It’s pretty clear by now that U.S. employment continues to grow at a faster clip in the services sectors than the manufacturing sector (BLS). This has been a trend for many years now and has been intensified by automation occurring in manufacturing. Consequently, the single greatest expense that most companies have these days is compensation expense.
To get the absolute most for the dollars spent on employee compensation, I believe you can achieve the greatest return by following four basic Principles. And because I haven’t seen these principles articulated by anyone else, I’m going to humbly call them “Olivieri’s Principles” (for now):
• Principle #1: Operate with as few people as possible
People are expensive, so be careful about adding people to any organization despite the pressures from managers. At least have a good rationale for adding headcount and understand how the addition will affect net income. My rule of thumb is that if revenues per employee are going up, it is safer to add people. However, when an organization is rolling out new products/services in new markets it may be appropriate to add headcount. Count it as an investment.
• Principle #2: Try to shift as much compensation into variable expenses as possible
Base salaries make up the greatest portion of compensation expense and it is fixed expense. Since no one reduces an employee’s salary, the only way to reduced fixed expense is generally though layoffs, and that should always be a last resort. Things such as incentives and stock are variable expense and should fluctuate over the years based on organization and individual performance. If things don’t go well variable compensation expense should be less.
• Principle #3: Provide employees with upside compensation opportunity
If the individual employee and/or the organization does really well, the good fortune should be shared with employees primarily through the use of incentives and stock. This upside opportunity should be higher than market medians. If you want employees to act like shareholders, you have to treat them like shareholders.
• Principle #4: Differentiate pay based on individual performance
Everyone wants to be a “pay for performance” organization these days but not as many practice this philosophy to the extent they could. Not all employees are created equal when it comes to contributing to the bottom line. Those that contribute the most should get paid the most.
Ok, there you have it, Olivieri’s Principles for achieving the greatest return on the dollars you spend on compensation. There are obviously limits to how far any organization can go with each of these Principles. For example, I would not recommend targeting your salaries to the market 25th percentile and making it up with incentives. You would probably have difficulty attracting and retaining the right people for your organization. However, if you can adhere to these Principles in general, and have a good rationale for why you are varying from them, you can impact the bottom line.
What do you think?