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August 2007

Selecting Variable Pay Goals

by Pat Zingheim & Jay Schuster

One of the most powerful advantages of variable pay is the ability it gives to organizations to select measures and goals for determining awards based on the business strategy, operating plan, and business case for implementing variable pay. The reason is alignment with the direction the organization needs to go to be a success, and the reason for cascading goals is to communicate to employees about what is expected of them in terms of performance in order to add value to the business.

Five Critical Goal Categories

After all is said and done, there are probably five key variable pay goal categories to consider depending on the specific organization—financial, customer, operational, people, and future-focused. They are defined as follows:

1. Financial Goals. Goals such as profit, earnings per share, revenue growth EBITDA (earnings before interest, taxes, depreciation, and amortization), cash flow, economic value-added, and return on measures (for example, return on capital employed, assets, equity, sales, investments)

2. Customer Goals. Goals such as service, customer retention, customer penetration, satisfaction, new customers, brand awareness, and market share.

3. Operational Goals: Goals such as process improvement, quality, efficiency, cycle time, delivery, cost, productivity, safety, and environment.

4. People Goals: Goals such as learning and development goals, re-skilling, re-goaling, value-added from skill and competency development, workforce engagement, workforce retention, workforce productivity, and implemented workforce suggestions.

5. Future-focused Goals: Goals that the company and workforce need to ensure a compelling future, such as new products, new services, product and service line expansions, innovations, new markets, acquisitions, mergers, and globalization.

This does not mean that all of these goal categories need to be in a given variable pay plan. It does mean that all these categories should be considered based on the organization's business objectives and the influence certain parts of the workforce have on these goal categories. However, tactically these categories give variable pay designers the chance to evaluate alternatives and make the proper connections between the organization’s priorities and the role the workforce plays in meeting those priorities.

Current Thinking about Goals

Customer relationships clearly influence organizational performance. The primary competition is for customers because they are the way all other metrics are satisfied. In order to be attractive to customers, organizations are increasingly suggesting that the organization is successful only when customers are also successful. To achieve this, organizations are more frequently making the measures and goals employees have in their incentive plans known to customers to verify alignment.

This means balancing the selection of goals in order that incentives do not pit employees against customers. Measures to watch would include the following:

• Cost Goals: Do these save money at the expense of customers?

• Financial Goals: Do they increase profit ignoring customer interests?

• Service Quality Goals: Do they give preferential service to some customers at the expense of others?

• People Goals: Do objectives make employees satisfied at the expense of customers?

While no specific guidelines exist relative to which metrics are most likely to cause organizations and their customers to compete based on incentives, one major test can be made to see how the metrics will be viewed. Is the organization willing to share the measures and goals used for incentive purposes with customers? If a customer is touring a customer contact center or a distribution center that has an incentive plan for employees, will the organization share the goals with the customer to show that to earn an incentive award, employees must be aligned with customers?

Many public utilities, for example, have an excellent opportunity to implement incentive plans and post the metrics on their websites to verify a link between employees earning an incentive and customer interests. This makes it critical to show alignment—many publicly-owned utilities hesitate to use incentives because of customer pressures. Metrics like control of customer rates, environmental impact, and promptness of repairs can show that employees are aligned with customers.

Conclusions about Goals

Five categories of goals can help an organization reward high performance. Any combination that fits the organization's business case and the direction it needs to go will work. Organizations can also shift goals as needs change. The new concern is what customers think of the measures and goals used for incentives. How do customers of oil companies feel about the high profit levels these organizations are extracting at the expense of customers? Is there anything customers can do about it?

Years ago we developed an incentive plan for the masters (captains) of oil tankers. Two key metrics were safety and environment. Speed was not used because the objective was the safe transport of oil. Given the recent fire on a large luxury cruise ship, one must wonder the role safety might have played in determining the pay of crew members and, of course, officers in that case.