Special Financial Report: Employee Compensation
There hasn't been a labor market like this in years. Maybe ever. Entire industries -- financial services, real estate, auto -- are imploding. Unemployment is about 9 percent; in many parts of the country, it's well into double digits. Inflation, meanwhile, is nonexistent. It adds up to an unprecedented situation. It was only a few years ago that the top concern for many employers was finding qualified candidates to fill open positions. Now, those same companies not only have the pick of top applicants -- they don't have to overpay to land them. Clearly, the old rules do not apply. But operating in this kind of environment is far from easy. For one thing, businesses often find themselves in the position of simultaneously firing some workers while hiring new ones or cutting the pay of some while granting raises to others. What's more, employees who appear to be a bargain today seldom stay cheap -- especially if they prove to be good at their jobs.So what are the new rules of compensation in this most unusual market? Meet four entrepreneurs who made bold changes in the way they think about compensation. Their tactics vary, but the goal is the same: a work force lean and flexible enough so that when the economy does begin to rebound, the company will be in a position to pounce.
Controlling payroll may be easier than you think
Patrick Maher knew he needed to cut costs. The question was how. Maher is CEO of Eight Crossings, a medical and legal transcription company in Sacramento. When the economy began to stumble, Maher's clients -- most of them hospitals and doctors -- began pressuring him to reduce his fees. The request was hard to resist. But Eight Crossings, which brought in about $3 million in 2008, operates on tight margins, and nearly all its costs are related to labor. Cutting fees, in other words, meant cutting payroll.
The company employs 80 medical transcribers who work from their homes and earn from $20,000 to $70,000 a year. (Full timers get health benefits.) They are paid per line of text at a rate that depends on the complexity of the subject matter. From the outset, Maher had been paying his transcribers about 5 percent more than the industry average, in a bid to attract the best employees.
Maher was loath to alter that strategy and began considering his options. He could automate more of the transcription work by investing in voice-recognition software. He also could try outsourcing a portion to low-cost contractors in India. But he also knew that technology has its limits, and he didn't much care for the idea of sending jobs overseas.
So Maher began taking a closer look at the work itself. Most of the transcriptions, he knew, contain a certain amount of boilerplate text that is automatically generated and inserted into the document. Yet transcribers had always been paid according to the total number of lines in a document, including those boilerplate sections. To Maher's mind, that looked like a roughly 5 percent bonus on each assignment. In that light, a 5 percent pay cut no longer seemed so unreasonable.
Maher decided he didn't have a choice. He knew the cut would be hard on his transcribers. But he also knew that Eight Crossings had been inundated with unsolicited resumés from experienced transcribers seeking work. If some workers decided to quit, finding replacements probably wouldn't be that hard.
If making the decision was difficult, implementing it would be even harder. Eight Crossings's work force is spread over 22 states and communicates mostly by e-mail and instant message. "The truth is that I have not met most of my employees face to face," Maher says. The first thing Maher did was inform each of his eight supervisors, who are responsible for collecting and editing the transcribers' work. All of them expressed concern about losing employees, but they also said they understood why it needed to be done.
Maher then sent a companywide e-mail explaining why he was forced to make the change. He also stressed that such changes would be permanent. "I tried to make it very clear and open about why we needed to do this," says Maher. "I also let them know that I and their supervisors would be on standby for their feedback and questions." It took a lot of nerve to hit Send. Maher wondered how the news would be received.
As it happened, most of the feedback was supportive; many employees even thanked him for doing what he could to save jobs. Since Eight Crossings is now paying the going rate, there is no advantage to seeking work elsewhere. And what happens when the economy rebounds? Maher has no plans to reinstitute the old pay rates. "I made it very clear that the cuts were going to be permanent," he says.
Change the way you structure sales commissions. Then watch the bottom line grow
Paroon Chadha has a thing about discounts. He doesn't like them. Sure, a well-timed price break can spark a sale. But offer one too often, and customers come to expect it, which can wreak havoc with the bottom line.
So when the financial sector imploded last fall, Chadha immediately grew concerned. His company, Passageways, designs Web-based applications for banks and credit unions -- customers that Chadha knew would be tough sells in the months ahead. Indeed, clients soon began demanding big discounts before signing a contract. And the salespeople at the West Lafayette, Indiana–based company, who earned a base salary plus 3 percent to 6 percent commission, were agreeing to cuts of as much as 10 percent. "We were leaving a lot of money on the table by doing this," Chadha says.
Chadha was sympathetic to his sales staff members. He understood that they had to work harder than ever to close deals. But he wanted to find a way of rewarding them that ensured they could continue to make decent money without having to resort to discounts.
After all, say a salesman earning a commission of 5 percent offers a 10 percent discount on a $50,000 deal. He would be giving up merely $250 in commission -- earning $2,250 on the $45,000 sale, instead of $2,500 on a $50,000 deal. Passageways, on the other hand, would surrender $5,000 in gross revenue. That struck Chadha as way out of balance.
Complicating matters, Chadha had just signed up several reselling partners to help market and sell Passageways's software in Canada and other new markets. He knew he needed to get everyone selling at the same price or his sales teams could find themselves competing against one another. Discounting had to be thought of as a last resort.
Chadha found his answer by accident. His wife, who is attending business school, happened to be reading a book called The Strategy and Tactics of Pricing, by Thomas Nagle and Reed Holden. Chadha, who had read the book during his own days in business school, picked it up and came across the solution to his problem: a tiered commission structure.
In such a scheme, salespeople earn a bigger commission the less they discount the price. For example, when a deal closes at the list price, a salesperson might earn a commission of up to 8 percent; if the price was $50,000, he or she would take home $4,000. But if the deal is discounted 10 percent, to $45,000, the commission would drop to 3 percent, or just $1,350. The structure is meant to create incentives to discourage discounting and align the interests of the salespeople with those of the company.
To put the new plan into action, Chadha called the members of his sales team together, gave them each a copy of the book, and explained his goal: to minimize discounts. The four salespeople seemed to understand immediately. Next, Chadha bundled the firm's 25 products into combinations designed to make it easier for salespeople to offer suites of products without having to haggle over the price of each component individually.
Chadha's team closed eight deals in the first quarter of the year, on a par with the past few years. Margins, however, were up nearly 9 percent, because discounts nearly disappeared. At the same time, Dave Shockey, who heads the firm's business development, says his commissions are up nearly 25 percent under the new structure. "I was able to turn the tables on my sales team and got them thinking the way I do," says Chadha.
Conditions change in a hurry. Don't be afraid to do the same in response
On a list of recession-proof businesses, Gotham Dream Cars would have to rank near the bottom. The New York City–based company rents luxury sports cars, including Ferraris and Lamborghinis, to highfliers in Manhattan and Miami for $2,000 to $13,000 a week. Until the fourth quarter of last year, business was on track for a record year. "Then everything fell apart," says Noah Lehmann-Haupt, the founder and CEO.
Revenue plunged 30 percent, prompting Lehmann-Haupt to slash prices by nearly the same amount. In January, scrambling to keep the business from falling too far into the red, he slashed his salary 40 percent and the pay of his nine employees up to 20 percent. He held his breath and waited to see what would happen.
But what happened wasn't what he expected. Almost as soon as Lehmann-Haupt cut prices, the volume of rentals skyrocketed. Revenue in the first quarter may have been down 8 percent from 2008, but rental activity, spurred by word of mouth and e-mail marketing, jumped some 15 percent.
It was great news, but it presented a problem: Lehmann-Haupt's employees, who after the cuts earned an average of about $60,000 a year, were now working harder to pick up, drop off, clean, and maintain his fleet of 18 vehicles. Only now, they were making 20 percent less. Three months after the cut, three of his most senior employees marched into the boss's office and issued an ultimatum: "We know revenues are down," they told him, "but we're working just as hard -- in fact, even harder -- and we need to be compensated." And if Lehmann-Haupt balked? "We're giving you our two-week notices," they said.
After his employees left his office, Lehmann-Haupt pondered his options. On the one hand, revenue was down -- and probably would remain that way for some time. Lehmann-Haupt was aware that his people were working hard, but he also knew that replacements wouldn't be too hard to find. Maybe, he thought, he should call his employees' bluff. But then he considered the hassle and cost of hiring and training. What's more, the job also requires people to be on call seven days a week, often until midnight. Lehmann-Haupt wondered how easy it would be to find new employees willing to put in that kind of effort.
Lehmann-Haupt decided to restore salaries to 2008 levels. When he announced the move, cheers erupted in the office. He immediately began looking for other places to trim. He renegotiated his rent and asked for breaks from some vendors. "Given all the other challenges facing the business, I didn't even want to think about hiring replacements," Lehmann-Haupt says. But he isn't afraid to draw the line somewhere. "One guy wanted a 50 percent raise," he says. "Of course, I told him no. Even if you're the best employee ever, you can't ask for a 50 percent raise during a recession."
When hiring, be opportunistic. Scratch that: Be ruthless
Kevin Burke had a dilemma, and it needed to be addressed. Burke is CEO of Centuria, an IT services firm in Dulles, Virginia. The company, whose 110 employees work with federal agencies such as the U.S. Department of Agriculture and the State Department, has been on a roll; revenue hit some $21 million in 2008, up from $8.1 million a year earlier. Suddenly, Burke's dream of driving revenue to $250 million seemed attainable.
Burke's problem had to do with his No. 2, a partner who owned 20 percent of the company. But Burke had grown increasingly concerned that his partner wasn't the right person to manage Centuria as it entered its next phase of growth. Things reached a head when the company's recruiter handed Burke the resumé of a man named Tim Green.
As a thriving business in a troubled economy, Centuria had been flooded with resumés. But this one stood out. On paper, Green looked perfect -- a West Point graduate with an M.B.A., a proven knack for landing big contracts, and a record of helping take small companies to the $100 million level. What's more, Green was willing to accept the same base salary as the current second in command.
Burke's instinct was to make the hire. But was he truly prepared to dismiss his partner? "I worried that everyone in the company would start asking themselves, 'Am I next?' " he says. Still, he wasn't going to miss this opportunity. So in March, Burke broke the news to his partner. He agreed to step aside, and the two began negotiating the terms of his exit.
Burke's next step was to explain the move -- and control any effect it might have on morale. After introducing Green to employees in Dulles, Burke took him on the road for meetings with employees at the sites of six projects in nine states. Green was quickly accepted as part of the Centuria team. If fact, the change went so smoothly that Burke began looking for other places in the business that might benefit from new blood. "I decided," he says, "to upgrade all of my B-level players to A-level players."
He asked Green to evaluate the performance of every Centuria employee. If someone was not up to snuff, the company began looking for someone who would be. In one case, a project manager for a key account seemed to be in over his head. The company quickly found a more seasoned candidate who was willing to take the position for a smaller salary, but more upside if she succeeded. Again, Burke made the switch -- though this time, he moved the former project manager into a more appropriate position.
Burke remains on the lookout for more opportunities. After all, labor markets like this don't come around too often, he says. And managed correctly, such moves, however disruptive, don't have to drag the company down, according to Kate Wolf, the company's HR director. "When we replace the B players, it actually elevates morale," she says. "They're not dragging down the average anymore."
Darren Dahl is a contributing editor.
Darren Dahl is a contributing editor at Inc. magazine, which he has written for since 2004. He also works as a collaborative writer and editor and has partnered with several high-profile authors. Dahl lives in Asheville, North Carolina.