A FRESH LOOK AT THE METRICS IN YOUR MANAGEMENT INCENTIVE PLANS

Professionals in the human capital space are often confronted with questions about business performance metrics, especially when it comes to plan design for short-term and long-term incentives. Most for-profit companies have some flavor of a pay-for-performance philosophy in place, and by nature this necessitates that organizations define what is poor, good and outstanding business performance. Whether at the business unit or enterprise level, a lot of effort goes into identifying the relevant metrics, debating the respective merits of each, establishing a threshold, selling the plan to leadership, getting approval from the board of directors, and communicating all relevant components to participants in the plan.

But how does an individual manager even begin to calculate commonly used measures such as ROE (return on equity), ROIC (return on invested capital), and EBIDTA? More concerning is the likelihood that most managers don’t have a clue how to personally impact those results—bringing into question the whole notion of incentive.

Certainly among large employers—but also in some medium-sized companies—this is an effort that annually accounts for hundreds of hours. And while the intent is to provide an incentive framework for outstanding achievement, more often than not it creates confusion and mistrust.

Despite good intentions, not every organization will correctly predict all of the twists and turns that impact a company’s financial performance. When this happens, the dark side of human nature can rear its ugly head, for example:

  • Senior leaders who attempt to manipulate financial results to yield a larger payout.
  • Senior leaders who attempt to convince the board of directors that the financial targets were too aggressive and, while admitting they didn’t make the grade, ask for mercy so that management can receive bonuses anyway.
  • Boards of directors that reluctantly approve bonus payouts, when they know darn well the goals were sand-bagged.

So, if the common practice of setting performance metrics can be wasteful, inefficient, divisive, and lead to inappropriate outcomes, is there a better solution?  

Ask yourself, “What are the basic, fundamental business results that most any leader, employee, shareholder, and investor can understand and would welcome?” Results may vary, but let me suggest these three simple things:

  1. Revenue growth that is 110% of the prior year,
  2. Profit efficiency that drops $.50 of every incremental revenue dollar to the bottom line,
  3. Total shareholder return of 15% or better (stock price appreciation plus dividends, if applicable).

No budgets, no confusing metrics, no debates, and no excuses. The expectations are simple, consistent, and repeatable.

Oh sure, there are other important things to deliver on—like customer retention, employee engagement and product pipeline—but I’d argue that those are inputs to the annual performance outputs of revenue growth, profit efficiency, and shareholder return that we reward through the management incentive plan. Most managers and leaders I know would love being in a business that performs and rewards based on those three simple criteria.

Look around your organization and see how short-term and long-term incentive plans are designed. If the process is inefficient, wasteful, divisive, and complex, you might want to advance the idea of simply looking at revenue growth, profit efficiency, and shareholder return. If your organization can deliver on the simple formula of 110%, $.50, and 15%—and do so year after year—plan participants will be dancing all the way to the bank.