By Steve Rizer
A new report from FMI Corp. offers a slew of advice for construction companies that are thinking about launching or improving an incentive compensation program. The firm -- which provides management consulting, investment banking, and research to the engineering and construction community -- offered the recommendations following a survey it conducted indicating that there is “an enormous opportunity to improve the effectiveness” of such programs across the industry in the United States.
The report, entitled “Incentive Compensation Effectiveness Study: The 2013 U.S. Construction Industry Incentive Compensation Survey,” profiles seven “critical issues” involving such programs, examining survey results from 224 “top executives” as those responses relate to these issues and comparing common practices to best practices for each issue. The seven issues that FMI identified are as follows:
Discretionary vs. Structured -- “The first critical issue with incentive compensation plans commonly used in the U.S. construction industry is that they are predominantly discretionary. Seventy-five percent of the [survey] respondents indicated that their incentives are determined by senior management or owners’ discretion. In other words, senior management and/or the owners of the business decide what the incentives will be without any tangible reference to company performance, divisional contributions, and/or individual achievements…. This survey reveals that [respondents whose companies offer] nondiscretionary structured plans [believe] their incentive programs [are] significantly more effective than those [programs that] offer only discretionary incentives or a combination of discretionary and structured incentives. Purely discretionary incentive programs appear to be the least effective [programs] in motivating employees toward better performance…. Limit discretion in the plan.”
Arbitrary Pay vs. Market Value -- “The second critical issue lies in determining the appropriate incentive amounts to motivate employees in various positions throughout the company. How do we best determine the appropriate amount of incentives to inspire our employees [to pursue] better performance? There is ample market data collected and available, but surprisingly few firms actually use industry-related surveys to determine base pay and incentive compensation. In this survey, only 37 percent of the respondents indicated utilization of industry-related surveys, including the FMI compensation surveys, as references to ensure the incentive opportunities offered are market-based and motivating…. Get market data to benchmark the appropriate base pay and incentives.”
Balanced Design Based on What Is Strategically Important -- “The third critical issue is that companies are not tying incentives to what is strategically important. Less than half (47 percent) of the respondents [reported that their companies] offer incentives to support and drive their … strategic initiatives. How can a company design an incentive compensation plan without articulating what is strategically important and why? Vagueness on what outcomes and behaviors are expected or desired -- and thus rewarded with incentive pay -- can lead to flawed designs of the incentive plans that will yield less-than-desirable results or induce unintended consequences, such as silos…. Allocate a portion of the incentive to the overall success of the company while [dedicating] another portion of an employee’s incentive [to] the individual’s achievement of predetermined goals.”
Top-Down vs. Bottom-Up Funding Mechanism -- The bottom-up approach “makes it easy for the person in charge of finance to begin with the end in mind. This way, company owners decide the desired return on equity in the business or stock value per share of the company and plan from the bottom up to figure out their annual budgets. It is easy then to add the cost of the incentive plans at target performance to determine the appropriate goals for the entire organization, business units, or divisions. Conversely, a company utilizing the bonus pool [also called the ‘top-down’ approach to funding] concept cannot predict how much money will flow into the bonus pool throughout the year and thus cannot define the potential incentive opportunity for the participating employees.”
Employee Empowerment -- “The fifth critical issue originates from employees not knowing how they contribute to the company’s success, coupled with [a] lack of incentive opportunity for achieving goals. Although the construction industry desires to drive employee commitment to the company success, … the construction industry is not empowering the majority of the employees to excel and hold them accountable for their results. Only 49 percent of the respondents indicated [that their companies provide] opportunities to participate in incentive compensation to most or all of their employees…. Involvement begets commitment. Providing an incentive opportunity to your employees will help them focus on what is important and support their commitment to company success that the vast majority of respondents desire.”
Communication and Transparency -- “The sixth critical issue is poor communication and lack of transparency. It appears that the vast majority of owners of privately held construction companies are resistant to sharing financial results of the business with their employees. We are not advocating full disclosure of the company financial information to the employees. However, if you want your employees to be excited about the incentive program, then they must understand what the goals are, how to measure success, and what is in it for them. Ideally, the incentive plan is co-created with input from participants in the plan, which helps not only in designing a fair and equitable incentive program but also in driving … employee commitment and understanding of the plan.”
Clear and Measureable Stretch Goals/Objectives -- “Only goals that can be tracked and measured should be included in the employees’ incentive plans. The clear stretch goals are especially important to companies desiring rapid growth. This way, a company can openly celebrate and reward the employees who take on the stretch goals. Occasionally, there may be an unforeseen circumstance that will create immense growth or contraction within a business, and therefore we always recommend that management retain the right to modify or adjust the company goals as necessary due to potential unpredictable events.”
When asked which one of the report’s suggestions for improving an incentive compensation program is most important, Radek Knesl, a consultant for FMI, told ConstructionPro Week (CPW), “All of the seven issues are critically important and interdependent. However, if we had to prioritize, we would say that defining the incentive opportunity up front is key. Three out of four contractors pay discretionary incentives after the fact.”
A full transcript of CPW's interview with Knesl appears in the ConstructionPro Network member version of this article. To sign up for a membership, click here.
The 32-page report can be accessed at http://hosting.fyleio.com/21574/public/FMI_Studies_and_Reports_/IncentiveCompSurveyReport_2013_FINAL.pdf.