Strategic Planning Issue: 3 Pieces of Paper

BACKGROUND
There has been a lot of discussion about how we have entered a “new economy” or a “post-capitalism business environment.” The idea is that businesses can no longer be managed like they used to. Profit has become less important. Being a good corporate citizen has become more important. A new relationship with employees is needed. And on and on the list goes. If you want to be successful now, you have to abandon the old rules and embrace the new rules. Traditional capitalism is passé. Embrace the new economy.

A lot of sophisticated reasons are usually given for the need to change. They usually include factors something like these:

1. Changing Customers: The internet has shifted the balance of power from the company to the customer, and the customer isn’t all that interested in how profitable you are, but rather how nice you are.
2. Changing Employees: The Millennial generation expects more from its employers than mere profit machines. If you want to hire the best of the Millennials, you have to satisfy their more diverse requirements for an employer.
3. Changing Approach to Problem Solving: The world is full of serious global problems. Individual governments have not proven themselves to be particularly effective at solving them (they just talk and squabble with each other). However, if you point large international businesses at these problems, you may get a more effective outcome.

These all sound so noble and sophisticated and academic. And there is some truth in all of this. But I think the main reason why business is changing is a lot less noble, sophisticated and academic.

I think the main driver of change is the change in the type of paper we use to compensate employees.

THE OLD PAPER: CHECKS
In the middle of the 20th century, most of one’s compensation came in the way of a check. The vast majority of it was in the form of a regular paycheck. Then, at the end of the year was a bonus check.

The most important thing one needs to know about checks is that they only have value if there is enough money in the checking account to cover the check. Therefore, to keep the employees from rioting, you need to ensure that money is flowing into the checking account at levels to cover the checks.

In the middle of the 20th century, the primary source for the money in the company’s checking account was either profits or standard bank debt. And you couldn’t get standard bank debt unless you could prove to the bank that the company was on a path to create enough profits to pay off the debt.

Therefore, success at that time required a high focus on creating profits and significant cash flow on a regular basis. And the best way to do that was via traditional capitalism. It was all about profit, so that you could keep writing those checks.

THE TRANSITIONAL PAPER: STOCK CERTIFICATES
As we moved towards the later portion of the 20th century, compensation practices were changing. For executives, the percentage of their total compensation from their base of paychecks was shrinking. Non-base compensation as a percent to total was increasing. And instead of just being a bonus check, the non-base compensation was increasingly coming from stock or stock options.

Now stocks are different from checks. You don’t need a lot of money in the bank to issue stock. In fact, you don’t need any money at all in the bank to issue stocks. I had a lot of friends who worked at Best Buy in the early days, when the company always seemed to be on the verge of bankruptcy. The company couldn’t afford to write bonus checks, so it kept giving everybody tons of Best Buy stock. 

Although the stock had little value at the time, there was at least the hope that it could become very valuable in the future (which is better than a bounced check). And, in the case of Best Buy, eventually that stock did became extremely valuable (and made many of my friends very wealthy).

In a compensation world full of stock paper rather than check paper, management priorities start to change. It is no longer about focusing on keeping the checking account balance high through growing today’s profits. Now, it was about finding ways to increase the value of the stock.

Yes, the economists will tell you that there is a correlation between profits/cash flow and stock price. In other words, if profits keep going up, stock prices tend to go up. But the correlation is not as close to 100% as it is with check balances. Other things now start getting in the way.

As it turns out, there are a variety of other tools to increase stock price beyond activities to increase current profits. They include activities like:

1. Changing People’s Perception of the Future: If you get people to think to that the future will get a lot better for your company, the stock price will go up, even if nothing is different in profitability today.
2. Making the Company Bigger via M&A: At that time, growth through acquisition tended to increase stock prices, because the combined bottom line was larger. However, if you paid too much for the acquisition without meaningfully changing the rate of profitability, you were actually destroying value. But this was sometimes overlooked by the market at that time.
3. Stock Buy-Backs: Earnings per share is a ratio. There are two ways to increase the ratio: either increase the numerator (earnings) or decrease the denominator (number of shares). So by buying back shares, I can increase the price per share without having to deal with profits.

So, as you can see, by shifting the paper from checks to stocks, I’ve moved a bit further away from pure capitalism. The profit motive is diminished a bit and other things are coming into play.

Probably the best example of this transitionary period would be to look at Enron. Enron was one of the most extreme at using stock as a compensation tool. It dominated the total compensation package, it was administered quarterly, and it was the driving force behind Enron’s everyday decision-making.

The extreme focus on raising stock prices at Enron lead to far less focus on profits. In fact, in the final years of Enron, they typically weren’t paying taxes, because they weren’t really making profits. But the stock price kept skyrocketing, making the employees wealthy, because of the stock tricks they were using.

Of course, eventually they lack of a profitable business model eventually caught up with them and the company collapsed (along with the stock price).

THE NEW PAPER: DEAL PAPER
The new economy of today tends to be more about start-ups in the social media and technology space. There are a couple of things worthy of note in how these companies operate.

First, their checking accounts are not filled with money from profits or standard bank debt. They are filled with money from firms that invest in start-ups. In other words, the start-ups are writing checks that draw from someone else’s source of money, not their own.

Second, nearly all of the compensation comes from when the start-ups cash in, by either going public with an IPO or by selling at some outlandish price to someone like Google, Facebook or Apple. Regular payroll checks are an insignificant percent of the total compensation. The work is done to get to the point of cashing in. You’re looking to sign the deal paper that makes the cashing in possible. Practically your whole life’s earnings come from that single point in time when you sign the deal paper and sell out.

In this scenario, profits have moved from being less important to almost being non-important. Since the money at first comes from private equity investors and later from whomever you sell out to, profits are never a big part of the equation.

If the profit prognosis in the early stages becomes too dire, you typically don’t try to fix it. Instead you shut down the start-up and try again. That is why I sometimes refer to this as the “Lottery Economy”: You just keep trying start-ups until you luck into a winner.

When the whole operating model is built around getting to the “cash in” deal paper, you naturally have moved quite far away from traditional capitalism.

It is like people who flip houses for a living (buying houses with no intent of living there, but only to sell at a profit). They don’t invest in improving the foundational issues in the house. They invest the cosmetic issues that make a house more appealing to the next buyer without having to spend a lot (called curb appeal).

In the same way, the start-ups in the new economy don’t build the foundation for profits but work on the cosmetics that make it more appealing when it is time to cash in.

IMPLICATIONS
The implications here are that although there are some noble, sophisticated reasons for why the economy has changed, that is not the whole story. It may not even be the main story. The main story may be about how people are getting compensated.

Knowing the primary cause of the change is important because of what it implies. If the new economy is primarily a result of a changing environment, then we have to adapt to the new environment. But if it is primarily due to a change in compensation tactics, then perhaps the old rules of capitalism are not as obsolete as we think.

My fear is that extremism in the Deal Paper economy may lead to the same thing as extremism in the Stock Certificate economy. We may end up with a repeat of Enron, where the abandonment of profit as the focus eventually catches up to us and everything collapses.

SUMMARY
Yes, the economy appears to be operating under new rules. But until we fully understand the cause, we may want to be careful about the extent to which we embrace them. The dominance of profits in business may not be completely dead—just asleep.

FINAL THOUGHTS
This only briefly touches on the subject. It is too much to cover in a single blog. But hopefully this can get the conversation started.

Strategic Planning Analogy #362: Driving Force

THE STORY
Awhile back, a friend of mine took a job running a division of a large retail company. Not very long later, I heard he had decided to quit that job and retire early. I asked him why he quit running that business so quickly. He said he quit because the company he went to work with was very corrupt. It seemed to him like almost all the executives were taking bribes under the table.

Not only was he personally against corruption (and was uncomfortable in that environment), he felt it was ruining the company. Decisions were made based on where the bribes were coming from, rather than what was best for the business. In addition, the corrupt culture was so pervasive that my friend knew it would take a significant amount of time and energy to eliminate it from the company. And he didn’t think he would get the support necessary to do such a difficult task. Therefore, he decided to retire.

Not very long after that conversation, I came across a new book which tried to explain why the company my friend just left was having severe financial troubles. The book listed a small handful of mistakes the company had made and made suggestions as to how your company could avoid making those same mistakes.

I decided to call the author of that book. I told her that I thought a lot of the financial problems at that company were due to the corruption and bad decisions made based on the bribery of the executives. I wanted to know why that wasn’t a focus of her book.

The author sort of stammered and stuttered after hearing my question. She got rather vague and evasive in her answer. Reading between the lines, I got the impression that what she wanted to say, but was ashamed to admit, was:

1) She knew about the corruption.

2) She knew that, as an author, she would have been putting herself into harm’s way if she accused management of rampant corruption in a book. Without an airtight case, and lots of concrete evidence, she could be sued and have her life ruined.

3) She knew that publishers could sell more copies of a book announcing “a handful of tricks for avoiding failure” than a book that merely says “don’t be corrupt.”

So she took the safe route and side-stepped the topic of corruption.

I started thinking that her approach wasn’t all that different than that retail company. She wrote content which would put the most money in her pocket rather than writing the truth. The company executives did what would put the most bribe money in their pocket than do what was truly the best for the company and its customers. As a result, both the customers of that retailer and the purchasers of that book got less than they deserved.

THE ANALOGY
Just like that book was supposed to be a guide as to how to avoid failure, strategies are supposed to be a guide—pointing the way to avoid failure and create long-term success. Unfortunately, that book was a poor guide, because it focused on saying what the author thought people wanted to hear, rather than the truth which they needed to hear.

In the same way, if your strategy remains in the lofty world of platitudes and fancy phrases, and avoids the messy reality in front of it, it will be a worthless strategy. Strategies only work well if they match the context of the company which has to implement it. If the company is corrupt (like the one my friend left) or incompetent (like the company portrayed in Dilbert), then you have a bad context for almost any strategy. Unless you address these messy issues, the written strategy is fairly worthless. It will fail under the weight of corruption or incompetence.

THE PRINCIPLE
The principle here is that one’s real strategy is the sum of what one does rather than the sum of what one says. If you have a toxic culture due to tolerance of bad activity (such as corruption, incompetence, excessively selfish greed, or abuse), then that becomes your strategy.

In these cases, all those pretty little words in the planning document are a waste of time, because they are not what is driving the behavior. Instead, the behavior is being driven by the toxic culture. Whatever you tolerate, that is what you will get. If you tolerate bad behavior (in any form), then your company will become infested with bad behavior.

Toxic cultures tend to promote selfish behaviors which ignore the best interests of the company’s key stakeholders. Rather than doing what is best for the customers, or the shareholders, or for the business, employees in toxic cultures merely look out for themselves (at the expense of everyone else). This creates sub-optimal behavior for the business—a strategy for failure.

Even if the company in the story had not made the mistakes in that book, I am sure they still would have been a failure, because of that corruption. You cannot win in the marketplace if you ignore the marketplace in your decision making. Bribe-driven decisions rarely lead to the best choice for customers.

Most businesses tend to operate in highly competitive spaces. If you are not providing excellence at a value, then you will lose business to others who are.

Toxic culture makes it hard to create excellence, because all of that ignorance, corruption or abusive behavior gets in the way of creating greatness. Toxic culture also makes it difficult to create value, because all of that personal greed sucks excessive money into the pockets of employees, robbing the company of the ability to pass on savings to the customer.

A lot has been written about the success of Wal-Mart. As in any success, there are a lot of factors at play. However, one factor which I think often gets under-emphasized is Wal-Mart’s intolerance of toxic behavior. Wal-Mart tends to take an extreme approach to ensure that its buying staff is not corrupted by bribes. Buyers (and vendors) know that their job (or relationship) with Wal-Mart is in jeopardy if the buyer is caught taking as little as a free cup of coffee from a vendor. Both the buyer and the vendor will be punished. This zero-tolerance approach makes it extremely difficult for toxic behavior to creep in and over-ride the core strategy.

Back around 2006, Wal-Mart fired Julie Roehm, its new Chief Marketing Officer, because there was an appearance of toxic behavior between Roehm and the advertising agency. There was the appearance of Roehm accepting financial benefits (like fancy dinners) from the ad agency. There was also the appearance of potential sexual misconduct between Roehm and one of her subordinates.

At some point, I suspect Wal-Mart almost didn’t care what the extent of the toxic behavior was. Wal-Mart wanted to send a message that even the appearance of potentially toxic behavior was not to be tolerated. Wal-Mart was very loud and very public about why they let Roehm go. Based on this, and many other examples, the word gets out that toxic behavior is not tolerated. Instead, one is to focus on getting the Wal-Mart strategic agenda accomplished.

So, if toxic culture can ruin a company like the one in my story and zero tolerance of toxic behavior can help create one of the largest and most successful companies on the planet, then it appears that this is an important area for strategic concern. So how can you help keep toxic behavior from becoming a ruinous strategy?

1) Watch the Tone From the Top
Everybody below in an organization is watching the people at the top. If they see the people at the top getting away with toxic behavior, then they will see toxic behavior as tolerable and acceptable for everyone else. “Do as I say, not as I do” won’t cut it. The people at the top need to set the example. In fact, they need to set a higher standard for themselves so as not to even give the appearance of tolerating toxic behavior.

Actions speak louder than words. Strategy words lose out to bad behavior every time. Make sure your leaders are modeling the right behavior.

2) Watch out for How Your React When Your Star Players Behave Badly
What do you do when your highest performers behave badly? Do you tolerate their toxic behavior as a tradeoff for getting their high performance? In the long run, it is usually better to get rid of even star performers with toxic behavior, because the negative impact on the whole organization of that tolerance is worse than the added benefit of their slightly higher output.

3) Watch out for How You Set Rewards
People need to be rewarded for doing the things which are in the best long term interests of the company and its strategy. Otherwise, there is the temptation to use toxic behavior in order to maximize near-term bonus. There are lots of ways to hit a short-term sales or earnings target. Many of those ways can involve toxic behavior. If your bonus only focuses on the achieving the “what” rather than the “how” it was achieved, you may be rewarding toxic behavior without even knowing it.

SUMMARY
Your strategy is the sum of what you do, rather than the sum of what you say. If your company tolerates toxic behavior like corruption, abuse, incompetency and excessive selfishness, then that becomes your real strategy. And when employees are only trying to optimize their own selfish gain at the expense of everyone else, you have a losing strategy. Fight to keep toxic behavior from getting a toehold in your organization. Fight to keep the focus on living the strategy instead.

FINAL THOUGHTS
The irony is that if you try to make the money the easy way, via bribes, your gains may be cut short. Either you lose your job or the company you work for goes away because the bribery culture leads to destruction. However, if the toxic behavior is avoided, the company prospers, and you can share in that prosperity for a long time. I suspect that more employees got wealthy on Wal-Mart bonuses and stock options than employees who got wealthy taking bribes at the failing retailer mentioned in my story.

Strategic Planning Analogy #295: Bonus Backlash

THE STORY
Many years ago, I was working at a company that was having mediocre (at best) performance, yet paid its top executives quite well. I complained about the high pay relative to the performance and was told, “You have to pay a lot to get this caliber of management.”

My reply was, “Are you saying that if I pay less I can get a better caliber of leaders?”

THE ANALOGY
My point (half in jest) was that if a company pays too much money to top management, they will attract people who are primarily there to satisfy their personal greed. Pay less and that caliber goes away, replaced by people who are more motivated by doing a good job for all the business stakeholders.

Before throwing me overboard as a heretic, consider an article published today in the Wall Street Journal in collaboration with the MIT Sloan Management Review. The article advocated eliminating the executive bonus, using words which echoed some of my assessment. In particular, the article said,

“It has been claimed that if you don’t pay [bonuses], you don’t get the right person for the CEO chair. I believe that if you do pay bonuses, you get the wrong person in that chair. At the worst, you get a self-centered narcissist. At the best, you get someone who is willing to be singled out from everyone else by virtue of the compensation plan.”

This article was not written by some young anti-capitalist revolutionary. It was written by Dr. Henry Mintzberg, a long-time business professor at McGill University.

While I disagree with Mintzberg’s ultimate conclusion to eliminate bonuses, I agree that the current system is a bit broken. And my biggest concern is not about the greed. A little greed can be a useful motivational tool. My key concern is that compensation influences action, and long-term strategic actions tend to get little emphasis when the compensation plan is created.

THE PRINCIPLE
The principle here is that people act based on how they are rewarded. Therefore, if you want leaders to act in the best interest of the strategic plan, make doing so a key part of the reward plan.

Now some might argue that long-term strategies are already well baked into most executive compensation plans. After all, most of them have a large component tied in some way to stock price. Doesn’t a rising stock price represent some sort of approval of long-term future strategic performance?

The problem is that there are a large number of causes for rising/falling stock prices which have virtually nothing to do with implementation of a strategic plan. These causal factors can include everything from short-term financial manipulations (that have nothing to do with strategy) to stock buybacks to macro-economic factors outside a company’s control. Given all the factors which impact a stock, it is virtually impossible to isolate how much the price fluctuation has to do with strategy implementation (or lack of implementation).

In fact, there can often be a negative correlation. By cutting back on investments with more strategic, long-term impact, one can make the near-term results look better, which can temporarily increase stock prices. Of course, this is like saving money today by eliminating automotive maintenance, only to have a longer-term disaster when the engine eventually blows up due to lack of maintenance.

At best, stock is a weak indicator of strategic success. At worst, it is a false indicator which only corrects itself after it is too late and the damage is already done.

A good strategic plan is a roadmap to the future. It shows your desired destination and an action plan of steps to get there. If you want to give incentives for strategic success, then reward achieving those particular actions elaborated in the plan.

For example, your strategy could outline specific action plans similar to the following:

1) Shifting the product portfolio mix in a particular direction (less of some types of products, more of others).
2) Shifting the customer mix in a particular directions (less of some types of customers, more of others)
3) Shifting the way particular work is done, so that it is more productive.
4) Shifting the perception of the company’s position in the marketplace.
5) Entering particular new businesses, geographies, or customer segments.
6) Exiting particular old businesses, geographies, or customer segments.
7) Gaining market share from a particular competitor.

These are actions that can be measured—did you accomplish them or not? If yes, you get rewarded; if no, then no reward. Action-based compensation is more closely aligned with strategic plans than near-term financial outcomes or today’s stock price.

Step #1: Have Actions Written Into Your Plans
Of course, this assumes that your strategic plan includes concrete and specific action steps/goals. If it does not, then I question the value of your strategic planning process. Therefore, the first step is to make sure your strategy is linked to actions. Just providing a vague platitude like “We will be great corporate citizens while providing our shareholders with an adequate return” is not enough.

Somewhere in the strategic plan one needs to explain in broad terms what actions must be accomplished. And remember, numbers are not actions. Saying “We will increase profits by 50%” gives no strategic insight into how to bring this idea to reality. One needs to explain how this is to come about—what needs to be done.

Step #2: Put Actions into Compensation
Now, assuming we have actions described in our plans, the next step is to get those actions into the compensation program. Setting compensation is not just the responsibility of the Human Resources Department or the Compensation Committee of the Board of Directors. If you want people motivated to accomplish the strategic plan, then take responsibility for getting that accomplishment rewarded in the compensation program.

The idea is to reward if the action is accomplished and not reward if the action is not accomplished.

Step #3: Watch Out for Cheaters
No matter how a compensation system is set up, employees (including top executives) will try to find a way to exploit the rules to their advantage. For example, if my goal is to expand into bio-technology, I can do so very quickly if I am willing to acquire a bio-tech company for 1,000 times what it is worth. I got the task done, but in a way that could bankrupt the company by paying too much.

No compensation system is 100% free from cheaters. Loopholes can always be found. But at least with an action-based system cheaters need to at least accomplish something related to the plan.

Some safeguards can be put into the compensation system to ensure that the actions are not blatant abuses of the system. Approvals will need to look at the quality of the action, not just the quantity. Limits need to be placed on how many resources you use as inputs in order to get those outputs, to ensure that there is a positive return on investment.

This should stop a lot of the abuse. And if a habitual cheater still regularly abuses the system, then maybe the problem is not the system, but the person.

Step #4: Properly Size the Prize
If a bonus is too large a percentage of total compensation, then you are increasing the likelihood for abuse. You are also increasing the likelihood that you will be attracting people motivated by excessive unproductive narcissism, rather than people looking out for all of the various stakeholders.

Therefore, make the bonus a minority of total compensation—enough to incent the right strategic behavior, but not so much that it creates unbalanced behavior.

SUMMARY
Bonus systems are effective at providing an incentive for action. If set up wrong, they can provide an incentive to do the wrong things. They may even provide an incentive to attract the wrong people. However, if managed properly, bonuses can create the incentive to accomplish your strategic plan. This requires: a) Putting Actions into your Strategic Plan; b) Giving Rewards when those Strategic Actions are Accomplished; c) Putting in Safeguards to Slow Down Blatant Abuse of the System; and d) Making sure that the Size of the Bonus is kept below a level which Distorts Greedy Behavior too Much.

FINAL THOUGHTS
Next time you hear someone say they are “results driven,” ask them what they mean by that. Does it mean they are driven to achieve a number on an income statement regardless of how much strategic damage is done in the process? Or does it mean they are driven to get the right tasks accomplished in the right way?

Raking Up Losses

THE STORY
Once upon a time, there was a wealthy man who owned a large estate out in the country. The back of the estate was filled with large trees. They were beautiful to look at, but a real nuisance in the fall when all of the leaves came down.

The wealthy man did not like having those leaves all over his yard, so he decided he would hire all of the young boys in the neighborhood to rake up his leaves for him. It was important to this man that each boy got paid fairly based on the amount of work the boy did. He didn’t want the lazy boys to get paid as much as the boys who worked hard. Therefore, he designed what he thought was a clever plan.

He divided the huge yard into sections. Each boy was given his own section to rake. The rules were simple. Every time you clear your section of leaves you would get paid a predetermined amount. If you didn’t clear your section, you did not get paid anything at all. The wealthy man put his lazy, spoiled son in charge of inspecting the sections, to see if they were cleared of leaves and to then pay the boys each time their area was clear.

This plan made the wealthy man happy. He was so confident in the plan’s success that he ignored the yard for several weeks. Eventually, he decided to go out back to see how the raking was going on. When he got there, he was shocked to find that all of the leaves were still scattered all over the yard. It was a real mess.

He angrily looked for his son to find out what happened. The wealthy man yelled at his son, saying “After all of these weeks, none of the leaves have been raked up. I certainly hope that you didn’t pay any of those young boys.”

“Actually,” the lazy son said, “I ended up paying them a hundred thousand dollars.”

“A HUNDRED THOUSAND DOLLARS?” the man screamed. “Why did you pay them so much money, when it is obvious that all off the leaves are still on the ground? Are you crazy??”

“I only did just what you said,” replied the son. “Each boy started working with the boy in the section next to theirs. One boy would rake his leaves just over the line onto the section next to him. I would pay him. Then the other boy would rake the leaves back over the line to the first boy. So then I would pay the second boy. All day long, they would rake the pile of leaves back and forth just across the line of their section. Each time one of them pushed the pile of leaves across the line, they would get paid. Eventually the boys got very good at quickly moving the leaf piles back and forth. After awhile, they had made so much money that they all decided to go back home.”

Suddenly, the wealthy man could see the major flaw in what he originally thought was a clever plan. He sighed, “Well, it looks like the only thing that got raked over and cleaned out here was my bank account.”

THE ANALOGY
It’s natural to want to reward the people who work hard and not reward the lazy ones. It seems like the fair thing to do. This was what the wealthy man was trying to do. However, in his attempt to be as fair as possible, he lost sight of the bigger goal. What he really wanted was to rid his yard of leaves. By focusing too much on fairness, he created a reward system that encouraged behavior that did not lead to achieving the desired ultimate goal.

Once we determine a desired strategic goal, we want to set up a compensation system which fairly rewards people who help achieve the strategy. However, if we concentrate too much on “individual fairness” we can end up rewarding people for things that never get us closer to achieving the strategy. Like the man in the story, the only thing we end up doing is raking up losses.

THE PRINCIPLE
As people, we often link “fairness” with “control.” We think that the fair thing to do is to only compensate people for those things that they have direct and/or complete control over. After all, does it seem fair to penalize someone when undesirable results happen over which they do not have direct or complete control? Or, conversely, does it seem fair to reward someone when desirable results happen which they didn’t control?

I couldn’t count the number of times I’ve seen someone look at how they were to be compensated and heard them complain by saying something like, “You can’t bonus me on that. I don’t control the outcome. It’s not fair.”

The problem is that if the individual has complete control over the results, then they have complete control over how to manipulate the results to their personal advantage. Now, to me, that doesn’t sound fair, either.

The boys in the story pretty much had complete control over their situation. Not only could they control how quickly their area got clean, but they could also control how quickly it got dirty. By manipulating that control, they got paid far more than they should have while never accomplishing the greater task of getting the yard clean.

That is why the fairest compensation needs to be one that goes well beyond just compensating people for what they can directly control. It needs to include areas for which they have indirect control and areas which relate directly to moving the company towards achieving the desired strategic outcome.

As it turns out, people have more influence on a business than just areas directly under their control. For example, I know of a clothing retailer where the buyers were compensated for buying the apparel from the manufacturers as cheaply as possible. After all, they are buyers, so they should be compensated for buying well. However, in their attempt to get the lowest price, the buyers would not have the manufacturers put the clothes on hangers or put price tags on the clothes. If they would have asked the manufacturer to do these services, the manufacturers would have charged a higher price, which works against the buyer’s compensation.

Unfortunately, because the buyers did not take care of negotiating for the hanging or tagging, someone in the retailer’s distribution center would have to do that service. It is like in the story where the boys did not clean the yard. All they did was push the leaves into someone else’s grid. All the buyers did was push the hanging and tagging problem into the distribution center’s grid.

In most cases, the manufacturer could perform these services for less than half the cost of the distribution center. So the actions of the buyers had an impact over the costs of the distribution center, an area over which the buyers would say they had no control. In reality, however, they had significant influence. Had the buyers been compensated on the lowest cost to get the goods from the manufacturer to the sales floor, they would have complained about lack of control. However, they also would have negotiated to get the manufacturers to hang and tag the goods, thereby saving the company more money than they did under their current compensation.

Often times, the biggest cost bottlenecks are at the point of transfer between two areas in an organization. As long as compensation stays within the areas of complete control, these transfer points do not get adequately addressed, since the responsibility is shared. By compensating based on areas outside one’s complete control, the transfer points get addressed.

Even in areas where there seems to be very little, if any linkage, there are still ways in which you can control the outcome. There is peer pressure. One can give advice or assistance. One can shift or trade some areas of responsibility that will end up making everyone more productive. And so on.

Finally, it is important to link rewards directly with the strategy. The compensation given the boys was never linked to the goal of getting the entire yard cleared of leaves. As a result, the yard was never cleared. At the end of the day, it is more important that the organization achieves its strategy than for individual areas to temporarily gain while the strategy is ignored. For if the strategy is ignored, eventually everyone loses…and that isn’t very fair.

SUMMARY
It is more important to link compensation to a broader strategy than to what an individual area can completely control. Although this may at first seem unfair, it is actually more fair, because complete control leads to “gaming the system” for personal benefit at the expense of the rest of the organization.

FINAL THOUGHTS
When you focus on smaller goals, you can sometimes perfect a process that does not need to be done at all. For example, if the only thing the wealthy man wanted was to get rid of the leaves, he could have cut down the trees. Then all the costs of raking the leaves every year could be eliminated. Perfecting the unnecessary is a waste of energy. When you focus on the big picture, you often find more creative solutions.