COMPENSATION By Richard M. Segal

A better way to pay

Approaching compensation systematically will
eliminate inequities and annual debates.

How to compensate workers has been a dilemma since the hunting and gathering societies. From communism to capitalism mankind has questioned the value of work, education, time and brawn. Even within capitalism, employment reward systems range from “performance bonus” to “union scale.”

During our last economic boom, surveys showed that employees favored job security, “being valued” and good communication above compensation. In today’s economic downturn, compensation—income—would likely rise on the list. Certainly, these economic times have made all businesses more keenly aware of their compensation policy. If you haven’t already revamped your family businesses compensation, there is no better time than the present.

Family businesses are notorious for confusing the business and family systems. It is no different when it comes to compensation. Family members are usually exempt from the compensation policy used to reward the rest of the employees. Bad practices include bonuses for house down payments or having babies as well as underpayment with the promise that “one day this will all be yours.” Probably the practice that heads the top ten list of bad practices is paying all the children equally regardless of their relative value to the business, educational background, experience or expertise —which in some cases even means paying someone for doing nothing.

While there is no “right” compensation policy, there is a process that will eliminate inequities and annual debates. Make no mistake, you do have a policy, even if it isn’t in writing. If you are not sure what it is, just ask around. If you don’t have written compensation guidelines, your employees will say the policy is “management discretion,” or something similar. While that is, in fact, a policy, you may want to draft something more specific that will provide for both family and non-family employees in a fair manner.

Philosophy

Start with a compensation philosophy. How does your industry pay? How does your company compare with the industry standard? Is your compensation policy based on individual performance, or is it a team effort reward system? Do you reward goal achievement? Do you promote from within to increase compensation potential? Is your fringe benefit package optimal or minimal? How are profits shared, if at all?

Draft a few paragraphs that state your company’s compensation philosophy. This will make the rest of the task easier. Keep in mind that you want to be competitive in your market in order to attract and retain good employees.

Fair market value

There is a fair market value for each job, and it is possible to find the range of compensation for that job. Many websites offer compensation data based on job description, industry, company size, location, etc. The difficult task is matching the actual job to the job description on the site you chose to use. You may have to combine salaries and average them. If you can find a site that is specific to your industry, you stand a better chance of finding parallel job descriptions.

If you don’t have job descriptions, you will have to start there. You might ask your employees to create their own first, and have their superiors work with them to fine-tune the results. Again, many websites can help with this task. Once final drafts have been obtained, your executive team should review the results for omissions and overlaps. This task will offer an opportunity to streamline your organization. Organizational mapping would be very useful.

Next, go the site you have decided to use and research the job descriptions it provides. If you don’t find solid matches, you will need to improvise a bit. Then, you should be able to apply your philosophy to the data you have obtained and come up with a range of compensation. The data will break down the compensation into salaries, bonuses and fringe benefits. It will give you a selection based on percentages. This is where your philosophy will help you to establish your range.

Let’s say you decide to pay on the low end of regular salary, but offer larger incentive bonuses based on profitability. You also want to offer a fringe benefit package in keeping with your industry and location. You might develop a range of pay within the 25th to 50th percentiles for that job description, and define your bonus plan and fringe benefit package. This allows you to reward employees based on their jobs and individual skill sets. Top performers should be at the top of the range. New hires with little experience would be at the bottom. You can adjust for education, attitude, seniority and other skills you find desirable.

You can then decide what to do from year to year. I suggest an annual cost of living increase based on a relevant Consumer Price Index with a re-ratchet every three years. This allows you some flexibility to offer raises to those who deserve to move up within the pay range and to adjust the pay range every three years. It also prevents overpaying for a job. Once someone maxes out at the pay range, the only options are to adjust for CPI or re-ratchet increases. To make more money, the employee must get a promotion to a higher-level position.

This policy should hold for family and non-family alike. It is best administered by a small committee (three members are recomended) to add objectivity.

Bonuses

Bonuses are a key element of compensation. Employees come to expect a bonus after the first one they receive. Any compensation policy should address how bonuses will be determined and paid. Usually, bonuses are based on individual performance against some goal, such as sales or profit. Keep in mind that if you offer a formula, the data used to establish the numbers will be questioned. If the bonus is based on profitability, your accounting is likely to be challenged. If you do not intend to share financial information, it is preferable to find a way to offer bonus incentives that won’t be based on the way you do your accounting or take your income. Units of widgets, sales volume and percentage increases over a previous time frame are ways of eliminating the need to share financial information.

If family members are part of the bonus plan, and you intend to treat their bonuses differently from those for non-family, you must clarify exactly what constitutes their bonus. You might want to write two checks—one for the regular plan and one for the family plan. Often the family plan is really a dividend or distribution of profit given merely because someone is family! These distributions may be given to family members who are not owners; that amounts to the owners sharing their return on their investment. The key is that whoever gets a check should know what it is for and feel deserving. Otherwise, you are contradicting the message that a bonus is an incentive.

Be mindful about a bonus formula that pays out in lean years, or when there might not be sufficient cash. Remember, too, that bonuses reward past performance. They offer incentive only if they are anticipated in the future. Most employees consider them a part of regular compensation and feel cheated if the bonus decreases or is omitted.

Evaluation

Any compensation policy requires a corresponding evaluation process. To add objectivity, it is best if the evaluation is done by a small committee. It’s also best if the evaluation is delivered to the employee at some time other than when compensation is being adjusted. Otherwise, it is likely that the only message will be the compensation adjustment and not the other facets of the evaluation.

Use caution

Getting buy-in from key em-ployees will go a long way toward preventing disorder. Working with a small committee to obtain job descriptions and determine fair market value will help achieve employee acceptance.

If you decide to revamp your entire compensation policy, you must crunch the numbers and compare them to your current payroll. Any revamping will likely result in some employees getting increases while others suffer decreases. You might choose to soften decreases by spreading the pain over time, or increasing bonus incentives. Remember, the idea is to develop a compensation policy addressing fair market value and not to merely find a way to increase wages.

It is strongly recommended that you retain a competent professional to guide you through this process. In the end, you will find that a systematic approach to pay makes great sense for both your business and your family.

Richard M. Segal (rmsegal@segalconsulting.biz) is a family business consultant and chairs the Family Business Council, a membership organization for family firms in Southeastern Michigan. He has served as an adviser and a director on several family business boards.