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Compensation Modeling: Is this the ticket to greater profits?

September 17, 2013

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Professional Service Organizations who need to drive new behaviors examine their greatest motivator: compensation

During the great recession (as we now refer to 2000 through 2010) the U.S. witnessed a perplexing phenomenon, where the number of professionals working, and the number of professionals filing unemployment claims, both increased. Both of these numbers rose because clients were demanding more for less.

In many organizations, revenue was down significantly. Additionally, organizations had to monitor receivable balances carefully; taking a “hard line” on past due fees. The economics of the service organization reflects that fifty to sixty cents of every dollar collected is expended on personal and related costs. Shrinking revenue forced organizations to critically examine the talents of each professional and the associated costs. Determining how to cut personnel costs put organizations in a difficult position. Should a non-rainmaker senior professional be “let go” and replaced by new young talent. The premise is conditioned upon the theory that “technicians” are interchangeable. Therefore, replacing high cost senior professionals with less expensive young professionals was a way to deal with less funds available for compensation. And who knows; some of the younger hires may become “rainmakers” over time. In reducing the overall personnel cost, many thought they could continue on with business as usual. This wholesale dismissal of non-rainmakers did not work well for many organizations.

Eventually, organizations came to the conclusion that they needed to find a way to obtain new business, to change their focus and services to match the new markets/clients, and find a way to retain both the rainmakers and the non-rainmaker professionals.

This resulted in a realization that the compensation model employed in the past was a disincentive to their new objectives. Compensation is viewed by most as the workforce’s greatest motivator. In order to support the new goals, organizations needed to create a pay model that incentivizes the right behaviors while being fair to all.

Traditional Compensation Models

Traditionally, many service organizations operated with the “eat what you kill” (EWYK) method or the “lock-step system”. Under the EWYK method, individuals are compensated based on the revenue that they bring into the organization. There is an allocation for costs, direct and indirect, associated with the client service. The remaining income is paid to the professional.

The EWYK method has become a problem for organizations as it does not penalize for bad behavior such as high accounts receivable or lack of cross selling of the organizations other services/products. It also does not provide incentives for desired behaviors outside the revenue stream. Often, this method provides little/adequate reward for the individuals that service or maintain the client.

Under the lock-step system, compensation is purely based upon seniority. The more senior a professional, the higher is his or her compensation. The inherent problem with this model is that it disincentives younger professionals from working hard and bringing in new clients; producing higher revenues streams, etc. Accordingly, organizations will in time, “flat line” in growth and profit.

New Economy, New Vision, New Compensation Model

Focused compensation modeling is the first step in changing downward financial trend of many organizations. After an analysis of the financial model, management need to match monetary incentives with desired changes in behavior. Effectively, let the compensation model drive the individual to attain results that come with a behavior change. Some of the most common desired behavioral changes are: an increase in billable hours, an increase in realization, a reduction in the number of days of fees that are outstanding (managing accounts receivable) or new business produced either for the professional or for another professional in the organization. Obviously, the desired change in behavior will vary dramatically from one individual to the next. Well thought out goals combined with an empowerment of the individual to attain his or her goal will make the individual directly accountable to his or her partners. Truly, the individual takes ownership of his or her financial reward.

Profitability of one’s book of business is often difficult for an individual to understand. Educating the individual as to the profitability of his or her clients allows the individual to adjust behavior which should result in larger profits. Adjusting behavior may include who makes up the service delivery team, what the fee structure should be and even the most basic; “should we accept this client given the nature of the client’s business, the client’s ability to pay and the inherent risk; economic and reputational.”

Money Talks In Every Industry

Compensation modeling is applicable to any professional service organization. The first step to any model is a review of the behaviors that we want to improve or reward and identify the bad behaviors that we want to avoid. Compensation as the most effective incentive; tied to measurable outcomes, will drive behavior and result in larger and more consistent levels of profit. When reviewing compensation models, organizations should focus on behaviors that result; either intended or unintended. As your organization evolves; the incentives and goals can be tailored very specifically to fully achieve peak performance for each individual. As no two individuals are identical in their strengths or weaknesses; so should the goals laid out by the organization for each individual be different. Ensure that the compensation model reinforces, rather than undermines success. Compensation modeling is not a one time; “done, put it on the shelf, work product”. Instead, as changes occur in the organization, whether internal or external, behaviors need to change. Your, compensation model needs to have the flexibility and ability to change over time.

Fred Francis has significant experience serving the professional services industry with compensation modeling projects as well as tax services. Candice DeClark-Peace is a shareholder in the Firm who advises professional service organizations and other businesses in financial reporting, cash flow improvements, mergers and acquisitions, succession planning and decreasing tax burdens.

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a Clark Schaefer Hackett professional. Clark Schaefer Hackett will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.

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