You Get What You Pay For

If you want money to talk, you'd better be clear about what it's supposed to say

Just a few years back, incentives were hot. Pay-for-performance plans were the cutting edge of compensation strategy. The press hyped them. Managers tried them. Consultants got rich off of them.

What's happened since? Were incentives, as advertised, the panacea for work-force ills? How did they operate when companies actually used them? In other words, has practice lived up to theory?

Let's find out. -- B.G .P.

Five years ago -- a couple years sooner than most people -- Jim Bernstein found Truth.

By then his young business had survived its infancy and, as a provider of health-risk information to insurance and industrial companies, had become steadily if unspectacularly profitable. Now, Bernstein wanted more. He wanted General Health Inc. to grow. But how to make that happen? he wondered. Then it came to him, the managerial magic wand that could transform stasis into growth: incentive compensation.

It made such simple sense. You want your company to get from A to B. More important, you want your employees to want your company to get from A to B. So you put a price, a reward, on B's head -- a bounty no respectably materialistic worker could ignore. Then you watch your people gun for it.

What Bernstein wanted, specifically, was for General Health's revenues to grow from $1.8 million to $2.7 million in a year. The company's margins were firm, so it stood to reason that the sales growth would convert into profit growth. Perfect. The company would blossom. Life would be sweet.

With this happy sequence in mind, Bernstein promised all 30-some employees that, if the company hit the sales target, each would get an extra month's pay.

It worked. In fact, it worked too well. The incentive plan had immediate impact. "It was incredibly motivating," Bernstein recalls. Instantly, General Health began booking business faster than ever before. Unfortunately, it was soon evident that the increased volume was creating problems. As sales shot up, the expense of generating and servicing the new accounts -- the product literature, computers, support staff, and so on -- also went crashing through the roof. The company's bottom line, which had habitually shown 10% pretax profits, turned dangerously red. "We thought there were enough mechanisms in place to control our costs," explains Edwin Russell, a director who headed General Health's compensation committee. "But the volume of orders was creating amazing pressures to spend money.'

Luckily, the company addressed the problem before it was too late. Bernstein installed a new incentive program -- one that balanced the desire for growth with the need to control costs and maintain adequate cash flow. Salespeople were still encouraged to bang down doors, but other employees were rewarded both on the basis of company profits and on their ability to meet specific goals. The manager in charge of computers, for instance, was measured by his ability to meet his budgeted cost structure. "The thing about incentive plans," says Bernstein, shell-shocked but wiser, "is that people take notice. You can meet your goal -- and run yourself right out of business.'

Bernstein is not the only CEO who has found this out. All across America, managers just like him have been flocking to incentive systems -- often called pay-for-performance plans -- in a spirited attempt to simultaneously fire up and control the businesses they're trying to build. The idea isn't new. It's been around ever since managers began fretting about the consequences of boosting pay without bettering results. But only in the past few years has the notion of putting significant dollars at risk become the norm. Nowadays, says Lester B. Jackson, president of Compensation Consultants Inc., in Scottsdale, Ariz., "entitlements are out. Companies want improved results before they hand out pay increases, and there's more willingness to experiment.'

What once was an avant-garde idea has quickly become conventional wisdom. The genie is out of the bottle, and it's almost inconceivable that it will go back in. Companies such as General Health have lived with incentives for a while, and we're beginning to see how they work. Incentive compensation, in practice, has a history. And history has its lessons.

As the General Health episode suggests, getting incentive plans in proper alignment can be difficult. Not that the principles themselves are flawed. If anything, experience shows they're more persuasive than imagined. "People are going to try to take you where the money is, whether you like it or not," says Jim Mullis, a principal and compensation consultant with Ernst & Whinney, in Atlanta. So you'd better be comfortable with where you want to go.

At many businesses, the problems begin right away, with the definition of company goals. Most CEOs have an intuitive sense of the direction they want to move -- be it increasing sales or profits, or improving quality. If you've never experienced the power of incentives, picking a goal might seem tame. The risk, however, as General Health found, is that setting up one objective against all others can unleash forces beyond your control. When General Health began pushing sales, the feeling was that profits would take care of themselves. After all, Bernstein understood the cost structure of the business -- or so he thought.

In retrospect, notes director Russell, one might have anticipated that the drive for sales would throw things out of whack. After all, the name of the game was booking orders, not saving paper clips. "Ask people to focus on X and they go hell-bent for leather on it," Russell says. "They forget about Y.'

So there's a lesson here: before picking a goal, prepare yourself for what will no doubt happen when people begin shooting for it. Depending on the circumstances, you may want to rethink your objective or at least figure out how to monitor what happens. "Unless you watch it," says Mullis, "incentives can take on a life of their own.'

It would be nice if having the right goals was all you needed to make incentive plans work. Unfortunately, successful goal selection is just the beginning. Companies get equally snarled up in figuring out the best ways to measure progress toward those goals. For better or worse, the technique you use for keeping score -- both for the company as a whole and for individuals -- is critical. It sets the course. And the wrong yardstick can be just as dangerous as the wrong goal.