CHAPTER 12
PAY FOR PERFORMANCE: ALIGN COMPENSATION TO FIRM INITIATIVES
“While many compensation systems are constructed to be fair, few are ever constructed to be strategic.”
—August Aquila
According to a white paper titled “Best Practices in Recruiting and Retaining Talented Staff,” from the AICPA Private Companies Practice Section, the AICPA Alliance for CPA Firms, 75 percent of responding firms do not have a documented pay for performance plan that aligns compensation with firm strategic initiatives. The fact that 53 percent of the firms responding to our 2006 Compensation Survey do not tie owner compensation to achievement of their strategic plans was one of the most surprising findings. Almost 10 percent of the firms responding to our survey tie compensation to achievement of their strategic plans, and the rest (37.5 percent) responded by saying the owner compensation system is tied to achievement of the strategic plan to some extent.
As a result of Coral’s work with Conner Ash P.C., we have evidence that firms can significantly increase net income per owner when owners and employees are aligned with the firm’s strategic plan and have cascading performance goals. According to Howard Rosen, principal and president, “The results have been better than we ever expected. Our associates have really embraced the program, and everyone’s income is up far more than would have otherwise been possible. Nonowner bonuses have averaged more than 17 percent of compensation, and owner income has risen 75 percent in two years. Paying for performance, or rewarding for results as we call it at Conner Ash, has been a great tool for recruiting as well as retention.”
While there are different ways to tie the compensation system to achieving the strategic plan, developing cascading goals and using a pay for performance system are usually best because you reward owners and employees for achieving the firm’s business objectives in such a plan. Because a pay for performance system rewards the firm’s above-average performers more than average and below-average performers, it is also an effective way to motivate top performers to stay with the firm. In today’s tight job market, one high performer may be worth two or more mediocre or average performers.
ONLY PERFORMANCE IS REALITY
Harold Geneen, former CEO of ITT, said, “In business, words are words, explanations are explanations, promises are promises, but only performance is reality.” If we agree with Harold Geneen, then it seems we need to reward for strategy implementation and performance.
Firms have been struggling for years to get better performance from their owners and employees. This is often because they cannot see the alignment amongst mission, vision, strategy, and systems, and they do not know completely what they need to do on a day-to-day basis to help achieve that alignment. As discussed in Chapter 3, the Organizational Effectiveness Cycle is one tool you can use to better align the firm, by helping everyone see alignment and effect it. We often remind our clients that “all firms are perfectly aligned to get the results they get.” The first step to getting alignment with mission and vision is to communicate the mission, vision, and values and what successful performance looks like.
Finally, firm performance is driven by execution or implementation of its strategic initiatives. Execution is a discipline that firm leaders must learn. While most firms are getting better at creating strategic plans, many still suffer from poor implementation of the plan.
ALIGN COMPENSATION TO STRATEGIC GOALS
If you want to drive results (performance) in your firm, align owner and employee compensation to the firm’s strategic initiatives. Before you even get started down that road, however, be sure you and your fellow owners have answered the following questions:
▮ Do we have a shared vision for the firm?
▮ Can everyone in the firm clearly state it in 25 words or fewer?
▮ Do we have one firm culture or many cultures in the firm?
▮ Have we identified the three or four most important goals the firm needs to accomplish this year?
▮ How many people in the firm know what the three or four most important goals are?
▮ Have we identified what success looks like in each one of these goals?
▮ Do we know how motivated the owners and staff are to achieve these goals?
▮ Do we know how committed the owners and staff are to achieving these goals?
No discussion about pay for performance is complete without examples of firms that experienced paradigm shifts and then created and implemented such systems as a result. You will note that each system varies, but all have the ultimate goal of aligning performance with strategic initiatives.
REAL-LIFE EXAMPLE ONE—A FIRM IN TRANSITION
In early 2003, Conner Ash P.C. was continuing to undergo transition—the impending retirement of its managing principal, the hiring of a very capable tax principal, and the need for a shared vision in terms of niche development and people development. When Coral began working with the firm, its short-term goals were to:
Clarify mission and vision.
Create a strategic plan to support the mission and vision that included:
A subplan for transition from soon-to-be-retired owners to new owners
A marketing and advertising strategy
An analysis of current operations and how the firm compared to similar firms
A clear understanding of what distinguished the firm from the pack
Refine existing systems and processes to support the strategic plan.
The first two goals were completed in 2003. For four years, the firm has been committed to its mission “to provide high-quality accounting and business advisory services that help our clients achieve what matters most to them and to do so in a manner that exceeds their expectations.” In accomplishing its mission, Conner Ash team members have made a commitment to, and are evaluated on, living the firm’s core values:
▮ Our family members are owners in our success.
▮ We enjoy ourselves.
▮ We are profitable.
▮ We have integrity.
▮ We value continuous learning.
▮ We are timely.
▮ We communicate consistently.
The third goal (systems and processes refinement) was completed throughout 2003 and 2004, the most significant refinement being the design, development, and implementation of a compensation system for both owners and employees that rewards for results. As previously noted, the firm’s associates embraced the program, and everyone’s income has increased far more than would have otherwise been possible.
While each owner and staff member has individually developed winwin agreements, one owner’s agreement was based on the following criteria:
▮ Personal Stewardship
—Client Development
Extras (cross-sold) $$
New $$ developed or co-developed
—Client Management
Client meetings attended
SpotLight™ letters delivered and discussed
—Business Management
Personal charge hours
Days of lock-up (A/R and WIP)
Client work completed by agreed-upon date
Keep tax department within budget
▮ Firm-wide Stewardship
—Coordinate planning for upcoming tax season
Software—ensure all items ready (rollover, e-file, practice aide)
Training—develop and implement
Coordinate needs of professional staff and support
—Begin development of tax department identity
—Get 401(k) plan document in place; ensure all participants receive info
—Niche marketing (play visible role in transportation and pension plan marketing programs)
—Be a strong referral source (measured by number of referrals)
—Ensure mentoring program is in place
REAL-LIFE EXAMPLE TWO—ONE MANAGING OWNER’S WAKE-UP CALL
According to Michael Epstein, the managing partner of Toronto-based accounting firm Fuller Landau, LLP, his wake-up call came in the year 2000. Two things happened. First, he realized nowhere near enough time was spent on people matters, despite it being the number one challenge to his firm. Second, Michael became familiar with the service profit chain, which is the notion that firm profitability and growth is tied directly to client satisfaction and loyalty as well as employee loyalty, satisfaction, and productivity. There is a direct relationship between happy people and clients and profits.
The authors of The Service Profit Chain1 discovered that “the strongest relationships are those between (1) profit and customer loyalty; (2) employee loyalty and customer loyalty; and (3) employee satisfaction and customer satisfaction. Moreover, these relationships are mutually reinforcing; that is, satisfied customers contribute to employee satisfaction and vice versa.” The service profit chain is outlined in the following chart (see p. 155).
The authors believe that this is the foundation for a powerful strategic service vision; a model on which any leader or manager can build more focused operations and marketing capabilities. For example, the authors demonstrate how, in Banc One’s operating divisions, a direct relationship between customer loyalty, which is measured by the depth of a relationship (the number of banking services a customer utilizes), and profitability led the bank to encourage existing customers to further extend the bank services they use. The authors of The Service Profit Chain describe how companies in any service industry can:
Measure service profit chain relationships across operating units.
Communicate the resulting self-appraisal.
Develop a balanced scorecard of performance.
Develop a recognitions and rewards system tied to established measures.
Communicate results across the company.
Develop an internal best practice information exchange.
Improve overall service profit chain performance.
As a result of a detailed understanding of the service profit chain and acknowledgment of some of the people, development, and management mistakes he and the firm had made in the past (for example, not following up on an employee satisfaction survey or having an owner rather than a human resources professional handle people and people systems), Epstein modified his and his firm’s journey toward making a difference. He knew it would be important to develop a firm-wide recognition and rewards system tied to established measures, that is, pay for performance. He also knew it would be critical for people to do what, in their minds, matters most to them, as long as it matters to the firm. Finally, he knew the firm needed help in designing, developing, and implementing the system. Coral is honored to have had the opportunity to work with Epstein and the firm’s human resources director, Jennifer King, in creating a system that exactly meets the firm’s needs.
According to Epstein, a number of paradigms are required to build such a system:
▮ Leaders with a passion for people and an understanding of the importance that building relationships plays in such a system
▮ Genuine interest in making people a priority
▮ Deep understanding of who the firm’s people are and what they expect from the firm (which is no different than taking time to understand what clients want)
The system has been in place for two years, and minor refinements have been implemented. According to King, “The great thing about this system is our ability to tailor it to our firm’s culture and to adjust it periodically to reward the activities that are important at the time, usually those that make the firm more profitable.”
REAL-LIFE EXAMPLE THREE—NEEDED: FIRM GROWTH; CHALLENGE: HOW TO GET THERE
In June 1999, Meyners + Co., LLC, lost one of its rainmaker owners to retirement, highlighting the need to develop a marketing culture that supported the remaining, already-stretched owner group. Only a few members of the owner group considered themselves to be strong rain-makers. The firm, therefore, decided to get all employees involved, to some degree or another, in cross-selling to existing clients, developing and nurturing referral sources, and prospecting for new clients. The firm’s owners also knew employees would need training to develop the needed knowledge and skills for successful business development. Hence, the training began! In addition to training, employees were also asked to track their progress toward personal marketing and business development goals and report periodically to an outside consultant who would, in turn, report to firm management. Nothing changed.
When the Growth Partnership, Inc., was asked in 2001 to assist Meyners + Co. with its marketing initiatives, we gathered a wide variety of data—both statistical and anecdotal—about the firm’s growth, business goals, niches, services, and people development systems to support it all. In short, we found there was no way for the firm to handle the additional work we believed we could help them win. The firm had neither the time nor infrastructure needed to provide the level of client services that it so strongly believed in. It also needed clarity on its mission, vision, and core values, and it needed well-tuned people development, performance management, and compensation systems to drive its goals. The owners at Meyners + Co. agreed.
After the firm gained clarity on its mission and vision, we assisted the firm in defining:
▮ Core values (and how to evaluate whether employees are living them)
▮ Specific, measurable goals and objectives for each person that drive desired business results
▮ Competencies needed to achieve the specific goals and objectives
In short, we helped the firm design, develop, and implement its first pay for performance system, but not without some additional findings. After two years, based on user evaluations of the system, it became apparent that system administration (bonus calculations and paperwork) of an otherwise well-designed compensation system was not as simple as it needed to be. We share this learning with you as advice to keep the paperwork and bonus calculations manageable.
REAL-LIFE EXAMPLE FOUR—TIERED REWARD SYSTEM
In the June 2002 issue of the Journal of Accountancy, Michael Hayes, Senior Editor, discusses several firms, their pay for performance systems, and how they keep track and reward owner productivity.3 One of the firms is Stambaugh Ness, P.C.
Stambaugh Ness, P.C., uses a tiered reward system that focuses on seven performance areas (business development, book production, billable hours, hours managed, realization, managing the firm, and process improvement). This system is outlined in Exhibit 12–1, “Sample Tiered Pay for Performance System.”
As in any effective pay for performance system, owners compete with themselves and not with each other—the system promotes a win-win environment of mutual benefit rather than a win-lose or lose-lose environment in which scarcity exists. The maximum score any single principal can achieve is 400, and the firm monitors performance during the year using objective data. According to Hayes, the executive committee evaluates owners based on the data. The firm also asks for grades from clients as well as staff members.
The five factors at the bottom of the chart (account management; personal planning; recording time; situations, opportunities, and concerns; and firm support) are considered hygiene issues. Owners do not get rewarded for performing these activities, but penalties exist if they do not perform in these areas. Each of the five factors has a total weight of 20 points. Hence, an owner can lose up to 100 points (20 points × 5 areas).
At Stambaugh Ness, P.C., annual owner compensation comprises two components. The first—an equal base amount for all owners—is multiplied by the total number of owners. The firm compares that base-salary total with the firm’s owner-compensation budget. The difference becomes the firm’s incentive and bonus pools. Owners must achieve a minimum score of 250 to be included in the bonus pool. The firm’s goal is to reduce the base salary each year.
There is only one drawback in this approach. It fails to reward owners for building future capacity in the firm. While the hygiene factors are important, they fail to address such needs as training, mentoring, coaching, systems development, and refinement.
REAL-LIFE EXAMPLE FIVE—COMPENSATION SYSTEM IN A MID-SIZED FIRM
A mid-size firm with five owners asked us for assistance in developing a pay for performance system for the owners. They wanted to develop a new compensation plan that could be implemented over the next several years. After gaining an understanding of their needs and what they were willing to embrace, we proposed the following plan.
We started with the previous year’s total owner compensation and agreed upon a percentage of that amount as total base compensation for the current year. We called their base salaries Level 1 compensation. The owners felt comfortable taking 77 percent of the previous year’s total compensation as their Level 1 draws (salaries). They estimated the current year’s net income and decided to allocate the difference between net income and Level 1 draws to a performance pool. This performance pool was Level 2 compensation.
Note: When firms take this approach, we usually recommend they allocate approximately 75 percent to base salaries and 25 percent to the performance pool (Level 2 compensation) during the first year of the new system. The goal is to continue to lower the base salary and increase bonus opportunities over time. Because most owners will not receive 100 percent of their bonus potential, a third level of pay was developed to reward owners who have an extraordinary year. Here is an example of how this would be calculated.
Let us assume that in the previous year, total owner compensation was $1.3 million. For the current year, the firm decides to distribute to the owners 77 percent ($1,003,000), which is allocated based on the previous year’s draws. This leaves $497,000 for the performance pool or a potential of $99,400 in bonus for each of 5 owners. Each owner has an individual scorecard or win-win agreement with the firm. There is an example of this in Exhibit 12–2, “Sample Compensation in a Mid-Sized Firm.”
The owner in the example received $82,502 of the potential bonus of $99,400. It is important to note that each owner in this system must reach a minimum level of performance in each area to receive the bonus amount for that area. The difference between the potential bonus amount and the amount the owner actually received is returned to the performance pool for distribution at Level 3 (extraordinary performance), which is discretionary and mutually-agreed upon by all owners.
The key here is that each owner had different tangible (objective) and intangible (subjective) goals to achieve.
REAL-LIFE EXAMPLE SIX—USING THE BALANCED SCORECARD
As we saw in Chapter 5, the Balanced Scorecard usually focuses on 4 key areas (financial, client, employee, and internal systems and business processes). Developing a compensation system based on accomplishment within each of these areas is not difficult. The real danger is having too many objectives and measures within each of the key areas.. For example, if you have 4 areas and 2 or 3 objectives in each one, you have created 8 to 12 key measures. Twelve is definitely on the high side, especially for the first year of implementing the Balanced Scorecard and new compensation system. We suggest you limit firm-wide goals to a total of 5 to 7 key measures that will drive the best results for the firm.
Let us look at the example included as Exhibit 12–3, “Firm Objectives.” The firm has six objectives in four areas. Each objective is given a performance target. The target defines success. Finally, the firm decides what weight to allocate to each objective. Exhibit 12–3 shows the area, firm-wide objective, target, weight, and the actual performance of our hypothetical firm.
In this example, the firm has agreed to pay each person in the firm a bonus of up to 10 percent of his or her compensation, provided the firm achieves or exceeds the targets it sets for itself. In the exhibit, the firm achieved its objectives related to revenue growth, profitability increase, client satisfaction, and employee satisfaction. The firm failed to achieve its employee turnover and reduction in turn-around time objectives. As a result, the firm will pay each person in the firm 70 percent of his or her potential bonus. In this case, the firm is paying for firm performance, so even average and below-average performers benefit.
Even when firms develop scorecards for the firm, they often fail to develop scorecards for each owner and employee. We believe this is a mistake. Individual scorecards with objectives in each of the four areas—that tie to the firm’s objectives—should be created. Examples of three scorecards are included in Exhibit 12–4, “Sample Firm-Wide Balanced Scorecard;” Exhibit 12–5, “Sample Owner Balanced Scorecard;” and Exhibit 12–6, “Sample Manager Balanced Scorecard.”
FINAL THOUGHTS
As the examples demonstrate, there are countless ways to share the compensation pie. What works in one firm may not work in another. With this in mind, we end this chapter with the following keys to success when developing your pay for performance compensation system:
Diagnose before you prescribe. When you visit your doctor with symptoms, he or she must diagnose before prescribing medication or treatment. Be sure you know the underlying problems—not just the symptoms—of your current plan.
Understand that individual behavior drives firm-wide culture. Each firm will design its own compensation program, and it should motivate individuals to live the firms’ values, develop their competencies, and hit their performance goals, thus creating the desired culture. Your compensation plan will not change the firm’s culture, so make sure you start with developing the culture you want and then design the compensation plan to support that culture.
Involve everyone in the diagnosis and design; get their input. Involvement is absolutely essential for a successful program. We often say, “No involvement, no commitment.” This does not mean, however, you must gain consensus. The ultimate decision rests with the firm’s management team.
Be sure everyone understands the new plan and owners buy into it. You cannot spend too much time educating staff members and owners about their programs. They must understand how it will work, how it will be funded, and who will administer it.
Keep it simple. It is quite easy to make the compensation system more complicated than it needs to be.
EXHIBIT 12–1 Sample Tiered Pay for Performance System1
EXHIBIT 12–2 Sample Compensation in a Mid-Sized Firm
| Area | Objective | Target | Weight | Actual Performance |
| Financial | Revenue growth | 20% | 20% | 20% |
| Financial | Profitability increase | 6% points | 20% | 6% |
| Client | Improve satisfaction | 85% | 10% | 86% |
| Employee | Improve satisfaction | 85% | 20% | 85% |
| Employee | Reduce turnover | 5% or less | 20% | 6% |
| Business process | Reduce turn-around time | 10% decrease | 10% | 8% |
| Firm total | 100% |
EXHIBIT 12–4 Sample Firm-Wide Balanced Scorecard
| Area | Objective | Target | Weight | Actual Performance |
| Financial | Increase revenue growth | 20% | 20% | |
| Financial | Increase net income | 6% points | 20% | |
| Client | Improve client satisfaction scores | 85% | 20% | |
| Employee growth and learning | Satisfaction | 85% | 25% | |
| Internal systems and business processes | Implement a uniform tax preparation process | 12/31/XX | 15% | |
| Install CRM program | 12/31/XX | |||
| Firm total | 100% |
Exhibit 12–5 Sample Owner Balanced Scorecard
| Area | Objective | Target | Weight | Actual Performance |
| Financial | Increase new business development | 20% | 20% | |
| Financial | Increase managed book of business to $1.1 million | $1.1M | 20% | |
| Client | Implement client development plans for top 20 clients | 20 clients | 20% | |
| Employee growth and learning |
▮ Serve on employee training and development committee. ▮ Assist in developing manager and senior manager competency tables |
12 meetings | 25% | |
| Internal systems and business processes | Chair the tax preparation processing committee | Finalized by 12/31/XX | 15% | |
| Firm total | 100% |
EXHIBIT 12–6 Sample Manager Balanced Scorecard
| Area | Objective | Target | Weight | Actual Performance |
| Financial | Increase personal production to $185,000 | 20% | 20% | |
| Financial | Acquire 5 new clients | 5 | 20% | |
| Client | Improve client satisfaction scores | 85% | 20% | |
| Employee | Obtain CVA certificate Prepare business valuation course for seniors | 12/31/XX | ||
| Business process | Serve on CRM committee | 6/30/XX | 15% | |
| Firm total | 100% |