependent nature of these components in an organization can help any executive team improve its company's performance.

That said, the companies that surge forward while others are lagging seem to have the foresight and courage to make what others would view as counter intuitive decisions during difficult economic cycles, as they relate to these functional areas. For example, Intel will often increase its capital expenditures during a recession while others are cutting back. As Navarro says, "Where the true Master Cyclist' goes on the offensive is through the implementation of a well-timed countercyclical expansion to prepare for the next recovery."

Companies that adopt this kind of strategic approach discover many opportunities during times when others are strictly adopting a defensive posture. For example, during economic slowdowns including recessionary periods, high performance companies recognize and take advantage of the following:

Weak competition dies off creating opportunities to acquire higher market share

Top talent becomes more available in the marketplace and usually at more "affordable" prices

Opportunities exist for re-focusing capital expenditures during recessionary periods in anticipation of a recovery

Acquisition opportunities become more available during recessions

A tight economy often "forces" a company to look more closely at its compensation structure and strategically "re-vamp"; helping them both during the recession and once they come out of it

Those that adopt an "emergence strategy" during hard economic cycles will need to have a strong visionary business plan. That plan needs to be supported by great talent and powerful rewards programs that keep that talent focused and motivated. Several real life examples of how this is done exist in well-known successful businesses. These companies have learned the art of "cherry picking" and other well timed tactics for managing their human resources. Here are just a couple examples.

Progressive Insurance goes to college campuses during recessions to sign up and train high-quality college recruits that are desperate for jobs.

Isis Pharmaceuticals locks top scientists into permanent long-term positions at bargain salaries during sharp downturns in the biotech industry

Companies like these recognize that in good times and bad the key to their success is their talent pool. They also recognize that it is precisely at the trough of a recession that the labor pool will be at its deepest and wage pressures will have subsided. Again, Navarro points out the following.

"That is a great time [the trough of a recession] to cherry pick this labor market with the goal of staffing the company with the most talented workers at bargain wages. The Master Cyclist executive team is able to deploy a more highly skilled work force with lower labor costs than its rivals when the new expansion begins."

Attracting Great Talent through Strategic Compensation Design

During good economic times or bad, high performance businesses seek to acquire great talent, not just good talent. They look to hire people that will believe in and commit to the company's vision and strategy. They want a culture made up of individuals with an ownership mentality, not an entitlement mentality.

As a result, the goals of any good compensation policy should include the following three elements:

Win the talent wars

Focus employees on the most important results

Produce a positive return on the compensation investment

So what type of compensation package does great talent respond to?

For the most part, talented individuals want to participate in an opportunity that rewards them for their performance. In other words, they want an almost micro entrepreneurial experience within the context of the business by which they are employed. They want to see a relationship between how they perform and execute the expectations associated with their roles and how they get paid.

At the same time, great employees recognize and respect the balance that must exist in that equation between guaranteed and incentive compensation, and long-term versus short-term pay. They recognize and respect the economic outcomes the business needs to achieve if their personal goals are to be fulfilled. They further recognize that economic conditions at play during a given period can also impact the shape and form that compensation will take.

In general terms, a compensation structure that is going to attract great talent will address three primary needs that any key contributor wants fulfilled.

Sustainable cash flow and lifestyle

Security

wealth accumulation

Understanding these elements, a company must then formulate a compensation philosophy that reflects the range of compensation plans that can be used to create the desired result and that properly reflects the business cycle the company is experiencing. Let's assume, for example, that a company wants to infuse the following characteristics into its culture of execution and success. What philosophy might they adopt as a result?

Entrepreneurial

Ownership oriented

Reasonable

Expect long-term rewards for patience during down years

Such characteristics might lead a company to formulate the following philosophy statement regarding their rewards approach.

XYX Company Philosophy Statement

We pay salaries at market (not necessarily to be above market)

We provide significant upside for exceeding annual expectations (goals must be meaningful)

We provide significant long-term wealth accumulation opportunities for helping to sustain growth (we share value)

We provide benefits at market with upside value in strong years (flexible benefit structure)

Can you see how such a philosophy could help guide a company during various economic cycles as they try to navigate turbulent times? Such a philosophy communicates the belief system of an organization about how compensation should be earned and what will be rewarded.

Such a philosophy can absorb modest adjustments as the business faces various challenges, be they recession related or otherwise. Consider the following two complimentary approaches and how each might be used in a given business cycle.

Businesses that adopt these philosophies can then interject practical solutions that are compatible with the overall approach and yet respond to the basic economics of the business at a given point in time. For recessionary periods, here are some examples of what companies might do to protect their workforce and respect the philosophy the company has articulated.

Sabbatical leaves are offered some employees instead of layoffsparticularly less "key" employees that the business doesn't want to lose, but can afford to. Such a leave suspends guaranteed payments to such employees for a period of time but keeps them eligible for long-term benefits and wealth building programs in which they may participate. This approach also keeps them employed while lowering the employer's outlay.

Tiered pay cuts are implemented that reflect adjustments in salaries or other guaranteed pay while at the same time emphasizing the long-term potential of incentive programs that have been put in place and are tied to growth metrics the company has set.

Companies can just stop hiring during recessionary periods and not lay off employees in the current workforce. Recruiting, training and other attraction costs are immediately eliminated. In addition, the salary and benefit costs associated with the additional employees are not added. (However, this may not be the best course for a company that wants to take advantage of the increased talent pool that is available during economic downturns.)

Those that stop hiring during downturns might "fill in the gaps" with temporary hires and/or outsource services that are employed. Many find that when the economy has turned around and business is better, these measures can be continued and that greater cost efficiency has now been integrated into the company's infrastructure.

For some companies, it may make sense to institute an early retirement for certain classes or "tiers" of employeesto accelerate attrition during economic downturns and to make room for the new talent that will need to be added within the context of the emergence strategy referenced earlier.

Examining Some Models

With these principles in mind, let's examine how we might apply them to the formation of real life models that a business might adopt during various performance cycles.

When VisionLink works with its clients, we customarily help them formulate financial models that will allow them to envision the impact of various incentive plan arrangements on their balance sheet, income statement and cash flow. These projections make certain assumptions about revenue growth, expenses, profitability, etc. In that context, we ask businesses to think in terms of a base model (just above survival mode), target (what they anticipate achieving based on their strategy and current growth assumptions) and superior (what could happen if there is breakthrough performance).

Companies approaching the compensation design process in this context might implement the following policies at the target and superior levels of performance.

Target

Do not expect bonuses this year

We will grant some stock options (or SARS in a private company)

The short-term incentive plan will resume at designated growth levels in 2010, at which point we expect the STIP to be 50% above the market

Our supplemental executive plan accrual will be suspended for 2009

Our wealth accumulation value will remain constant (based on our 5-year target)

Superior

Bonuses will be paid at 200% of target

We expect to increase option grants by 50% (or SAR grants in a private environment)

Our supplemental executive retirement plan accrual will continue for 2009

The wealth accumulation value is anticipated to be 250% of the target opportunity

Do you see the nuances involved in each of these approaches? Both align pay with performance and project an opportunity for employees to participate in the results they help the company achieve. At the same time, these guidelines protect the economic foundation of the business and don't "promise the moon" when there may be some delays in the "rocket launch."

Such a thought process, when coupled with the strategic initiatives that great companies instigate during difficult economic times, can help a company continue to attract and retain a great workforce and keep them focused on the key performance factors most critical to the business.

Getting From Rewards to Results

Ultimately, companies at any stage of their developmentand whether operating in good economic times or badmust have great people executing a great strategy. The key to that happening is passionate, focused people. Rewards, then, are the mechanism by which a company implements passion measures that will create the desired focus and execution.

As businesses consistently execute, they experience success. That success spawns confidence, which propels the company forward to higher levels of success. This culture of confidence is what a competitive advantage is made of and you will find it in companies that successfully face various external and internal pressures on their business. Recessionary times are no different.

To arrive at this performance equilibrium, businesses would do well to examine four critical areas that will impact their ability to create a compensation strategy that engenders a competitive advantage; that leads them from rewards to results. Performing an assessment of these four issues will help your company determine what areas of weakness it has and how to prioritize its efforts going forward.

Future

Do employees feel compelled by the company's vision?

Is there a belief among employees in the business strategy?

Do employees feel there are opportunities for personal and professional growth and development?

Foundation

Is the rewards strategy aligned with the company's vision and strategy?

Does the rewards philosophy "and associated strategies" have attraction power?

Does the rewards strategy engender an ownership mentality in the organization?

Framework

Are there clear performance standards and expectations communicated to employees?

Is there an appropriate balance between guaranteed versus incentive compensation, and short term versus long term rewards?

Is the company achieving an "efficient" return on its compensation investment?

Focus

Are employees achieving the desired results and demonstrating the intended behavior?

Does the company have a rewards reinforcement strategy and management system for its compensation programs?

Is the rewards strategy of the company creating "line of sight" between company vision, strategy, roles and expectations and financial rewards?

If a company can isolate the source of its primary rewards shortfalls in this manner, it will help reveal solutions that can compel a company through the business troughs that all companies experience to one extent or another.

In Conclusion

Can a recession offer opportunities and not just barriers for finding, retaining and rewarding key talent? Hopefully, you have seen through this article that the answer to that question is a resounding yes!

Likewise, high performance companies create strategies at all levels of their organization to realize the opportunities that down markets can offer. Those strategies range from product introductions and capital expenditures to "cherry picking" the choice talent that becomes available during harder economic times. Their ability to do so requires them to formulate a well thought out value proposition for prospective and current employees that clearly communicates the total economic value of their association with the business. Those that do will see more than a light at the end of the tunnel. They will see themselves emerge from that tunnel light years ahead of the competition propelled by a culture of confidence fueling further growth and momentum.

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