Improving Profits Through Higher Employee Compensation

If you were to ask most business owners or executives how they feel about compensation
paid to employees, for the most part they will answer, "part of the cost of doing
business" or "my biggest expense," or even "the cost I fear the most."

</p><p>There is, however, a group of owners or executives who, while agreeing with the
importance of compensation, have instead viewed it as a catalyst to improve
profitability—<i>i.e.,</i> as an opportunity cost as opposed to a lost cost.

</p><p>My first exposure to this new vision came almost 20 years ago upon my entry into
the turnaround business. I became the president and chief operating officer of a
fast-growing, almost bankrupt corporate travel and fulfillment company.

</p><p>It was clear from the outset that the basic core business was sound, but labor
costs, which made up more than 50 percent of operating expenses, seemed
uncontrollable. I immediately keyed in on this area and began to question how we
could stabilize these costs, improve productivity and at the same time enhance the net
profits. Over the years, I had read many stories of successful companies that
rewarded employees with all types of stock options in the hope that one day a big
payoff would come. However, we were a small $50M service provider,
entrepreneurially owned, trying to create a market niche and enterprise value at the
same time.

</p><p>As we examined our employee profile, I concluded that the most important issue
for our employees was cash. In fact, the average employee in any company, even with
two wage-earners, struggles on a monthly basis to make the car and house payments,
put braces on Sally's teeth and save a little for a rainy day, college or
retirement. Options or equity-kickers are long-term issues and do nothing to improve
the current quality of life or cash flow.

</p><p>After careful analysis, I concluded that the best thing we could do was to find
a way to incentivize the employees so that through their efforts, if our bottom line
improved in excess of our expectations, we would repatriate back to them on an ongoing
basis a portion of the excess earned. In effect, we were creating a "gain sharing"
relationship between the owners and employees.

</p><p>Prior to that time, like all of us, I had seen many annual bonus plans that
were discretionary or were tied to the famous "Christmas bonus" concept, where each
year everyone waits with baited breath to find out how many weeks or day's pay he
or she was going to get. I knew that in order to be successful, a plan had to
be achievable, quantitative, meaningful and, in my view most important of all,
distributable with some degree of frequency.

</p><p>Our plan had three key components: fair, frequent and formal.

</p><h3>Fairness</h3>

<p>My previous experience had shown me many companies where bonus plans were set out
with the bar so high that it was almost impossible to reach or, if achieved, it
came at the end of the year and there was little or no value. These plans, while
well-intentioned, generally create a negative attitude and are discounted by the
employees before their first dollar of revenue is earned.

</p><p>I decided to make sure that even under only the most modest of levels of success
there would be some value of gain for the employee group. I therefore looked at our
anticipated and budgeted goals, taking into consideration our reasonable expectations based
on the current wages we were paying, and then adjusted it downward less than 10
percent so that somewhere in the 90 percent range of achievement, a small amount
of bonus could be earned. There is some treachery here in that you could pay for
results that are less than satisfactory, but I submit that any good owner, executive
or turnaround specialist could set the minimal bar at a level that would encourage
rather than discourage commitment to improvement.

</p><h3>Frequency</h3>

<p>This is the area where many of the arguments against gain-sharing plans start to
kick in. How many times have you heard, "We have to finish the year before we can
calculate this year's bonus." Really—why is that? A well-managed business certainly
has budgets and/or projections on a monthly or at least quarterly basis. Why can't
the measurement period be less than a year? Why not set shorter-term goals and reward
as those goals are achieved? Give the employees the sense that their efforts are
improving profits today and that they don't have to wait until Christmas to get
rewarded. The more frequent the distribution, the more important the bonus becomes to
the employee group. The fruits of their labors are rewarded as they accomplish the
goals that have been set, and their reward is current.

</p><p>Each month we set our parameters, monitored our accomplishments on a daily basis,
transmitted where we stood on a daily basis and created a daily focus for that month
to be a winning month. By the last day of the month we generally knew what that
month's bonus pool would be, and by the next check the cash was in the hands of
those who had earned it.

</p><p>There are many who challenge the frequency concept. There are all types of
arguments, including, "Why would I reward for only one month that exceeded
expectations?" That's a reasonable argument, except that I believed that the more they
saw of the cash, the harder they worked toward improving our performance. I was
willing to run the risk that they would get passive, and it just never happened.

</p><h3>Formality</h3>

<p>Here is where the rubber meets the road. There is nothing worse than a plan that
is discretionary and left up to the goodwill and whim of owners or executives. A
good plan should be well thought-out based on what a company may be looking to
drive. Profits are not the only criteria.

</p><p>I knew what we were looking to accomplish and understood our key drivers. Since
we were essentially in the ticket-sale business, our profits were directly correlated
to the number of airline tickets sold in a given month. I also knew what the
average ticket sale was and our related commission. Carefully building a fixed- and
variable-cost model, I knew at each ticket-sale level what our profits would be,
then, using the fairness criteria, set our bonus on the number of tickets sold in
a given month, seasonally adjusted and modifiable if the average sales price changed.

</p><p>Through the use of lighted message boards and daily memos in our reservation
centers, I posted the number of cumulative tickets sold and where we stood in
relation to our goal for the month. I controlled the baseline on a monthly basis,
and our employees understood that if costs went up via raises or other matters,
including carelessness, that I would adjust the monthly standard to provide ownership
the minimum return we deemed acceptable.

</p><p>The data we shared with our employees was general yet specific enough for them to
understand how I arrived at the bonus amount. To further incentivize the employee
base, I implemented a "put and take" pool as well. For example, since Mondays and
Fridays were our most important days, I put a fixed dollar amount into the pool
for every Monday and Friday that everyone who was supposed to be there was there.
I was amazed. People literally crawled to work so that they would not be the one
who prevented the additional pool contribution. I had other additive factors based on
letters received from customers and other events.

</p><p>On the negative side, I had takeaways as well. Here is where we really got
creative. Since everyone (except owners) in the company participated in the pool
(sharing was based on a numerical measurement for each level of employee), I had
the employees elect one person from each level to form a team of evaluators. They
were the ones who evaluated problem situations and made the determination how much the
pool lost. They were far harsher than I would have been.

</p><p>We deemed it critical that everyone in the company should participate at some level;
the team spirit created when everyone pulls in the same direction produces extraordinary
results.

</p><p>The results of our plan were a dramatic change in attitude, productivity and
profits. The amount paid out during the period of our ownership resulted in a
geometric gain in profitability, which in turn established an enterprise value that
resulted in a sale two years later that was far in excess of expectations.

</p><p>Over the years, I have used similar plans in numerous turnaround situations, and
I believe that in each case the improvement in performance and enhancement of value
can in part be directly linked to the vision of compensation and its use as a tool
to improve corporate performance. A successful turnaround is difficult to achieve. It
requires the implementation of sound business practices and nimble and creative
techniques.

</p><p>I encourage each executive, owner and turnaround professional to consider the success
that I have discussed and think about how they too can get creative and improve
performance and enhance enterprise through the use of creative and innovative
compensation schemes.

</p>