PDF Summary:Scaling Up Compensation, by Verne Harnish and Sebastian Ross

Companies often implement compensation systems without deeply considering how those systems align—or don't align—with their culture and strategy. By failing to make compensation a strategic driver, they miss a valuable opportunity to attract, retain, and motivate the right talent to achieve their organizational goals.

In Scaling Up Compensation, Verne Harnish and Sebastian Ross explore effective compensation approaches that connect to an organization's objectives and values. They provide insights on formal pay structures, group incentives, and employee ownership plans. This book offers a framework for building compensation strategies that complement your company's culture and direction.

While compensation alone does not motivate high performance, done right, it can shape behaviors, cultivate excellence, and create competitive advantages. By fostering alignment between how employees are paid and the business's mission and identity, organizations generate a powerful feedback loop that propels organizational success.

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• Volunteer to be a part of a peer-to-peer financial mentoring program within your company. If one doesn't exist, propose the idea to HR. As a mentor or mentee, you can exchange personal experiences with financial management, discuss strategies for saving or investing, and provide moral support for financial goals and challenges.
• Create a personal cash flow calendar to visualize income and expenses on a weekly basis. By plotting out when you receive income and when bills are due, you can better manage your cash flow, similar to how weekly paychecks help employees. For example, if you freelance, set specific days of the week to invoice clients and schedule bill payments right after your expected payment dates to mimic a weekly pay cycle.
• Encourage pay equity through consumer choices by supporting businesses that are known for fair pay practices. Before making a purchase, research the company's pay structure and prefer those with smaller pay gaps between their top executives and regular employees. This can be done by looking for certifications or statements on corporate responsibility on the company's website or through third-party assessments.
• You can advocate for a living wage by writing to your local representatives to express how it can boost community productivity. Explain in your letter how ensuring a basic income for all could lead to a more vibrant local economy and improved public health, drawing on studies that link financial security to better performance outcomes.

The Limitations of Individual Financial Incentives

Motivators May Cause Goal Conflicts, Gaming, and Reduced Collaboration

Harnish and Ross caution readers about over-reliance on personal monetary incentives. While they might be effective for simple, repetitive tasks, they often lead to undesirable side effects like conflicting objectives, gaming the system, and reduced collaboration.

Financial Incentives Shape Behavior Through Selection and Messaging, Not by Directly Motivating Effort

The authors acknowledge that monetary incentives have limited effectiveness as direct motivators, drawing on research by renowned motivation theorists like Maslow, Herzberg, Deci & Ryan, Pfeffer, and Pink. They argue that monetary rewards primarily influence behavior through selection (attracting those who value financial compensation) and information (signaling what's important to the company), rather than by motivating employees to work harder.

The authors illustrate this point through Egon Zehnder International, a prestigious executive search firm that deliberately avoids individual bonuses and comisiones, instead opting for a profit-sharing model based on seniority. This approach, according to founder Egon Zehnder, reinforces their culture of long-term relationships and teamwork, crucial for success in their industry.

Context

• Research in psychology distinguishes between intrinsic motivation (driven by internal satisfaction) and extrinsic motivation (driven by external rewards). Monetary incentives are extrinsic and may undermine intrinsic motivation, which is often more sustainable and linked to personal fulfillment and engagement.
• Insights from behavioral economics indicate that people are not always rational actors. Financial incentives might not always lead to increased effort or productivity, as individuals may respond to incentives in unpredictable ways based on cognitive biases and social influences.
• Compensation strategies can be a powerful tool for reinforcing company culture. By choosing a model that emphasizes collective success and longevity, Egon Zehnder International aligns its compensation with its cultural values, ensuring that employees who thrive in this environment are attracted and retained.

Requirements for Effective Personal Motivation Strategies

Harnish and Ross present eight conditions that must be met for individual incentives to work well:

1. The position involves repetitive tasks and centers on a single activity.

2. The objectives are clear and straightforward.

3. Assessing both the amount and the caliber of outcomes is straightforward.

4. The worker manages the whole procedure and its results from beginning to end.

5. Manipulating or cheating the outcome is virtually impossible.

6. The position requires a high level of independence and minimal need for collaboration with others.

7. The individual isn't required to assist or support anyone else.

8. The employee sees the reward as valuable, and payment is frequent.

The authors argue that these prerequisites are largely absent in the knowledge-based service economy. They further explain how common pitfalls such as excessively complex or overly simple reward plans, unanticipated actions, and biases in evaluating performance can derail even well-intended systems.

Other Perspectives

• Focusing solely on repetitive tasks can lead to job dissatisfaction and decreased overall motivation if employees do not find the work engaging or meaningful.
• Clear and straightforward objectives may not always account for the complexity of certain tasks, which could require a more nuanced understanding and flexible goals.
• Straightforward assessment may not capture long-term impacts or the development of skills that are not immediately visible in the outcomes.
• Having a single person in charge of the whole procedure could result in a lack of checks and balances, increasing the risk of errors or oversight.
• The claim does not account for insider threats, where individuals with a deep understanding of the system may be able to manipulate outcomes without detection.
• High independence may lead to isolation and a lack of diverse perspectives, which can be detrimental to problem-solving and innovation.
• In many modern workplaces, the ability to collaborate and support colleagues is a key skill that contributes to a positive company culture and overall job satisfaction.
• Dependence on frequent rewards can make employees less resilient to changes in reward structures during economic downturns or organizational restructuring.
• Knowledge workers often have clear objectives and performance indicators that can be used to structure effective incentive programs.
• Unanticipated actions may be addressed by designing reward systems that are adaptable and can evolve in response to changing circumstances and behaviors.

Compelling Motivators for Salesperson Archetypes

The authors acknowledge that sales positions are often more suited for individual rewards, yet emphasize that these require careful design and tailoring to different salesperson archetypes. They reference research from professors Ahearne and Steenburgh, who categorize sales teams into different performance profiles: high achievers, average sellers, and underperformers. They provide examples like Dell's strategy of limiting its high-performing sales representatives to completing just nine deals annually, driving them towards larger and more complex deals, to illustrate the power of customized incentives that address the unique motivations of each archetype.

Harnish and Ross suggest focusing on internal motivation through factors like culture and guidance, while complementing it with strategic extrinsic incentives. Their key message is to use financial incentives sparingly, acknowledging that while these rewards can motivate a sales team, they are not a cure-all and require careful design and implementation to avoid unintended negative consequences.

Practical Tips

• Role-play with a friend or family member to practice and refine your tailored sales archetype. Choose a product or service you're passionate about and have your partner act as a difficult customer. After the role-play, ask for feedback on your approach and what could make it more convincing. This exercise will help you adapt your sales style to different customer personalities and objections.
• Set up a peer-mentoring group with colleagues. Pair up with someone who has different sales strengths and weaknesses. You can learn from each other's experiences and techniques. If you're great at initiating contact but struggle with closing, find a colleague who excels at sealing deals and exchange insights.
• Introduce a 'choose your reward' system for reaching sales targets. Instead of a one-size-fits-all reward, provide a selection of incentives from which sales representatives can choose upon achieving their goals. This could range from gift cards to different stores, a variety of tech gadgets, or even a menu of experiences like a dinner at a fancy restaurant or a day at a spa. This strategy respects individual preferences and can make the pursuit of sales targets more personally engaging.
• Create a peer review group with colleagues or friends where you evaluate the quality of each other's work. This could be a monthly meetup where you present one of your projects or deals and get feedback on how to improve the quality. This will encourage you to focus on making each project count, knowing it will be scrutinized for its excellence, not just its existence.
• Create a vision board that represents your ideal culture at home or work. Use images and words to depict the environment you want to foster, including the types of relationships and attitudes that are important to you. Place this board somewhere you will see it daily to remind yourself of the cultural aspects you want to cultivate in your personal or professional life.
• You can create a personal reward system for achieving small milestones in your daily routine. For instance, if you're trying to exercise regularly, promise yourself a small treat, like watching an episode of your favorite show, for every week you complete all planned workouts. This approach uses extrinsic rewards to reinforce your intrinsic desire to stay healthy.
• Experiment with non-monetary rewards to recognize achievements, such as a personalized thank-you note or an extra day off. This approach can create a sense of appreciation that goes beyond financial compensation and can be more memorable and meaningful.
• Organize monthly team-building activities that are unrelated to sales targets, such as volunteer work, sports events, or creative workshops. These activities can foster team cohesion and provide a sense of fulfillment that isn't tied to financial outcomes, potentially leading to increased motivation and a more positive work environment.
• Experiment with a 'buddy system' where you and a friend set goals and establish mutual incentives. This adds a layer of accountability and ensures that the incentives are desirable but not counterproductive. For instance, if you both want to save money, agree that for every $100 saved, you'll jointly donate a small amount to a charity of choice, reinforcing the positive behavior without directly spending the saved money on something frivolous.

Using Group-Based Gain-Sharing Schemes

Using Programs That Encourage Achieving Key Metrics Works

Harnish and Ross propose using shorter-term gain-sharing schemes as a more effective approach than individual incentives. These strategies revolve around gamifying business objectives and rewarding groups or the whole organization for achieving specific goals tied to critical business metrics.

Plans Leverage Informational and Group Responsibility Effects Over Financial Motivation

The authors highlight how providing information is the primary driver of successful gainsharing. By making company priorities more specific, tangible, and rewarding, these schemes inform employees about the most important aspects. They further explain that gamifying these programs can boost engagement and make the financial reward secondary, tapping into people's natural desire for fun and competition.

Harnish and Ross showcase MiniMovers, an Australian moving business, which incentivizes a "no breakage" culture by offering a quarterly bonus funded by part of their revenue. This bonus is only distributed if no items are broken during the quarter, encouraging shared responsibility and mutual accountability.

Practical Tips

• Develop a fitness challenge with friends where you track progress through a shared app or spreadsheet. Set up categories like steps walked, miles run, or hours exercised, and compete weekly for virtual badges or titles. Celebrate milestones with group activities or healthy treats. This approach gamifies the process of staying fit and encourages consistent participation through friendly competition.
• Start a peer-recognition program at your workplace where colleagues can nominate each other for careful and error-free work, with the winner receiving a small prize or recognition. This not only promotes a careful work culture but also boosts morale and team spirit.
• Start a team challenge with a visual progress tracker, such as a poster with a clear path to the bonus, marking each day without incidents. This creates a shared visual goal that everyone can see and contribute to daily, enhancing the sense of collective achievement and responsibility.

Creative Motivation Programs: MiniMovers' "No Damages" Incentive and Axiometrics' Gain-Sharing

Beyond MiniMovers, the authors offer additional examples of successful shared incentives. They introduce a home-automation business located in Los Angeles, where a "Happiness Guarantee" incentivizes the installation team to deliver an exceptional customer experience by tying the final 10% of the project fee to customer satisfaction. They also mention Hilcorp, an oil and gas company, which successfully implemented a "DoubleDrive" campaign, rewarding all employees with a $50,000 car voucher for doubling the rate of output and reserves within a specified timeframe. This program, subsequently repeated as "Dream 2015" with a doubled reward, exemplifies the strength of aligning personal and team efforts toward ambitious organizational goals.

Harnish and Ross showcase Axiometrics, a data company, which effectively used gain-sharing to achieve a 40% annual growth rate. Axiometrics linked employee pay to the accomplishment of three annual objectives (client loyalty, earnings per worker, and market coverage), operationalized through frequently-discussed, ambitious, specific, and transparent (FAST) goals. This system ensured everyone understood the organization's priorities and could track progress and potential payouts, creating a strong alignment between individual effort and business success.

Practical Tips

• Implement a damage-free packing challenge when preparing for a move or storing items, where you and your family or friends see who can pack items most securely. Share tips and techniques with each other, and the person with the best-packed box, as judged by the group, could get their box labeled as 'VIP' or 'Handle with Extra Care'.
• Start a 'family milestone jar' where each family member contributes to setting family goals, such as reducing household waste or collectively reading a certain number of books. Upon reaching these goals, the family can use the money saved or collected in the jar to do something enjoyable together, like a family outing or purchasing a new board game, fostering a sense of teamwork and shared success.
• Develop a reward system for yourself that corresponds to achievements in the three areas. For instance, treat yourself to a small reward when you receive positive feedback from a colleague or friend, which reflects client loyalty. Save a portion of any extra income you earn towards a special purchase or investment, reinforcing the earnings goal. Attend a new social or professional event to increase your market coverage, and reward yourself with a new book or course that interests you.
• Use a mobile app that allows you to set reminders for your FAST goals with specific actions attached to each reminder. For example, if one of your goals is to improve a particular skill, set a daily reminder with a prompt to practice that skill for a set amount of time. This integrates your goals into your daily routine and ensures consistent action towards achieving them.
• Develop a habit tracker that includes both your individual tasks and the larger goals of your organization. Use this to monitor how often your daily work activities contribute to the overarching business objectives. For instance, if your company aims to innovate, you might track how frequently you engage in brainstorming sessions or propose new ideas. This helps you visualize the direct impact of your efforts on company goals and adjust your actions accordingly.

Intermittent Rewards Drive Behavior Change

Drawing on psychological techniques used in gambling, Harnish and Ross suggest leveraging "variable reward systems," where rewards are dispensed irregularly and often unexpectedly, to maximize their motivational impact. They explain how this approach creates excitement and a dopamine rush, driving a significant increase in effort and engagement.

The authors share the example of HSN, which struggled to get its customer service representatives to encourage upselling. By using a casino-like system featuring a spinning wheel with opportunities to win various prizes, HSN achieved a 250% increase in upselling, despite no changes to the total commission pool. This straightforward but powerful change, according to Harnish and Ross, shows how effective intermittent rewards are compared to consistent commissions.

Context

• Unlike fixed reward systems, where individuals quickly adapt and the motivational impact diminishes over time, variable rewards maintain interest and engagement because the outcome is not guaranteed, keeping individuals invested in the process.
• Dopamine is a neurotransmitter in the brain that plays a key role in the reward system. It is released during pleasurable situations and stimulates feelings of enjoyment and reinforcement, which motivates a person to proactively perform certain activities.
• The spinning wheel is an example of gamification, where game-like elements are incorporated into non-game contexts to boost participation and motivation.
• Many tech companies use intermittent rewards in app design to increase user engagement. For example, social media platforms often use notifications and likes as unpredictable rewards to encourage frequent use.

Sharing Profits and Company Value With Employees

Profit-Sharing Aligns Employee-Owner Interests, but Impact Is Limited

Harnish and Ross support profit-sharing as a fair gesture and a method to instill an "ownership mindset" among employees. However, they point out that the effect on individual effort and motivation can be limited.

Profit-Sharing Creates Fairness and an "Owner" Mindset Rather Than Directly Increasing Effort

The authors emphasize that sharing profits primarily serves to align employees' interests with those of shareholders. It encourages a long-term perspective and incentivizes decision-making that benefits the company as a whole. However, they clarify that it's not a reliable tool for driving individual effort, as the link between individual actions and overall earnings is often too distant and abstract.

Harnish and Ross showcase Access Fixtures, a lighting distributor, which implemented a 20% profit-sharing program on top of competitive salaries. They emphasize how the strategy, coupled with a policy of transparency, fostered an ownership mindset, leading to more prudent decision-making by employees, such as cutting unnecessary expenses and scrutinizing new hires based on their potential contribution to the organization's bottom line.

Practical Tips

• If you're self-employed or freelance, propose a profit-sharing model to a client for a large project. Instead of charging a flat fee, negotiate a deal where you receive a percentage of the project's profits. This aligns your interests with the client's success and encourages you to work towards the most profitable outcome, simulating the long-term perspective profit-sharing aims to achieve.
• Consider forming a peer accountability group where members set their own goals and hold each other responsible for progress. This can be done with friends or colleagues who also want to improve their productivity. Each member would share their objectives and update the group on their progress during regular meetings. The social aspect can drive motivation, as you wouldn't want to let your peers down.
• Consider implementing a mini 'Shark Tank' style event within your company where employees pitch efficiency or revenue-generating ideas to a panel of managers, with the winning ideas being funded and the originators receiving a share of any profits generated. This not only promotes an ownership mindset but also drives innovation and engagement.
• Encourage a local small business owner to consider a trial profit-sharing initiative by presenting the potential benefits. Gather information on the business's operations and suggest a small-scale, low-risk profit-sharing model that could be tested over a set period. Offer to help track the results in terms of employee engagement and decision-making quality. This approach allows you to see the concept in action and provides the business owner with valuable insights.
• You can foster a culture of transparency in your workplace by starting a monthly financial health meeting. During these meetings, openly discuss the company's financial status with your team, including revenue, expenses, and profit margins. This can help employees understand how their work directly impacts the company's bottom line and can lead to a more engaged and invested workforce.
• You can incentivize cost-saving behaviors in your workplace by proposing a bonus system tied to the reduction of departmental expenses. For instance, if you're in a managerial position, suggest to your superiors that a portion of the money saved from reduced expenses in your department is distributed as bonuses among team members. This encourages everyone to actively look for ways to cut costs, knowing they will directly benefit from their efforts.
• You can evaluate your own contributions at work by creating a personal profit-and-loss statement. Just like a business, track the value you bring to your company versus the cost of your employment. For example, if you're in sales, compare the revenue from your sales to your salary and expenses. This will give you a clear picture of your financial impact and can guide you in making decisions that enhance your value to the company.

Equity Instruments Draw, Keep, and Inspire Employees

Harnish and Ross argue that equity instruments, such as shares and options, surpass short-term incentives by directly aligning employee and owner interests. The authors explain that these mechanisms are highly selective, enticing talented individuals with the potential for wealth creation, while also promoting employee retention due to longer vesting periods.

They highlight the Outback Steakhouse restaurant chain, which addressed the industry-wide problem of high manager turnover through a unique equity program that incentivized long-term commitment. By offering a combination of cash incentives and stock grants to managers who contributed $25,000 and stayed with the company for ten years, Outback cultivated a loyal and experienced workforce and achieved a significantly higher retention rate, a key driver of their success.

Practical Tips

• Consider joining or starting an investment club where members pool their resources to invest in stocks or other equity instruments. This hands-on experience will give you a practical understanding of how equity aligns interests and can improve decision-making and commitment among the group.
• If you're part of an employee stock ownership plan (ESOP) at work, maximize your contributions. This allows you to invest in your company's success over the long term and often comes with tax advantages. As you accumulate shares, you're likely to be more invested in the company's performance, aligning your personal financial goals with the business's success.
• Consider creating a talent attraction plan that emphasizes long-term growth and ownership opportunities. When you're interviewing candidates, highlight how their role could evolve as the company grows and how their equity could appreciate in value. This can be particularly appealing to ambitious individuals looking for more than just a job but a chance to be part of something with potential for significant personal and financial growth.
• If you're involved in a startup or a small business as a founder or early employee, propose the adoption of a vesting schedule for all members. This could involve setting up a clear agreement where equity or profit shares are earned over time, encouraging commitment and reducing the likelihood of early exits that could destabilize the company.
• Consider implementing a profit-sharing scheme in your workplace to enhance employee retention. By offering a percentage of profits to employees, you create a sense of ownership and direct investment in the company's success. This can be done by setting aside a portion of profits that are distributed to employees either quarterly or annually, based on their performance or tenure.

ESOPs and Phantom Stock: Alternatives to Traditional Equity and Shared Ownership Challenges

Harnish and Ross discuss ESOPs, which are distinct ways of distributing equity with tax benefits for both employers and employees in the United States. They describe the case of Palmer-Donavin, a building materials distributor, which transitioned to 100% employee ownership through an ESOP, creating a highly engaged and loyal workforce while also offering significant tax benefits to the selling owners.

The authors also introduce phantom stock, a nontraditional equity approach that bypasses the complexities of shared ownership. They explain how phantom stock provides employees with financial rewards tied to the company's value increase without granting actual ownership rights or voting power. Phantom stock, as Harnish and Ross explain, can be particularly advantageous for private companies that want to offer employees a share of the company's success without diluting ownership or introducing governance challenges.

Practical Tips

• Create a visual roadmap of how employee ownership could be implemented in your company. Start by researching different types of employee ownership structures and then draft a step-by-step plan that outlines the transition process. This could include identifying key stakeholders, potential financing options, and a timeline for implementation. Share your findings with your management team to initiate a conversation about the possibility of transitioning to an employee-owned model.
• Consider attending a webinar or online course on ESOPs to gain a deeper understanding of how they work. Many financial institutions and business schools offer free or low-cost educational resources that can provide you with actionable knowledge on ESOPs, including the tax advantages for selling owners.
• Explore creating a virtual stock market game with friends where phantom stocks represent real companies. This can be a fun and educational way to understand how phantom stock works without any financial risk. You can use a spreadsheet to track the 'performance' of your phantom stocks based on actual market changes, and periodically 'cash out' to see who earns the most from their virtual investments.