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The Navigator
Charting a Path to Leadership Excellence
Volume: # 17Spring 2013

President's Message

Be Careful What You Ask For: Revisiting Executive Incentives


It's easily seen in organizations that goal setting coupled with regular feedback can drive performance, especially in the hyper achievement-oriented executive population. And if what you count is what counts, then organizations must be extremely careful with what they measure as "success". For example, much has been written since the Great Recession about a disproportionate amount of organizational attention paid by some organizations to short-term financial goals (e.g., Lehman Brothers' balance sheet shenanigans to improve ROIC and consequently executive compensation). So when used as incentives, metrics like annual revenue, profitability, ROIC, or stock appreciation goals necessarily translate to a one-year, tactical horizon, and may not encourage strategic, and consequently, sustainable leadership behavior. In the worst cases, we have seen unethical, even illegal, manipulation to reach an annual financial goal (e.g., booking business that's only in the proposal phase at end of year to reach an accrual revenue target). Or in other instances, talent management systems are deferred, or neglected, as short-term gain trumps the need for sustainable, automated leadership succession systems.

Given that incentives can profoundly influence executive behavior, and if "what executives pay attention to gets attention," then the actual STRATEGY of an enterprise that overemphasizes financial objectives can tilt toward financial goals, and possibly away from operational excellence, customer/consumer focus, and sustainable talent development practices. This disproportionate emphasis is partly an artifact of the heavy burden of fiduciary responsibilities required in publicly traded companies. To shareholders, companies are often simply "black boxes" in which investments enter and then one month/quarter/year later dividends/stock appreciation exit. This is a strictly and starkly TACTICAL financial view.

What to do? Well, in the extreme, we've watched clients like American Greetings go private to better position themselves away from a tactical financial fishbowl of the stock market and to an incentive scheme that rewards and thus directs leadership toward more strategic goals. Absent that dramatic move, it would seem that using a more balanced variable pay system could promote a more sustainable and strategic set of leadership actions and decisions. A made-to-order system was introduced over a decade ago when Robert Kaplan and David Norton presented the concept of a "Balanced Scorecard" in an award winning book of the same name. Their proposed executive dashboard metrics moved away from a purely financial focus to a more system-wide and sustainable set of measures, namely a "balanced" dashboard containing indicators in four areas: 


Balanced Scorecard  

This scheme found an immediate home in strategic planning where it provided a better paradigm for thinking about a company's situation in broader terms. But we think it also could lend itself to individual executive compensation, especially in general management roles. Unfortunately this hasn't happened as much as might be expected. Variable pay in C Suite roles still seems fixated on financial metrics. Granted these are the most mature as they are the easiest to operationalize having long been measured in similar ways across diverse businesses using GAAP principles with common definitions for revenue, profitabiltiy/EBIT, cash flow, ROIC, stock price, etc. But we think there are parallel measures in the other three areas. For example, in the TALENT arena there is a general set of measures that can tell you how engaged and prepared your workforce is. Pepsico has established systems that use biennial 360 leadership competency surveys and employee engagement assessments to hold managers accountable not just for operational or financial goals, but also for ensuring an engaged and committed associate population. Other organizations have used culture surveys to benchmark status and progress.

For CUSTOMER metrics, there are also a variety of options. Pure service businesses like ServiceMaster have adopted the Net Promoter Score as a standard metric across brands. Net Promoter Score or NPS was introduced by Fred Reichfeld and Rob Marley in the book The Ultimate Question 2.0 as a more focused way to evaluate how satisfied consumers are with any service provided. NPS is based on the key consumer satisfaction question: "How likely is it you would recommend us to a friend?" Using a 10 point scale, 9's and 10's are considered "promoters" and 1 through 6 ratings are detractors. The NPS score is simply the percentage of promoters minus the percentage of detractors. Other service providers in hospitality (e.g., Starwood) have begun to rely on social media sites like Trip Advisor to provide general feedback on how consumers perceive them.

In the OPERATIONS quadrant, organizations can measure quality or efficiency indicators. For example, one of our quick service restaurant clients uses speed-of-service at the restaurant level as a key indicator of operational efficiency. Any increase is symptomatic of greater operational system problems.

In researching this article, we were surprised to learn that the industry with perhaps the most sophisticated and balanced leadership variable pay system was health care. In one instance, we found a health care system using the following measures (which we have placed in a balanced scorecard format): 

 

    Operations/Consumers

    • Quality: preventable harm, inpatient mortality, inpatient readmission rate, length of stay, inpatient experience, patient-centered medical homes, behavioral health
    Talent
    • Human potential: associate engagement, diversity of senior leadership team formation and development, associate health
    Customers
    • Physician partnership: primary care employment/affiliation, net patient revenue/provider FTE
    Finance
    • Growth: net operating revenue, emergency department quality and efficiency
    • Stewardship: operating margin, strategic plan development
This represents a set of well developed incentives that are more likely to lead to a sustainable and successful enterprise. So why haven't other industries followed suit? For publicly traded companies, the tactical focus of the investment community is probably one obstacle to thinking beyond financial incentives. And cynically, one could suppose that the system perpetuates itself as more easily gamed for the short-term rewards it offers. But as history reveals, the most sustainable and enduring 100 year organizations like Proctor and Gamble or 3M do find a way to align leadership incentives with long-term company health.
 Bruce Griffiths  

 

Bruce's signature


 

   Bruce Griffiths





Copyright 2013, Organization Systems International
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OSI Clients Include:

American Greetings 
Blizzard Entertainment
Bowling Green State University
Dow Corning Corp.
Fleetwood
GE Capital
Insurance Company of the West
Limited Brands
Nike, Inc.
Northwest Pipe
Portland State University
Schneider Trucking Company
ServiceMaster
Siemens
Skinit
Standard Insurance Company
Starwood Hotels & Resorts
State Auto Insurance
The Walt Disney Company
Wendy's International Inc.