With corporate contributions to 401(k) plans diminished to about 1 percent of payroll, an unforeseen problem has incubated over the past 30 years. Now faced with inadequate savings, rising health care costs and a decade of poor stock market returns, baby boomers are delaying retirement. The current situation will ultimately drive up payroll and benefit costs and curtail productivity unless private sector employers change course and get involved.
“Employers need to realize they can’t get out of the pension business; they’re in it whether they like it or not,” says Lee Morgan, consulting actuary with the Retirement Consulting Practice at Towers Watson. “They must take steps to help aging employees retire with dignity or suffer the financial consequences.”
Smart Business spoke with Morgan about the situation facing baby boomers and how employers can influence the bottom line by helping veteran employees plan for retirement.
Why are baby boomers delaying retirement?
The problem is that 401(k) plans were designed to augment not replace traditional retirement plans, and now a perfect storm of events has created financial conditions that the average employee just can’t navigate. And at some point, the Keynesian-style government spending that is propping up the economy and retiree savings, as well, has to end. This will cause aging workers to stay on the job even longer. Consider these facts:
- A 65-year-old couple retiring in 2010 will need $250,000 to pay for medical expenses throughout retirement, according to Fidelity Investments.
- Two-thirds of people aged 65 and over will need some level of long-term care in their lifetime, which runs around $75,000 to $80,000 per year. For couples aged 65, there’s a 50 percent chance that one will live beyond 92.
- The average net worth for those in their 60s in the U.S. is under $200,000. Our savings rate pales in comparison to Japan, where citizens had traditionally saved up to 20 percent of their income, or China, where the traditional savings rate averages around 40 percent. Even though current Japanese savings rates have dropped considerably due to the financial crisis, U.S. savings rates have historically been far below those of most industrialized countries. At this point, it is clear most U.S. employees are ill equipped for anything close to the traditional retirement lifestyle they may have envisioned.
Why should employers get involved?
In their quest to reduce costs, employers relinquished control over the timing and pace of employee retirements. Our statistics show that at least 3 percent to 5 percent of the current work force is unproductive and not engaged, yet firing underperforming veteran workers can be problematic. Age bias charges filed with the EEOC during 2009 were the second highest on record as monetary relief for victims totaled more than $376 million. To make matters worse, a reduction in boomer spending is partially responsible for the current economic malaise, as only those covered by traditional pension plans will feel free to spend their paychecks. In fact, consumer spending had reached more than 70 percent of GDP before the financial crisis, which is very high by historical standards, in part caused by Keynesian-style government spending and home equity lines of credit, which have dried up. As people live longer, only countries with financially secure retirees will be able to sustain economic growth.
In brief, it seems likely employers will either have ‘retirees’ on the payroll (not able to retire) or receiving a traditional pension. Those ‘retired on the payroll’ will have implications for productivity and ability to retain younger employees.
How can employers assist baby boomers?
First, offer financial planning services and education so employees can estimate how much they need to retire and save accordingly. Planning must be personalized and include a range of scenarios that contemplates a reduction in Medicare benefits and a realistic return on investments. Remember, the return on the S&P 500 has been roughly zero over the last decade and turns negative when you account for inflation. Second, review your company’s benefit plans and investment options. Employees may be able to address some of the risks of retirement by purchasing long-term care insurance or annuities.
What’s the best way to keep aging workers engaged and energized?
Employers need to bolster their engagement by continuously investing in their growth and development and offering them new and exciting challenges. Sometimes older workers have ample institutional knowledge but lack the technical or strategic skills to be fully productive. Japanese companies continually refresh their work force because they’ve learned that recycled workers are less expensive and more productive than new hires. Embracing that notion requires a cultural shift by U.S. employers.
Are employers considering a return to defined benefit pension plans?
The only viable long-term solution, if you want to allow employees the option of retiring at 65, is to bring back defined benefit pension plans. Also, younger workers may start considering careers in public service rather than the private sector, which may preclude businesses from hiring the best and the brightest. While CFOs worry about meeting future funding needs, the current pension shortfalls were created by investing in ways inconsistent with eliminating pension risk. Employers have the liberty of structuring a plan they can afford, but investing properly. Investing pension assets in bonds, which is more common in the U.K., can eliminate stock market volatility and facilitate long-term affordability. The data suggests that employees are struggling with self-directed retirement plans, so employers will be in the retirement business whether they like it or not.
Lee Morgan is a consulting actuary with the Retirement Consulting Practice at Towers Watson. Reach him at (858) 523-5553 or Lee.Morgan@towerswatson.com.
After two years of declining compensation, weary U.S. executives should be thrilled by projections of a modest increase in their average pay for 2010. But with shareholders, legislators and media watchdogs fixated on executive paychecks and layers of new regulations on the horizon, companies are still striving to fine tune compensation programs and strengthen the link between executive pay and performance.
A June flash survey of 251 companies by Towers Watson revealed that few were prepared to submit their executive pay practices to a shareholder vote as mandated by the new financial services reform bill. Although companies are waiting for further clarification on several provisions in the Dodd-Frank bill, more than two-thirds were taking action by proceeding with changes to executives’ annual incentive plans, and more than half were altering their long-term performance plans to ensure their programs do in fact align with performance and reward the right results.
“Now that the economy is improving, retention of key executives is re-emerging as a concern,” says Ann Costelloe, CFA, senior consultant for the Executive Pay Practice at Towers Watson. “Although preventing executive defections is a priority, companies must cautiously and thoughtfully alter compensation plans, given company goals and performance as well as the increase in regulations and scrutiny surrounding executive pay.”
Smart Business spoke with Costelloe about how companies are strengthening governance and addressing retention by altering their executive compensation programs.
What are the key regulations impacting executive pay?
The Dodd-Frank Act’s say-on-pay provision, among other things, requires public companies to fully disclose executive pay packages and conduct nonbinding shareholder approval votes at least once every three years, possibly beginning with the 2011 proxy season. Theoretically, shareholders could render a negative vote, making it imperative that companies proactively explain the rationale between the executives’ pay and the company’s performance and address shareholder concerns before they become issues.
Another key provision requires companies to disclose the median total compensation for employees and report the ratio of CEO-to-employee pay. While awaiting further clarification, it’s assumed that companies will need to substantiate higher ratios through better financial results or by demonstrating that their CEOs have greater experience, performance or capabilities than their peers.
Are there other significant regulations affecting executive compensation?
A provision in the Dodd-Frank law takes Sarbanes-Oxley up a notch by requiring clawbacks of executive pay in cases of fraud or criminal misconduct, and in situations where the company’s financial results were materially restated. Companies must develop policies to recoup improperly awarded compensation from current or former executives for three years preceding the required restatement filing date. Finally, a rule designed to prevent conflicts of interest requires members of the compensation committee, legal counsel and other compensation advisers to disclose their fees and be independent. Factors to assess independence are to be defined by the SEC.
How are companies adjusting executive compensation programs to comply?
The good news is that 49 percent of the surveyed companies expect to make modest increases in 2010 bonus funding for executives as a result of the improving financial conditions, while about a third expect to make larger long-term incentive grants. Although cost containment continues to be a priority, companies are being cautious about changes in pay and benefits, with only one in 10 respondents reporting that executive retention is not an issue. The survey revealed other trends in executive pay for 2010 and beyond.
- Grossing up parachute payments and providing perquisites like cars, spousal travel benefits and country club memberships
- Golden parachutes and hefty severance packages
- Change-in-control (CIC) protection and single-trigger CIC vesting of long-term incentives
- Supplemental executive retirement plans
- Employment contracts
- Incorporating tangible performance measurements into annual and long-term incentives such as operating profit, EBITDA, revenue growth and cash flow
- Incorporating nonfinancial operating measures into annual incentives such as strategic initiatives and satisfaction measures
- Stretch goals and increases in target award opportunity levels
- Higher grant values due to rising stock prices with fewer shares awarded
What else can companies do to stay in front of the new regulations and public perception?
First, embrace the changes by focusing your annual and long-term executive incentive goals and aligning them with the company’s performance through measurable goals. Next, address public scrutiny by clearly communicating your philosophy (and results) so your proxy and compensation discussion and analysis (CD&A) tells an accurate and compelling story. It’s vital to understand the hot buttons of shareholders and stakeholders and address them proactively in meetings. Research industry pay practices and conduct scenario modeling on proposed plan changes to understand how each element will perform under various conditions. Compare the total pay-out to other industry executives delivering a similar performance before fine-tuning your plan. Finally, watch for clarifications from the SEC while being mindful of the public perceptions that precipitated the regulations. Legislators won’t stop drafting new laws until they’re confident that executives have accepted their message about pay.
Ann Costelloe, CFA, is a senior consultant for the Executive Pay Practice at Towers Watson. Reach her at (415) 733-4244 or Ann.Costelloe@towerswatson.com.
Although the newly passed health care reform bill exceeds 2,000 pages, employers still lack critical details and guidance to implement many of the unprecedented changes that will affect retired, active and future American workers. For many employers, simply complying and maintaining the status quo is not an option. A recent Towers Watson survey found that nearly three-fourths (71 percent) of employers believe health reform will increase the overall cost of health care services in the United States.
“This bill is a call to action for employers both tactically and strategically,” says Caty Furco, senior consultant and actuary for the health and group benefits practice at Towers Watson. “Employers should evaluate the role of health care within their total rewards strategy and consider long-term strategic changes amid the new regulations.”
Smart Business spoke with Furco about the call to action for employers following the passage of health care reform.
What makes health care implementation challenging?
Many mandates lack specificity and consequently preclude employers from making key decisions. For example, the 2014 pay or play mandate requires employers to provide health coverage for employees working 30 or more hours per week, but the qualification methodology is ambiguous. A government task force is working to fill in the bill’s missing details, but the additional clarity won’t reduce the amount of time and resources it will take to implement these changes. There’s certainly enough information for employers to begin assessing risks, develop a communications strategy and conduct a strategic benefits review so that they’re poised to act as additional details become available.
What should employers consider during strategic reviews?
Tactical decisions always flow from strategy, so this is an opportune time to revisit your company’s benefits philosophy by asking these questions.
- Should the company provide employee health coverage or benefits? What should our role be?
- How are employer-sponsored health benefits viewed internally and externally? How do they influence our market position and talent strategies?
- What is our return on investment for providing employee health care benefits?
- Should total rewards or benefit packages be rebalanced to offset rising health care costs?
What are the critical action items for 2010?
The 2010 regulations surround retiree plans, so employers must communicate coverage changes and implement new accounting rules, resulting from the elimination of the employer’s deduction for Medicare Part D drug coverage. The communications plan should also touch current employees, since many are apprehensive about reform and have heard that their health coverage won’t change. To avoid surprising them down the road, explain that the company is reviewing the law, even if you haven’t worked out all of the specifics. Finally, employers must prepare for 2011 changes, including a reporting mandate, which requires disclosure of the annual value of employee health coverage on W-2s.
Is 2011 a pivotal year?
Employers will definitely be impacted by 2011 mandates, including:
- Coverage extended to adult children up to age 26
- Elimination of lifetime health benefit caps with restricted annual limits
- Elimination of pre-existing exclusions for those 18 and younger
If your company offers retiree health coverage, be aware that 2011 begins a three-year initiative to lower provider reimbursements through Medicare Advantage plans. This could diminish provider participation and plan availability, ultimately forcing retirees into more costly plans. Employers will need to closely monitor renewals and the underlying assumptions used to develop 2011 premium rates.
Which of the remaining mandates will have the greatest impact on employers?
Major changes occur in 2014 and include: the introduction of the pay or play mandate and employee free-choice vouchers, automatic enrollment for employees, restrictions on coverage waiting periods and new reporting requirements. The wild card in 2014 involves new fees on health insurers, which seemingly will be passed along to purchasers in the form of higher premiums. The looming excise tax on high-cost group health plans beginning in 2018 requires employers to immediately forecast future increases and possibly devise a strategy to avoid the tax by altering plan designs. Every company’s situation is unique and their response to reform will vary. It is imperative to stay abreast of emerging guidance through regular visits to Web sites such as www.towerswatson.com/health-care-reform.
Are there opportunities for employers to mitigate future cost increases?
State-run insurance exchanges launch in 2014, which may entice employers in the long term to offer a stipend in lieu of company sponsored plans as a cost-control strategy. Insurance companies begin selling coverage across state boundaries beginning in 2016, which is expected to increase competition and lower premiums. Finally, the bill increases incentives for wellness programs, and recent studies have shown that participation in wellness programs reduces health care costs. Remember, the legality of the bill has been challenged and there will be two critical elections between now and 2018, so savvy employers will evaluate their options and be ready to act under a variety of scenarios.
Caty Furco is a senior consultant and actuary for the health and group benefits practice at Towers Watson and can be reached at (415) 733-4309 or email@example.com.
After years of cost shifting, pay cuts and layoffs, employees have accepted their new roles as chief overseers of their own careers and financial security, according to a Towers Watson study exploring the post-recession attitudes of employees. But the burden of these added responsibilities on top of a stressful work environment is taking an emotional toll as employees doubt their ability to handle their expanding responsibilities.
Executives should not ignore employee worries or overlook their unfulfilled expectations. Instead, company leaders should take steps to help employees be successful in the context of an evolving employment relationship.
“In reality, the cost-saving measures enacted by executives during the recession are not cost-free decisions because they add stress to employees,” says Tom Davenport, senior consultant with Towers Watson. “These changes have drained employee confidence with potentially damaging consequences.”
Smart Business spoke with Davenport about the threats to employee engagement and why executives should intercede before productivity suffers.
What did the study reveal about employee attitudes?
In our survey of 20,000 workers in midsize to large companies, employees expressed angst about their futures. They’re worried about saving enough money for retirement as companies retreat from defined benefit pension plans, and about affording health care coverage as employers shift costs. They crave an emotional connection with their leaders and support for their careers, yet they sense a growing gap between their expectations and leader behavior.
Employees also said that executives often bend to the demands of shareholders and Wall Street analysts at their expense. In fact, employees say they rank third on executives’ list of priorities after shareholders and customers.
Overall confidence in senior leadership was disturbingly low with only 50 percent of employees reporting a favorable view. It’s time for executives to rebuild trust and help employees manage their diverse responsibilities in order to bolster their confidence.
How can employers boost employee morale?
Start by selecting the right managers and empowering them to make a difference. Executives often believe that line managers need more technical expertise than relational skills because they wear many hats. They think middle managers create additional expense and impede the lines of communication. In reality, supervisors and middle managers play a vital role in implementing major initiatives like cost reductions. They can communicate the reasons for change and take action to reduce stress in the work environment. Promote managers who possess a full range of competencies, and don’t overload line managers so they can be thoughtful leaders who spend quality time with direct reports.
Has the role of human resources changed?
HR must enable employee self-reliance by providing the tools and resources they need to survive under post-recessionary employment relationships. This new role requires an HR organization that can adapt swiftly to change, one that uses a holistic approach and addresses employee needs via a comprehensive plan. Traditionally, HR has been structured in functional silos, which leads to disparate data collection and programs. When you break down the internal barriers, HR can respond to signs of dwindling employee engagement, like increasing absenteeism or declining productivity, with coordinated and connected wellness programs, incentives or training.
While many companies offer self-service financial management tools, employees also need stress management skills, health management resources and career planning strategies to be fully self-sufficient. This is the perfect time to connect with employees and offer new services to boost their confidence.
How can employers use compensation, given smaller annual raises?
Many companies are moving to larger performance-based incentives and smaller annual raises, but it is still possible to raise confidence and limit turnover by designing a flexible compensation system that rewards high achievers and affords every employee the opportunity to increase income. This is treacherous territory, however, because competitive base pay is still the primary attractor of new talent according to our survey, and 61 percent of employees said that making more money was very important after several years of limited promotional opportunities and small raises. The stakes are high, so HR needs to take the time to get it right.
How can executives rekindle employee trust and sustain engagement?
Now that the economy has improved, executives need to focus internally rather than externally; in fact, 44 percent of surveyed employees said that senior leaders should be more visible and were conspicuously absent during the recession. Simply spending time with employees and giving them a chance to voice their concerns can be therapeutic after the prolonged downturn. Leaders are expected to care about the well-being of others, so if morale seems low, it may be time to take a stand and declare an end to cost cutting. Some CEOs have recently declared their companies fat-free, such as Mark Hurd, president and CEO of Hewlett Packard. His bold actions received kudos from his employees. Rebuilding employee confidence takes time and a plan, but the key is trustworthy leaders who keep their promises and advocate for employees.
Tom Davenport is a senior consultant with Towers Watson. Reach him at (415) 836-1127 or firstname.lastname@example.org.
Current economic conditions offer M&A bargain hunters a variety of strategic opportunities. But executives focused on plans for expanded product lines and market reach often overlook the need to consider the financial risks, not the least of which includes integration of employee benefit programs such as retirement and medical. The complex process might entail meeting future obligations and complying with both U.S. and international regulations and disclosure requirements.
The accompanying costs are often characterized as minor when the deal price is under negotiation, but with these costs rising around the globe and an increase in administrative and reporting complexities, a lack of proper planning and due diligence may undermine the success of M&A transactions.
“World-class acquirers assess the financial risks with benefits and plan the integration strategy during due diligence. It’s those that wait until after the announcement that run into trouble, since they don’t know what they are getting and can’t change what they’ve agreed to in the purchase agreement,” says Alex Young-Wootton F.I.A., F.S.A., senior international consultant with Watson Wyatt Worldwide. “Risks associated with cost and compliance for employee benefits often arise when the buyer begins to integrate two disparate benefit plans onto a universal platform, only to find the financial impact and integration strategy weren’t given due consideration when the deal price was calculated.”
We have all read about how many M&A deals fail to meet their objectives due to insufficient integration planning. Recent tough economic times only serve to reinforce the necessity for success.
Smart Business learned more from Young-Wootton about the hidden benefit risks that threaten M&A success and the steps executives should take to mitigate them.
Why is due consideration of employee benefits a key driver for M&A success?
Benefits assessment and their subsequent integration play a major role in assessing the true economic value of the target and in retaining key employees, which directly impacts the success of the newly combined organization. Also, it is critical to be able to correctly identify, quantify and allow for the financial implications of the liabilities being inherited.
In addition, the M&A transaction may necessitate compliance with additional regulations, either because a change in control subjects the organization to another country’s laws or the size of the newly combined organization mandates that additional benefits be offered to employees, which need to be reflected on the company’s balance sheet.
The recent fall in equity markets has highlighted the significant risk that pension provisions represent, however in addition to economic factors, a multitude of other factors affecting volatility, cost and competitiveness of the benefits provided need to be considered. Long-term obligations may be underfunded and require future cash infusions to plug these deficits, which can be offset during price negotiations if the financial risk is known, quantified and understood.
Why are employee benefit costs frequently overlooked?
Executives may perceive that retirement costs are relatively fixed and just look at what’s currently on the balance sheet, thus requiring no further investigation, without realizing that they bring with them compliance complexities and integration issues critical to the success of the M&A process. However, many inherited liabilities may bring with them previously not required disclosure requirements and, given the sign-off requirements imposed by Sarbanes-Oxley, executives need to include identification of these costs and risks as part of the early review process.
Which techniques reveal these hidden risks?
Simply, better due diligence, including integration planning before the transaction is complete by examining each element of your company’s benefit plans and those of the target organization. Sometimes the identification process may reveal hidden liabilities, especially around mandatory benefits outside the U.S., because those costs are frequently overlooked, especially by organizations that believe they only have a global ‘DC’ strategy in place. Many companies get confused with the term mandatory, assuming its state or government paid, but this is not the case; the state determines you have to offer the benefit, but the company pays for it.
Identify any accounting implications, including the need to comply with additional disclosure requirements, as well as how the transition to the post-deal benefits platform will take place. Once the liabilities are identified, quantify their value using an approach and assumptions that are appropriate for the purpose. Dollarizing the liabilities will help executives understand their impact on the transaction as a whole and potentially impact the deal price.
What other risk mitigation techniques are effective?
Once the risks have been examined during due diligence, additional techniques can reduce their impact.
? Attempt to leave the employee plans and their related liabilities with the seller as part of the negotiation process (and get the employee onto your plans for future service).
? Introduce indemnity agreements that result in post-acquisition price adjustments as a hedge against unforeseen benefit costs or lackluster asset performance.
? Communicate the possibility of an acquisition to your HR staff early on so they have time to conduct effective due diligence and reflect risks in final purchase price.
? Don’t lose sight of the need for a competitive package and its value when contemplating the long-term risks associated with employee benefits.
Executives need to garner increased levels of employee productivity and unabashed business innovation to drive their companies out of the recession. But capturing the hearts, minds and imaginations of workers has never been more difficult. With business plans in flux, budgets slashed and goals no longer attainable, employees are languishing under the weight of uncertainty, workplace stress and shifts in strategic direction. Executives can reap the benefits of an energized work force by capitalizing on engageable moments and creating a culture of continuous engagement.
“It’s difficult to align the efforts of employees with the company’s mission if the plan has become muddled,” says Matthew Kamensky, office practice leader for organizational effectiveness at Watson Wyatt Worldwide. “Leaders who set achievable goals, communicate continuously and capitalize on engageable moments can position their companies to emerge from the current crisis.”
Smart Business spoke with Kamensky about leadership strategies that engender a culture of employee engagement.
What’s the benefit from increased employee engagement?
Our Watson Wyatt research continues to validate the gains from employee engagement. Employees with high engagement work at companies with 26 percent higher revenue per employee and 13 percent higher total returns to shareholders over five years. Our research also shows that highly engaged employees have lower turnover and absentee rates, are more resilient and are better able to deal with the ambiguity of shifting business priorities than their lower-engaged counterparts. Furthermore, executives have a tendency to lean on the most engaged players to drive the company out of recession.
How do recessions impede engagement?
Engagement occurs when employees are committed to help the organization succeed and when they have line of sight — that they understand the business goals, the steps being taken to achieve those goals and how their roles and individual performance impact the goals of the organization. Recessions require constant course corrections, causing employees to lose their compass, so productivity suffers. Also, when goals become unattainable and monetary incentives are reduced, employee morale declines and stress increases, resulting in diminished focus on the business plan.
Which messages are most effective in driving an engaged environment?
Employees don’t expect executives to have all the answers, and it’s better to err by communicating more, rather than less, during challenging times. Engagement is bolstered by frequent executive communications, especially around milestone attainment leading to annual goals. But when milestones are missed and executives are struggling for answers, they are often reluctant to communicate just when it’s needed most.
Provide transparency around the difficult decisions you’ve faced, such as those involving staff reductions. Explain the reasons behind your actions so employees will understand why the moves were necessary. Capitalize on an engageable moment by educating survivors about why their performance is even more vital.
What other techniques bolster engagement?
Review past employee engagement surveys or conduct focus groups to discover employee hot buttons that don’t require increased budgets. Look to understand what drives engagement for the employee groups that have the greatest impact on the business. Recognizing employees for innovative ideas or cost saving tips doesn’t have to be expensive — yet public recognition of achievements offers an engageable moment and creates a culture of continuous engagement.
Look to your existing programs to create engageable moments. Any program or benefit, such as annual performance reviews or the launch of an open enrollment period, can offer an engageable moment if employers take the opportunity to connect those benefits to the value proposition employees receive for their contributions. Opportunities for engageable moments happen all the time; it’s just a matter of recognizing them and leveraging the moment.
What steps can executives take to reduce workplace stress?
Uncertainty, layoffs and pressure for results lead to workplace stress, which, if left unchecked, actually has a paralyzing effect on employees and is the leading cause of turnover. Expanding the company’s circle of core contributors reduces stress and bolsters engagement. Refocus employees on achievable goals that will not only help the company emerge from recession but enhance individual and company growth.
As an example, when layoff rumors persist, employees react by going into survival mode and become inwardly focused. Re-energize your employees around external goals, such as increased customer satisfaction, which is achievable in any economy. And, in the process of working more closely with customers, employees may even discover ideas for new products or services that will help the company emerge from the recession.
Matthew Kamensky is the office practice leader for organizational effectiveness at Watson Wyatt Worldwide. Reach him at (303) 575-9742 or matt.kamensky@WatsonWyatt.com.
Gerry Salontai’s greatest lesson as the president and CEO of The Kleinfelder Group Inc. is that successful change initiatives always begin within the organization. When Salontai first attempted to reposition the nearly 50-year-old engineering and consulting firm to meet the emerging needs of global clients, he launched a rebranding effort targeted toward changing the external perception of the firm. But the firm’s internal perception never changed, and employee owners continued to make autonomous decisions about which of the firm’s vertical markets, such as energy and education, they would support in each of the firm’s offices. Ultimately, the rebranding strategy failed. Then the firm’s largest client, Exxon Mobil, declared that it would reduce its contracted consulting firms from 50 to 15, and Salontai once again initiated change in order to meet the shifting customer needs. But this time, he started inside the firm.
“Given the changing needs of our customers, the obstacles to our long-term growth strategy soon became apparent,” Salontai says. “We’d be better off focusing on fewer markets, fewer clients and provide them with a wider array of services, but we didn’t have the service model to compete with larger firms. We really needed to build our technical capabilities and our employee owners’ disparate vision of our firm was an impediment to growth.”
Salontai faced the challenge of negotiating the most radical change in the history of the firm. Given the employee ownership structure, the only way to sustain growth at the then-$80 million firm was to work through the firm’s existing staff in forging a new vision of the firm as well as a new business plan and model.
Craft a new vision
Historically, Kleinfelder had followed a geographic expansion strategy, and the firm’s previous leaders had drawn a line in the sand at the Mississippi River in creating the firm’s eastern boundary. About 75 percent of the firm’s business came from California and now clients needed global coverage. In addition, acquisition had been the primary method for driving growth, but the transactions left the firm with a patchwork of fiefdoms, where each local manager selected his or her office’s area of specialization primarily based upon their own technical strengths and passion.
To build consensus among the firm’s employee owners about steering in a new direction, Salontai turned to a strategic planning process. He says setting a new direction through strategic planning is most effective when leaders coax and persuade people to change, rather than demand compliance. While the notion of using a business plan as a change agent may not be original, Kleinfelder’s business plan structure is unique. The written plan outlines the firm’s growth strategies over a five-year period on a single sheet of paper that contains only three goals, with each one defined by four strategies. Salontai insists that the plan’s brevity forces everyone on the team to decide what’s really important as they built consensus about the firm’s direction.
“The value of a short plan is that every word matters,” Salontai says. “The goals support the core values and the long-term vision, and everyone in the organization gets a copy. Because it’s brief and easy to understand, it’s easy for our leaders to drive the plan throughout the entire organization.”
A survey of 150 employee owners, who represented the top 10 percent of the company’s leaders, provided input about the changes that were necessary for growth. A 17-member planning committee sifted through the feedback and created the plan. One of Salontai’s key strategies was creating a planning committee composed of diverse, emotionally neutral people who could take an unbiased look into the future when crafting their recommendations.
“The committee came from all areas of the company, such as human resources and accounting and across the various geographic and market sectors,” Salontai says. “I avoided people who would dominate the conversations or sway the planning process toward their own vested interests.”
The original plan dovetailed with Salontai’s vision of a reinvented firm, narrowly focusing on fewer vertical market segments that would be universally supported by all the firm’s offices. To create a sense of urgency about the need for change, Salontai continually reminded the committee that the firm faced two options: It could move forward and become an industry consolidator or remain behind and be part of the consolidation.
While the planning process created some initial consensus about the need for change, convincing a group of professionals who are also owners isn’t easy, and Salontai says that when he initially floated the idea of narrowing the firm’s focus to fewer market segments, some of the firm’s 12 senior leaders were not on board with the idea. So his next tactic involved winning over a group of key influencers to help spread the word and bring along the balance of the staff.
“I have a sounding board that’s composed of roughly 12 champions who are principal owners in the firm,” Salontai says. “I worked on convincing a few of them at a time and they, in turn, convinced their direct reports that this was the right strategy. It’s like using a phone tree to build consensus. It’s natural that people gravitate toward certain key influencers; I just won them over so they could help me drive the change.”
Build up your capabilities
As Salontai narrowed the number of vertical markets supported by the firm, he began increasing the firm’s technical capabilities offered under each major market segment. The consolidation and expansion decisions were reached by reviewing client expectations, the needs imposed by the increasingly global economy and recommendations from a previous peer review.
“In 2003, we went through a peer review and one of their suggestions was that we restructure vertically to accommodate our clients,” Salontai says. “We took their recommendations and then began a phase of organic growth by developing our existing staff and hiring additional employees. Both moves have allowed us to increase our technical offerings for each market. As a result, we’ve opened more offices and have made only two small acquisitions in recent years.”
Another belief of the firm’s previous leaders was that the firm could function like a basketball team, because employees were capable of playing above their heads in meeting client demands. But the technical requirements in the expanded client contracts couldn’t be achieved solely through a stretch environment, so Salontai began building the firm’s technical expertise. However, he soon discovered that the firm’s senior leadership team was stretched too thin to support an aggressive organic growth strategy.
“We only had four or five senior leaders, and they were all wearing multiple hats,” Salontai says. “We had one person functioning as both the CEO and COO, and some people were running several states as well as handling training and development. They couldn’t do anything well, so they were really bogging down the company.”
Salontai hired two new senior leaders and reorganized the responsibilities of the senior leadership team, so that each manager could focus on specific tasks. Now, a firm chief operating officer focuses strictly on operations and that move has doubled the firm’s profitability. Salontai also appointed a chief marketing officer, a chief administrative officer and a chief technical officer, who expanded the firm’s technical capabilities by providing clarity and clout to the firm’s narrowed vertical market focus. Many of the key strategies designed to enhance the firm’s technical capabilities were developed through the strategic planning process.
“Now more than 40 future company leaders are learning from their more experienced peers, and we’ve organized formal mentoring programs, which support each practice group,” Salontai says.
He also notes there wasn’t a single indicator that pointed to the need to reorganize the firm’s senior leadership team, rather he observed managerial stress and missed milestones, which influenced him to make the change. He says leaders often make observations in a number of areas before making critical decisions and refer to it as their gut instinct. Salontai says that bringing people through such a radical change process was a difficult and challenging task.
“Not everyone saw the value in these structural changes,” he says. “Some people questioned why we needed the additional overhead and worried about how adding additional management would reduce their access to Gerry. They saw that the firm was moving from being a family organization to more of a corporation, like General Electric, and not everyone was comfortable with so much change.”
Create continued support for change
Despite the fact that the firm has achieved substantial growth, Salontai says he knows some doubters of his vision still remain. But he says the tipping point toward change occurred as the firm started to achieve success under the new plan, and he used the results to sway the majority of the holdouts. Showing that the company achieved $301 million in fiscal 2008 revenue, up more than $120 million from just three years before, certainly helped with that process.
Salontai uses a formal communications plan to continually reinforce his vision and travels to more than half of the organization’s 16 regions each year to review the firm’s strategic plan with the firm’s employee owners using a town-hall setting. Then, during the course of the year, he conducts conference calls for employee owners every six weeks that detail the company’s results and ties them back to the firm’s progress toward its five-year strategic plan.
“Really the top tactics for driving growth and change are authoring a strong message, believing in it and then communicating it over and over again,” Salontai says. “Then once you’ve achieved success, be sure and point that out to people because they will start to believe once they see that it will actually work.”
As an example, Salontai says that some employee owners were initially concerned that marketing additional engineering and technical services to existing clients wouldn’t be backed up by seamless execution and that unhappy clients would defect. In fact, the opposite happened. Marketing additional services to clients and expanding the firm’s technical capabilities created synergies, referrals and additional business opportunities. By continually reinforcing the positive outcomes from increased teamwork and the firm’s new cross-selling strategies, Salontai has engendered greater levels of behavior change.
“People really fall into three categories when it comes to dealing with change,” Salontai says. “There are those who are afraid of change, the group in the middle who tend to be supportive but are unsure, and those who are knocking down the door to initiate change. It’s really the CEO’s job to bring the changes forward, bring the middle group along and pacify the last group. But you have to do that without letting the group that needs comforting bog you down.”
HOW TO REACH: The Kleinfelder Group Inc., (858) 320-2000 or www.kleinfelder.com
The U.S. Small Business Administration (SBA) has been loaning money to Americans to start, build and grow businesses since 1953. However, many business owners may not realize that these loans do not require a lengthy approval process or a long-distance relationship with a faceless loan processor.
Through its Preferred Lender Program (PLP), the SBA grants some banks the authority to underwrite and approve loans for small businesses. And while borrowers must qualify, SBA loan authorization can take as little as 24 to 48 hours, which is great news for small business executives, given the current lending climate.
“Preferred lenders have full authority to underwrite and approve government-sponsored SBA loans because they are charged with looking out for the SBA’s interest,” says Albert Lee, vice president of Business Banking for Fifth Third Bank, Tampa Bay. “SBA loans were designed to facilitate access to credit for businesses that might otherwise have trouble securing funding.”
Smart Business spoke with Lee about why SBA loans are a viable option for business owners.
What types of business loans are available through the SBA?
Business owners can receive funding to grow or expand their business, including purchasing equipment, property, making leasehold improvements or just meeting operating capital requirements through the SBA’s loan program and portfolio of loan products. The SBA’s 7(a) loan program, for example, has a maximum loan amount of $2 million. Sometimes new companies don’t have a lot of assets or collateral to borrow against, so this program was designed to help those companies succeed.
What are the qualifications?
In some respects, the term ‘small business’ is misleading, because a company can qualify for one of the SBA loan programs if its after-tax income is less than $2.5 million or its tangible net worth doesn’t exceed $7.5 million. There are at least 1,200 businesses that fit that profile in the Tampa Bay area. Applicants must meet the bank’s lending criteria, and business owners must not be under indictment or on parole or probation. Other qualification criteria include loan size, type of business, use of proceeds and the availability of funds from other sources.
Is there a business ownership requirement for borrowers?
The borrower is required to have a cash investment stake in the venture. The SBA has a minimum requirement of 10 percent equity, although the local bank’s loan requirements take precedent, and those will most likely require the borrower to have 20 to 25 percent equity ownership in the business or even a higher amount.
How does the loan approval process work?
Business owners may apply through their local bank. A checklist is available that outlines the necessary documentation borrowers must furnish, and there’s also an eligibility questionnaire that helps borrowers gauge their ability to qualify. After the borrower completes the application, the local banker underwrites and approves the loan, using the bank’s lending criteria, and then submits the package electronically to the SBA. Authorization is usually issued within 24 to 48 hours, after which the banker will put together the loan terms for the borrower, including how the funds will be used. If the business needs to use the funds for a different purpose down the line, the banker has the authority to modify the loan documents to meet the business need.
How do SBA loans differ from traditional loans?
In theory, the SBA does not decline loans based upon a lack of collateral, whereas traditional loans require the borrower to demonstrate sufficient cash flow and collateral and execute personal guarantees. SBA loans do not necessarily have to be fully collateralized as long as any and all available collateral has been offered. The term of the loan is driven by the use of the proceeds, although the lending terms can be stretched to accommodate a longer time period than most conventional loans.
Historically, SBA loans have been unfairly characterized as cumbersome, when, in fact, the SBA loan process has become very user-friendly. Today’s process is highly streamlined and banks have authority to meet the needs of small business owners without the red tape.
ALBERT LEE is vice president of Business Banking for Fifth Third Bank, Tampa Bay. Reach him at (813) 306-2414 or email@example.com.
When Peter Nelson was applying for the president and CEO job at California Water Service Group back in 1996, he wanted to learn a little bit about his potential employer. He decided to drop in for an unannounced visit at one of the local offices.
“I received a call from a headhunter about the opportunity here at Cal Water, but I really didn’t know much about them,” Nelson says. “So I walked into the local office and said to the service representative, ‘Hey, I’m applying for a job with this company. What’s it like to work here?’
Over the next 45 minutes, the representative gave him a copy of the annual report, and three other people in the office came out to speak with him about the company. He also asked what the rep would change about the company, and the man replied that he’d like to have more tools to service customers. The board of Cal Water was searching for a CEO who could grow the company through acquisitions, and for Nelson, the local office visit cemented the deal, because it validated his ideas on how the company could grow. The only way for Cal Water to expand would be through improving its service image. In order to acquire municipal or independently operated water districts, Nelson would need a compelling value proposition for the local customers, and that value is most often created by one thing — improved service.
In order to do this, Nelson had to create a plan, involve his employees and then work to improve.
Create a plan
To validate his initial assumptions and establish his action plan, Nelson spent his first two months on the job talking with staff members.
“I spent time in one-on-one meetings with my direct reports, visited with the staff in all our locations and went out into the field with meter readers,” Nelson says. “I heard a lot of good ideas about how to improve service, but what was needed was a vehicle to get those ideas into place, because they weren’t being acted on.”
Nelson says that installing a continuous improvement process starts with a return to the basics, and that includes listening to the voice of the customer.
“In order to get more structure around creating a customer service ethic and to get that ingrained as part of your corporate culture, you have to start by measuring your results because you need data to track how you’re progressing,” he says.
Nelson began by reviewing water industry data, which produced a list of 69 customer needs. He prioritized the needs according to customer importance and then surveyed customers for performance feedback, establishing a performance baseline for the organization.
For Nelson, establishing customer service excellence as a part of the company culture was vital to achieving his growth plan because Cal Water’s union environment didn’t offer him the variable compensation options that many CEOs rely on to help drive key business initiatives. The organization’s growth would have to be supported by employee pride and a desire to service customers above and beyond their expectations.
“The next step is to train your employees on the continuous improvement process,” he says.
Nelson used trainers and conducted the training in-house. Employees went through these sessions every day.
“It’s vital that they understand how to interpret the voice of the customer as part of a continuous improvement process,” he says.
The vice president of human resources and the vice president of operations over-saw much of the training because those leaders are key to getting the training accomplished.
“Those VPs must work on getting rapid pull-through on any concepts that you’re teaching because it can take up to seven years to get a continuous improvement process fully implemented,” Nelson says.
Once the staff completed initial training and reviewed Cal Water’s first set of customer feedback scores, the staff was divided into teams of up to 14 employees by service location. Each team was led by a manager, who also acted as the team’s coach and a water quality expert. Because the customer survey results are measured by each service locale, the continuous improvement teams are charged with developing solutions that raise customer perception within their assigned geographic service area.
Teams met weekly, and they designed and presented a business plan around a suggested quality improvement to an officer review panel every 90 days.
“The plan must include step-by-step details outlining the problem, the analysis of the problem and the suggested improvement,” Nelson says.
Every member of the team must present to the panel, which is composed of other employees and three or four officers of the company.
“This step is vital because not only are we bringing forward ideas, but we’re teaching employees about the continuous improvement process and we’re building their confidence and presentation skills,” he says.
The presentation doesn’t always have to be a brand-new idea; they can also present an update on how a previous business plan is progressing. Under this system, he had 870 employees presenting in an open forum every 90 days.
“What you’ll find by installing this kind of process is that the employees build skills and talents they didn’t have before, or in some cases, it brings those talents to the surface and that helps you develop people as well as improve customer service,” Nelson says.
He says nearly every employee has stepped up through this process.
“It helps that they are part of a team because they can rely on each other and the team environment also helps in interpreting the voice of the customer, because they can discuss what the data really means,” he says.
In addition to requiring employees to articulate the prospective value of their ideas to customers, Nelson requires the teams to estimate the cost and the return to shareholders as part of their business plan. For example, if the customer service improvement plan calls for increased capital investment, the team must present a recommendation about how to finance the improvement, how many additional customers can be serviced through the proposed investment and when the company can expect to recapture the costs.
One of the best suggestions to come out of this process was improving customer satisfaction in Bakersfield.
“The customers were reporting a problem with water pressure and with water quality, and after the team conducted their analysis, they recommended that we build a new treatment plant,” Nelson says.
Although that idea would result in a major capital expenditure, the team moved forward with that recommendation and investment. In another service location, the customers complained about a strong chlorine taste in the water in the mornings. The team monitored the water quality and recommended a device that regulates the chlorine dispersal.
Work to improve
As a final step toward building an organization entrenched in continuous improvement and customer satisfaction, Nelson includes expectations in performance plans and implements continuous improvement process training for the employees of newly acquired companies immediately.
“This is part of the expectation of working here — it’s not voluntary,” Nelson says. “You always get some push-back from new employees when you acquire a company because it’s a change and so that’s to be expected.”
To get them on board, he spends time talking with the employee groups telling them why they do this and why it’s important. Once they complete the training, it helps them understand the process and overcome some of their fears, so they begin training with new employees right away. While a few opt out, most stay because it’s a better deal for many of these employees to work for Cal Water because the compensation, benefits and security are better and it has a larger footprint, which opens the door to increased career opportunities.
“That value proposition at least gets them to move forward with the training, and once they’re engaged, they generally don’t want to go backward,” Nelson says.
Every six months, he establishes a new set of objectives for his 20 field managers and six headquarters managers that support his corporate goals of providing excellent service, developing employees, delivering shareholder value and communicating well.
“You don’t want to set objectives that are too long-term because things change, and you can’t make corrections,” Nelson says.
He has eight officers on personal performance contracts with him, and he checks in on their progress every Monday. Additionally, they spend the day together once a year to select one major initiative for that year.
“If you just always focus on goals and objectives it gets routine and people can lose their enthusiasm,” he says. “I like to select one annual initiative that will really make a difference and focus on that. The officers are then charged with communicating the initiative and how each employee can contribute.”
By doing these things, Nelson has increased Cal Water’s service connections by more than 100,000 and has grown revenue from $210 million when he started in 1996 to $367.1 million in 2007. The company has made numerous acquisitions under his leadership, and he’s achieving the board’s original charge by delivering growth.
“It’s a great question to ask how customer satisfaction is tied to business performance, and I think it’s one that CEOs should ask themselves all the time,” Nelson says. “Good service is the key to customer retention, and when you have it, everything just seems to work better.”
HOW TO REACH: California Water Service Group., (408) 367-8200 or www.calwater.com
Since the advent of Sarbanes-Oxley, the role and the responsibilities of the audit committee have become vital.
“The audit committee must act in a proactive manner to monitor and assess risk mitigation activities within the company,” says Diane Wittenberg, CPA, partner for Audit and Business Advisory Services at Haskell & White LLP. “Members should ask hard questions of auditors and management and have authority to effectively execute their charter.”
Smart Business spoke with Wittenberg about how to build and engage an effective audit committee.
What constitutes an effective committee charter?
The charter defines the authority, functions and mission of the audit committee. Weak charters define only the minimum duties, such as simply reviewing financial statements, whereas strong charters spell out committee responsibilities in detail and encourage member participation. These are the major areas of responsibility that should be included in the committee’s charter:
- Oversee the accounting and financial reporting processes and the financial statement audits of the organization.
- Appoint, compensate and oversee the external auditor and ensure that his or her skill set is matched commensurately with the complexity level of the organization.
- Establish procedures for receipt and treatment of complaints in accounting, internal control or auditing matters, including anonymous submissions from employees.
The charter should stop short of directing the committee on how to carry out its duties; members should use interpretation and judgment in executing the committee’s mission.
Which tactics lead to effective execution?
Audit committee members should ask candid, frank questions of the external auditors about their assessment of the skills, controls and attitudes of management and others within the organization. Every quarter the committee should meet with the auditors without management present to ask questions and solicit opinions. Members should feel confident that management is aware of the financial reporting risks and has instituted the necessary internal controls to mitigate the risks and then implemented monitoring procedures to ensure effective operation of those controls. The committee chair must establish a culture that allows each member to act independently so the members can ask the critical questions to assure the proper level of stakeholder security.
How does member composition impact committee effectiveness?
In a perfect world, the audit committee would be composed of individuals who have audit, accounting and industry knowledge, but in reality, most committees have a blend of members with different strengths. Members who don’t have industry or product knowledge should go through training so they understand the risks and the financial statements. For example, audit committee members in a manufacturing company should understand the metrics for that industry, such as days sales in inventory and accounts receivable turnover, to assess if the company’s performance is in line with its peers. At least one member of the committee should be an independent financial expert who possesses the following attributes:
- Knowledge of GAAP and financial statements and the ability to use GAAP principles in connection with estimates, accruals and reserves
- Experience in preparing, auditing, analyzing or evaluating financial statements with a level of complexity that is comparable with the organization
- Understanding of internal control processes and audit committee functions
What are the most effective committee and meeting structures?
Three to four members is an ideal size so discussions and decision-making processes are streamlined. Note that having an odd number of members is preferable for reaching a quorum. In public companies, the audit committee should meet at least quarterly so it can have the required communications with the external auditors and maintain its momentum and continuity. Set an annual meeting schedule at the start of the year and send committee members the minutes from the prior meeting and the next agenda two to three weeks before the next meeting. This practice ensures that discussions remain strategic and that the committee spends less time on administrative tasks.
How should the committee assess its performance?
The committee should monitor its performance and assess its effectiveness at least annually, perhaps as part of a retreat, especially as it relates to the appropriateness of its charter in order to make recommended changes to the board of directors. In addition, the committee should review the performance of its individual members through self-evaluation checklists or by hiring an outside firm to do an evaluation. In private companies or non-profit organizations, the committee usually conducts a self-assessment and public companies often use an outside evaluator. The committee should use a continuous improvement process to implement changes after reviewing evaluation feedback.
DIANE WITTENBERG, CPA, is a partner for Audit and Business Advisory Services at Haskell & White LLP and audit committee chair for the Discovery Science Center in Santa Ana. Reach her at (949) 450-6334 or firstname.lastname@example.org.