I'm thinking of setting up client profitability reporting and making people's remuneration dependent on their financial performance - how do I start? - Agency CEO
Management theory tells us that superior performance should be rewarded with superior remuneration; this stands to reason.
However, an explicitly defined target-and-bonus culture is strong medicine and you'll need to be ready for the side effects.
If you give people specific targets that link to their remuneration, they will inevitably be incentivised to do exactly what will drive the bonus, regardless of whether that is what you really wanted them to do or even if it is in the best interests of the organisation.
For example, incentivising people solely on increasing sales could, if not properly managed, result in more bad debts, more accrued income and more low-margin business.
This is why balanced scorecards were developed - they consider a range of short-term financial and longer-term behavioural matters that, properly implemented and managed, will ensure the financial sustainability of the organisation.
Typically, you would want to include the following areas in your balanced scorecard:
- quality of work produced
- good collaboration, with colleagues, clients and suppliers
- revenue, profitability and cash collection targets
- efficient use of resources, both staff and non-staff
While differentiating remuneration based on an objective measure of performance feels instinctively the right thing to do, it works best in larger organisations. In smaller companies, where the CEO pretty much knows everyone, it is often more effective to do these things through force of personality.
Setting up and running a balanced scorecard system is heavy on administrative requirements - a smaller agency with only a finance manager may struggle to cope with this. By contrast, a larger organisation not only needs more well-defined systems and processes, it also typically has the infrastructure to administer them.
Based on all this, I suggest the following rules of thumb:
- in a small organisation (under 30 people) with only a Finance Manager, force of personality is probably the best way. Setting sensible salary bands by job level and a formal-but-subjective review of people’s performance (e.g. a semi-annual round table review, aka “slotting”) goes a long way towards ensuring everyone is – and feels they are – fairly treated.
- a medium-sized business (30-75 people) with an experienced Financial Controller or even an FD should benefit from some operational KPIs such as client / team profitability, staff utilisation or time written off, but you may prefer to use this alongside a consideration of the softer, more subjective elements rather than making it fully transparent.
- A large organisation of more than 100 people with numerous departments and divisions needs an experienced FD with some formality of systems and processes to ensure organisational cohesion. This is where formal and transparent targets are most likely to be needed and to succeed.
A standard pack of sensible management accounts will provide you with a decent set of basic KPIs – performance against budget, revenue growth and conversion, profit and margin, prompt billing and cash collection – so reviewing hard measures of performance need not require too much extra information.
To introduce a formalised set of bonus metrics you’ll need:
- Reliable, timely, meaningful management information
- A strong finance team with proper systems and processes
- Good agency discipline
- Targets that align to your corporate objectives
But most importantly, you’ll need buy-in from all the senior management team.
- start with the principle of being clear about what the organisation expects from staff and what staff can expect in return
- align your balanced scorecard to your corporate objectives; this is much harder than it sounds. You’ll need to think about what behaviours really drive your business success, so don’t forget to balance short-term financial with longer-term behavioural measures
- consider what rewards you are able / prepared to give: salary increases and promotions should be fairly easy. It may be harder, or even impossible, to award bonuses and equity
- remember that it is an investment of your time to collecting and analysing info, so you need to earn a return on that investment
- nobody likes completing a timesheet, so you will need to be prepared to chase and chide people into providing the base data for your subsequent analysis
- take it slowly and gently; to go from a system of completely subjective remuneration to totally objective and transparent rewards is a multi-year process. It is also no small distraction from the day-job