Publications & Resources

May/June 2010
Leadership & People

 

Are You Getting Enough Return On Your Payroll Spend?

By Ron Kent

Payroll represents a significant fixed cost, yet the base salaries comprising payroll may not necessarily motivate high-performing employees to contribute at the level that businesses need to succeed. To attain strong financial performance, banks should shift more of their compensation expense to a variable cost basis by redirecting their fixed-cost base-salary dollars toward incentive awards for the highest-performing employees. Implementing a solid performance management program, which measures the performance of an organizational and/or individual against pre-determined criteria and goals, is a critical element to properly determining incentive awards and the competitive positioning of base salaries.

The total rewards investment likely represents the largest line item expense for most banks. Just as banks can decide to emphasize direct versus indirect compensation, they can also choose to allocate their direct compensation investment to those employees contributing at the highest level. Banks that have accumulated very large payroll budgets can examine incentive compensation programs as part of their effort to reduce overall compensation costs.  A variable compensation model also adds flexibility to a bank’s cost structure, which is a definite plus in today’s unpredictable marketplace.

A bank’s most powerful tool might be a performance management program which improves high-performing employee engagement through a clear link between performance and variable pay in lieu of broad increases in base salary. The key to a good performance management program is to capture the essence of the critical indicators of business success, be it hard goals or essential behaviors, and have all members of the management team empowered and prepared to have frank discussions with their direct reports about how their actions contribute to overall company success. To ensure the program is truly effective it is imperative to establish clearly differentiated award levels to celebrate the achievements of those who have gotten it right. To properly craft such a performance management program, banks must:

  • Establish organizational performance criteria and gain clarity around those actions which are most critical to organizational performance

  • Determine how to involve all levels of employees in the organization for the most success

  • Enlist and engage all levels of management participation and support

  • Create formats, forms and suitable rating scales for evaluating employees

  • Determine how actual performance appraisals compare within and between departments and whether the program adequately separates high-performing employees from others

  • Establish differentiated rewards for each level of performance (does not meet, meets, exceeds)

A good variable compensation plan reflects a bank’s strategy and business direction. When linked to a good performance management program, this reflection is strengthened because the goals and behaviors needed for the business to succeed are identified and communicated throughout the bank. The indicators and activities pinpointed in the performance management system translate naturally into the measures and metrics used for incentive compensation, which should ensure that the plan participants have proper line-of-sight, and sufficient ability to impact results.

To the extent that the variable compensation program is being introduced as a means to reduce fixed costs, plan funding and costing are critical. Banks should establish plan eligibility, award opportunity levels by employee, and the funding mechanism for the plan to create an acceptable financial model under multiple performance scenarios. Since most organizational costs are funded out of profit, plan costs may then be stated in those terms. The number of plan participants and award sizes may then be calibrated under varying levels of projected profitability until an acceptable formula and cost is derived. Many organizations seek to establish “self-funded” plans, which are cost neutral on a relative basis and are funded by some added level of profitability beyond traditional targets.

While incentive plan funding and overall award availability may be determined by financial performance or some other enterprise measure, employee plan eligibility and award opportunity level may be determined by competitive market practices and individual performance ratings. Banks seeking to reward “top performers” will establish incentive plan eligibility only for those employees receiving superior performance evaluations, while other organizations seek a more inclusive program and use the individual performance rating to modify earned awards.

Of course the addition of a variable compensation plan needs to be addressed within an organization’s total compensation strategy, including the emphasis of base versus variable pay, market positioning and basis for pay increases, with specific focus on variable pay components.

It is important to bear in mind there will be a diminished return on cost reduction activities unless top performers benefit from the added recognition of their superior efforts and the increased financial rewards associated with those efforts. A coordinated performance management program properly linked to a healthy variable compensation opportunity will enable organizations to transition from recession survival mode to recovery mode, with their best people re-committed to the organization’s success.

Ron Kent is a managing director with RSM McGladrey. He can be reached at 949-255-6556 or ron.kent@rsmi.com.

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