In Search Of The Retentive Incentive
Hardly a month goes by that Chuck Bond doesn't get a telephone call from yet another executive search firm trying to woo him with job leads. "My name must be on every bathroom wall in Silicon Valley," quips the veteran software-development engineer. But he says it will take more than some headhunter whispering sweet perquisites in his ear to get him to leave Data Encore Inc. -- a software-duplication company formed in October 1982 as a wholly-owned subsidiary of Verbatim Corp., in Sunnyvale, Calif. "Other companies may pay bigger salaries or have the saunas and spas and the flashy parties," Bond says, "but being able to take part in a company's growth is what really matters to me -- and I can do that here."
Bond participates in an unusual stock-option plan that allows selected employees of Data Encore to purchase shares from Verbatim, its American Stock Exchange-listed parent. Unlike other plans that are open only to an elite corps of managers, this one includes all 27 of the original personnel that launched the now 90-employee operation -- even the assemblers and the receptionists. And, while the traditional stock-option plan carries 5- or even 10-year vesting provisions, Data Encore employees will be fully able to exercise their options as soon as the company clears two predetermined profit hurdles -- which could happen as soon as early 1985 if sales continue to click away at the current $1-million-a-month rate. This would mean option-holders could become stockholders within 3 years of the plan's inception. "Our plan is less remote than the other stock and junior-stock programs you hear about," Bond says, "and yes, I'd have to say it plays an important role in keeping me around."
Jim Dietz is equally determined to stay put. As engineering vice-president of Wilson Laboratories Inc., a $5-million manufacturer of test equipment for computer peripherals in Orange, Calif. (#389 on the 1983 INC. 500 list of the America), he has turned down employment opportunities that would have hiked his pay by 25% -- and little wonder. Through a homegrown royalty program in which the company pays him and his fellow engineers up to $25,000 on the sales of each new product they design, Dietz is already boosting his base salary by 50%. "To keep a guy coming to work for a small private company where you can't get stock, you need a strong financial incentive -- like knowing you're going to make money on every unit the company sells. That's one of the reasons why I'm still here."
Where these men come from, job-hopping is a fact of life. Such skilled professionals as engineers enjoy a seller's market in many parts of the nation, and the average manager of any growing company -- whether high-tech or low-tech -- has become resigned to the knowledge that many a good hire will be gone in two years or less. But Data Encore and Wilson Laboratories are of the opinion that any turnover is too much turnover. Believing that their long-term ability to expand and compete depends in no small way on the stability of their work forces, these companies have resolved to do all they can to make each employee see his or her position as more than just a stepping-stone to another job in another company. Most of their employees laud the effort. As Bond says of Data Encore, "A company like this has unique continuity needs. There are relatively few people here who understand all that's going on, and if we were to have people breaking ranks, we'd be in a world of hurt."
Data Encore managing director Doug Kenny says retention starts with good recruitment. Too many companies forget, he says, that the launch of a successful company requires more than the mere ability to make and sell a product. "You've got to be able to attract and retain people who are willing to work 60 or even 80 hours, week in, week out. And to do that, you've got to develop the right kind of corporate culture and offer good compensation."
Data Encore and Wilson Laboratories have taken it as a matter of faith that money is the most effective incentive, particularly when employees are being asked to devote more than a normal workday to the company. Then again, "you can't pay people $45,000 for a $25,000 job just because they're working long hours -- it only distorts your salary structure " says Kenny. Besides, adds Wilson president and chief executive officer Randall R. Wilson, "ordinary income is not enough for an employee who wants to feel that he's at least partially in business for himself." And that, Wilson points out, is the highly motivated, ambitious yet responsible "key" employee that companies value most -- and often find hardest to hold.
Whether it is the royalty program or the stock-option plan, each man is convinced that he has hit upon the solution most suitable for his employees, his company, and his growth strategy. Not that either idea is flawless; each, in fact, has created problems that otherwise might not have arisen. There will no doubt be changes over time. But the worth of the effort is apparent in the statistics. Turnover rates among skilled employees of both companies are, as Kenny describes them for Data Encore, "just about zilch."
Data Encore is in and of itself something of a retention vehicle. When members of Verbatim's management committee approved the original business plan for the subsidiary, they were, of course, primarily recognizing the potential market for copying and packaging computer software disks. But Verbatim's future expansion plans were never far out of mind. If the $120-million company were to entertain any serious thoughts of establishing and acquiring new subsidiaries, there would be a need for better bench strength in the management ranks. The quandary, however, wasn't so much how to get it as how to nurture and keep it.
"We assume that the average Silicon Valley company loses 20% of its exempt [salaried employees], and 60% of its nonexempt and hourly employees per year," Kenny says. "And because a certain percentage of people seems to prefer not to work for larger companies, Verbatim [which has more than tripled its revenues in the past five years] has always seemed particularly vulnerable to startups trying to pick off key people." It seemed only logical to funnel some of these employees into a start-up of Verbatim's own. "It was a de facto way of hanging onto people who we knew would be considering a move," he continues, "while giving them the opportunities they need to mature. And, believe me, one of the best ways to mature is to be thrown into a start-up."
Verbatim employees, it turned out, needed no pushing. Competition for jobs in many Data Encore departments was surprisingly stiff -- 20 applicants for a single position was not uncommon -- even in the absence of substantial promotions or salary increases. Nor was the stockoption plan used as a come-on. It took Kenny months to convince Verbatim's management committee of the benefits of such a plan, and by the time such details as the profit-oriented vesting provision were added, the original Data Encore crew was already on the job. Most employees, he says, were "flabbergasted" when he called them into his office individually to tell them of the equity opportunity. "Not all of these people even knew what a stock option was," he says. "It wasn't at all expected."
Kenny sees the creation of the stockoption plan as an "interesting and successful experiment" whose results have far exceeded mere retention. "People here work hard, and I believe the stock options have played a big part in motivating them. These first 27 employees have become the core of the company -- they are the corporate culture. They've set the work ethic, and the other people who have come on board have, almost without exception, adopted it as well."
While Data Encore's stock-option plan was the creation of a management-committee strategy session, the impetus for Wilson Laboratories's royalty program came at least in part from the employees themselves. "Almost every engineer has invented something that's made some guy money hand over fist, and then only got paid [on an hourly basis] for it," says Dietz. Neither he nor Wilson are unfamiliar with such situations, both having done long stints as consulting engineers. "I think we both just got to thinking," Dietz continues, "that if a singer can participate in the sales of his product all his life, why can't an engineer? So Randy and I sat down with a bottle of wine one night and decided royalties were a good idea. I only wish we'd done it earlier."
The program works like this: Once Wilson and his three key engineers decide to embark on a product-development project, Wilson determines how large a royalty he will pay on the finished device. That decision is based on the product's perceived market potential, as well as its anticipated longevity on the company's products roster. Wilson then privately informs each of the engineers on the project -- usually Dietz, plus the new-product-development manager and the software manager -- of the maximum figure their work will be worth. The cap can go as high as $25,000 on the hardware design of what Wilson considers a "primary" product, and up to $10,000 on the companion software or a shorter-lived "secondary" device. The royalties are then paid out in monthly checks containing a cut of the selling price on each unit shipped -- 5% per unit for primary products, 2% for secondaries -- until the maximum royalty is met.
Although the royalty program is relatively new, "the results have been fantastic," says Wilson. He is not just speaking of retention; he is talking about attitude. "When an engineer has a vested interest in the product he's designing, you end up with a better product. Each engineer sees the project as his baby. He wants to get the maximum amount of royalty possible, so he does everything he can to make sure it sells. He puts more effort into the testing of it, the marketing of it -- and he offers plenty of constructive criticism along the way. From an owner's standpoint, this royalty program means that I'm not the only one who's interested in making sure this product gets to the marketplace."
In the beginning, Wilson wondered if a bonus system wouldn't have done as well. He didn't think so then, and still doesn't now. "Bonuses are too much like ordinary income, and from the corporation's point of view, they go on forever. With the royalties, it comes right off the top [of the corporation's books], and when you reach the amount agreed upon, [the payments] come to an end. The product is yours, free and clear."
There may be an additional benefit for the employee, as well. Some case law could be interpreted to permit royalties paid by an employer to an employee to be eligible for capital-gains status on the employee's tax return, but the Internal Revenue Service is far from clear on the subject. There is always the possibility that the IRS would reject such employee claims, and tax the royalty payments as if they were ordinary income.
Wilson and his employees agree there are other questions to be answered, other gray areas that may require definition. For example, there is no assurance that an engineer won't balk at the terms of the royalty agreement that Wilson offers. What recourse does he or she have? None, beyond simple negotiation, Wilson says. He would write guidelines if he thought it feasible, but "I think most of that has to be up to me. I can tell you, though, that I wouldn't set a $10,000 royalty on a $5-million product. I just don't do business that way." (Most of his products have been worth $1 million to $5 million, for which he thinks a royalty of $25,000 per engineer is eminently fair.) Just the same, says Dietz, "I think it'd be better for everybody if we had a few more things written down."
Could a disgruntled engineer peddle a design to the competition? Not legally, Wilson says. He and his attorney are of the opinion that the royalty agreement is a quit-claim document that details the terms of a cash-incentive program, not a bill of sale between an inventor and a buyer. Because Wilson himself originates most of the design ideas, and his engineers use his facilities and equipment, the engineer is assumed to have no ownership rights to sell to Wilson Laboratories or anyone else. Besides, they say, any claims the engineer might have had were signed away before actual research began.
If there is a problem thus far, Wilson says, it is that "the walls are thin." All of Wilson's employees know about the royalty program and who is eligible, and that has caused some jealousy. Complaints from lower-rank engineers who have not been included in the program have forced Wilson to institute a separate bonus program for them. Now, on projects for which their superiors collect royalty checks, these support people pocket lump-sum bonuses of $1,000 to $3,000. Questions are also arising as to who is qualified to work on what project. So, to handle the inquiries that are bound to increase as the company grows and takes on more projects, Wilson says he may develop a sort of point system to differentiate one person's skills from another's. And if, somewhere down the line, an engineer who was not part of a project's original royalty agreement makes what seems to be a valid claim to the spoils, "maybe I'll offer a car or something" as an appeasement. "I'm only getting my feet wet as to how to be equal with a lot of this," Wilson admits.
Data Encore, too, may have issues of fairness to consider. The stock-option plan that covers the original 27 employees has, to this point, been a one-time deal; the only new employees who have received options are those who have been hired at relatively high-grade levels, and are thus qualified for Verbatim's own, more traditional stock-option plan. Right now, there are no plans to extend the more-inclusive plan.
Still, Kenny believes in the psychological power of a stock certificate to instill feelings of belonging and ownership, and if he had his way, each new employee would serve 90 days probation "and on the 91st day receive stock." He may consider asking Verbatim for dispensation to begin doing just that, "when the time is right -- when Data Encore is in a stronger position with the company."
Surprisingly, not all employees would favor such a move. "As it is now, the stock is a motivator," says quality-control manager Roger Cook, who has an option. "If it were opened to everybody, it wouldn't be that as much. It'd be more of a maintainer, something you come to expect, like a smock or a locker."
To most Data Encore employees, the major flaw in the stock-option plan is that it isn't really their stock-option plan. "Our ability to exercise the stock option is based upon Data Encore's [profit] performance -- and that motivates us, of course," says equipment-maintenance supervisor Tom Schoen. "But isn't it odd that the actual value of the stock is dependent only on Verbatim's performance? It seems to me it should be tied to our productivity."
Kenny nods, appreciating the contradiction. "As the company grows, we will probably have to shift the emphasis so that all of our recognition programs -- stock options, bonuses, and perks -- are based more on the performance of Data Encore and less on Verbatim's. If you're going to be a separate entity, and autonomous, then you really don't want to be compensated based on how another entity is doing."
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