?Every company has key managers that they depend on to keep the business running smoothly. But if those key managers decided to leave, would your business be able to survive?
To help attract and retain these key executives, many businesses offer bonuses as an incentive, on top of their salary. But that just may be the starting point, says Tony Brant, a financial planner with Skylight Financial Group.
“Typically, that bonus will be paid in cash, but maybe it should be paid differently,” says Brant.
Smart Business spoke with Brant about how to creatively structure an executive bonus plan to benefit both the employee and the company.
Where do you begin to structure a plan?
The objective is to use a compensation-based award to retain key management, and to do so in the most tax-efficient way. So how do you do that using a variation on the traditional bonus? You need to design an executive bonus plan that fits within the guidelines of Section 162 of the Internal Revenue Code, which allows a deduction by the business for ordinary and necessary expenses paid or incurred during the firm’s tax year in the course of conducting business. An employer can deduct bonuses as long as they are reasonable payment for services.
What options exist for executive bonuses beyond a lump sum?
You can grant employees bonuses but limit access to them. Under Section 162, the bonus is paid to the employee as ordinary compensation, taxable as W-2 wages and fully deductible by the business as an ordinary expense. But instead of paying the bonus directly to the employee, funds are used to fund life insurance or an annuity contract.
The policy is in the employee’s name, and the employee is the owner, but access to the cash is limited by the bonus agreement.
Under this plan, the business enters into an agreement with an executive to pay (via a bonus) all or part of the premiums for a life insurance policy or annuity contract owned by the executive. This bonus is tax deductible to the employer and taxable to the employee. The benefits to this option are that the employee has a contractual agreement to receive a set amount of money each year for a period of years and has access to that asset after a period of time per the agreement. In addition, it enables the employer to take a deduction each year, and the employee has no out-of-pocket expense as this asset builds over the term of employment.
This type of plan is particularly useful for small, closely held businesses that choose not to offer equity or ownership stakes in the company and for family businesses interested in attracting and retaining the next generation of management.
The complicating factor with these plans is that taxes are due on the compensation even though the employee hasn’t yet received it.
How does the employee pay these taxes?
One way is for the employer to loan the employee money for the taxes due. This loan agreement, in addition to the bonus agreement, binds the employee to a repayment obligation if he or she leaves the company prior to an agreed-upon date.
The loan, which must include interest, can then be repaid at retirement or departure from the company from the funds that have accumulated in the executive’s policy, or the loan can be forgiven by the employer. However, forgiveness of the loan cannot be implied or contractually agreed to; otherwise, it may constitute a deferred compensation arrangement. If the loan is forgiven, the employee must still pay taxes due on the forgiven amount.
Is there any benefit to the employee during his or her employment?
Because the employee owns the policy, he or she can access the cash before retirement, tax free, by borrowing or surrendering cash value from the insurance policy in the event that money is needed.
And if the employee dies prematurely, his or her family has a substantial life insurance benefit to make up for lost career earnings.
What are the challenges of this type of executive bonus plan?
The challenge is the employer’s commitment to fund this obligation. However, the plan can be designed with the flexibility to allow the company to suspend or partially fund the policy in lean years.
Some companies may be nervous about making that kind of cash flow commitment, but it can be viewed as a business decision to pay base salary plus bonuses. Employees often want adequate life insurance protection and tax-free cash accumulation with some guarantee above and beyond the company retirement plan. With the tax benefits to the company, there is a mutual advantage.
Attracting and retaining the best people is a challenge for many businesses. The success of a business can often be attributed to the abilities of a select group of key employees or executives. That is why it is essential for businesses to hire and retain talented, hard-working individuals who can help them prosper and grow. Executive bonus plans are simple, cost-effective and flexible benefit programs that are relatively easy to implement and administer. Talk to your financial planner about the several plan design options available that can help you to tailor the plan to meet the specific objectives that the business is trying to achieve.
The information provided herein is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any federal tax penalties. Entities or persons distributing this information are not authorized to give tax or legal advice. Individuals are encouraged to seek specific advice from their personal tax or legal counsel.
Tony Brant is a financial planner with Skylight Financial Group. Reach him at (216) 592-7352 or firstname.lastname@example.org. Anthony M. Brant is a registered representative of and offers securities, investment advisory and financial planning services through MML Investors Services, LLC. Member SIPC. OSJ: 1660 W. 2nd St., Ste. 850, Cleveland, OH 44113, (216) 621-5680. CRN201309-152734
A few years ago, Tom Heinen found himself heading to Dick’s Sporting Goods to look for a last-minute Christmas gift on Dec. 23.
What the co-president of Heinen’s found when he got there was the best parking spaces were occupied by employee vehicles. But when he entered the store, there was no help to be found and the stock was sparse. Making his way to the checkout, there were two employees nearby, but neither seemed all that interested in helping him.
“Not either of those employees showed any sense of urgency to wait on me and get me out of the store,” he says. “I thought, ‘This is unbelievable.’”
Fast-forward one year. Once again, Heinen was at Dick’s for a last-minute gift. His first thought: “Great, here we go again.” But this time, things were different.
An employee immediately asked him if he could help him find something. Surprised, he said yes and told him he was looking for a baseball bat. The employee proceeded to tell him what aisle it was in and explain that the store had different types and if he didn’t find what he was looking for, to let him know.
Skeptical and scarred by too many bad retail experiences, he headed to the aforementioned aisle, and sure enough, it was right where the employee said. When he made his way to the checkout area, there were now two televisions showing CNN and there were two people at the register, both highly engaged, who quickly checked him out in half the time from the prior year.
While he was relieved to avoid a repeat of his prior negative experience, there was something disturbing about the rapid change.
The problem for Heinen was that he didn’t see Dick’s as being a customer-service-centered business, but in just a year, it had completely changed his experience.
“If Dick’s, who isn’t even focusing on this, can get there, we have to do something differently,” he says. “That’s when we started to make a decision to distinguish ourselves on customer service at an entirely different level.”
It’s not that customer service wasn’t always the focus of Heinen’s; in fact, it’s always been one of the grocery retailer’s primary differentiators. But what the Dick’s experience showed was that if even the big box retailers could deliver a positive customer experience, Heinen’s was going to have to take the service provided by its 2,500 people up another notch.
And this is proven by the store’s own customer surveys that indicate a satisfied customer isn’t really all that loyal but a highly satisfied customer is.
“The value of highly satisfied customers, statistically, is that they’re virtually guaranteed to come back within two weeks,” he says. “A satisfied customer, the number is like 62 percent, so there’s this huge difference between having a satisfied and highly satisfied customer.
“You want to have everybody in that top box — highly satisfied — because they’re very subject to defection if they’re not.”
The challenge is, how do you go from being good at customer service — yielding satisfied customers — to being great at customer service — yielding those coveted loyal, highly satisfied customers?
It’s not the cost of a can of green beans. It’s not the color scheme in the deli department. It’s not whether the box of stuffing is on the top shelf or the bottom.
“If you really want to have a successful company, you have to have highly satisfied associates, which leads to highly satisfied customers, which leads to profit, which allows you to continually reinvest in the company, which includes the people,” Heinen says.
Choose your destiny
If you drive down Detroit Road in the western suburb of Avon, you’ll eventually be faced with a grocery store dilemma: On one side of the street is the low-cost, no-frills Marc’s, while on the other side of the street is the service-first Heinen’s. Each provides groceries, and in a lot of cases, the exact same groceries. But the two couldn’t have a more divergent strategy. One is focused only on price, the other is focused more on service.
When Tom and his brother, Jeff, the other half of the co-president duo, took over the business after the death of their father, one of the first things they focused on was to determine what their overarching strategy should be.
When you look at how to differentiate your business, Heinen says you have to consider three different models — operational efficiency, product leadership or customer service. Operational efficiency is similar to the Wal-Mart approach of being everything to everyone or competing on price. Product leadership refers to competing on your products — whether it be quality or selection — and customer service is a focus on providing the best experience for the people with whom you do business.
“The first thing you have to do is find where do you want to excel,” he says.
For Heinen and his brother, the decision was easy: customer service. Heinen’s reputation had been built on people and service, so it was just a matter of building on this foundation.
“You have got to decide, first of all, if that’s where you want to be,” he says. “I think Marc’s is one of the best-run businesses in Northeast Ohio. It’s not one that I aspire to be like, and it’s not one that I’d be personally proud to be a part of, because it’s not what we believe in, but it’s a great business model.
“The category killer stores like Dick’s or Staples or OfficeMax, they’re helpful, but they’re not winning any customer service awards, and they don’t care,” he says. “That’s not their strategy, and that’s fine. They’re still in business, and they have a heck of a lot more stores than Heinen’s does, so how can you argue their success? And Marc’s? Marc’s makes more money than Heinen’s will ever dream about making.”
When you decide how you’re going to market, you also have to look at whether the market can support your model or not. Right now, Heinen’s has 17 stores, and the market can support that based on the desire for quality products and service. Each location is carefully chosen based on demographics that show an affinity toward choosing service over just price.
“If you can imagine that the market didn’t exist for people who cared about high-quality food and a great experience in the store, if there weren’t those people, we wouldn’t have 17 stores,” he says. “We’d have 15 stores or whatever the market could support, or we’d have to build a different type of experience for the customer.”
Marc’s doesn’t invest a lot in its people, and the service is reflective of that. But because Marc’s isn’t built on service, it’s irrelevant. Heinen’s has to invest in its people, because that’s the whole key to the strategy. If your people aren’t your first priority in a customer-service strategy, it’s not going to work.
Prioritize your people
If customer service is your chosen path to success, then start by laying out expectations at every level of the business.
Heinen uses a service pyramid to illustrate where he wants his employees to be. At the bottom of the pyramid is a category called “nice, respectful.” Just above that is “helpful.” Above that is “knowledgeable,” and above that, at the very tip and where he strives for all employees to be, is “invaluable.” But there’s no silver bullet to get there.
“When people say, ‘What’s your secret?’ — it’s not a program,” he says. “Customer service commitment isn’t a program. It has to be — no matter how many classes you do, no matter how much training you do — woven into the cultural fabric of your organization so that when people come to our organization, they understand.”
It starts with placing a strong emphasis on your people, who, in turn, have to live out that culture. One of the first things you have to do is make sure that you and your company managers are communicating and clarifying on an ongoing basis.
“You have to clarify what your expectations are, and you have to provide feedback,” he says. … “Surveys will tell you that people want to know what their job is and what’s expected of them. They want to know how they’re doing and most companies are bad at both.”
A lot of companies have jobs that aren’t glamorous but are essential to success. The people in them may aspire to greater things, so it’s important to help employees find the roles that are best suited for their personalities and interests.
“The first thing we do is we try to help determine what their passions are, so if they come into work and they’re a cashier and they decide they love the bakery, we’re going to put them in the bakery, because if people are passionate about their work, they’re happier.”
And even if a particular job may not generate passion from anyone, challenge people by keeping their jobs fresh by moving them around.
For example, someone may be a cashier 80 percent of the time, but he or she may take on an extra role of being a customer service facilitator the other 20 percent of the time. In that role, the person would work with both new and seasoned employees, one on one, to help them understand how they can be better at customer service specifically in their department. Or someone may also work as a demo coordinator, so in addition to his or her regular role, he or she would oversee all the demos that go on in the stores.
“It’s not a full-time job, but it’s a way that if someone is interested in doing something different, ‘OK, here’s a way,’” Heinen says. “It could break up the monotony.”
There’s also the tried-and-true method of motivating employees toward customer service: Pay them for it.
Heinen’s supports its employees through a gain-sharing program, which began about three years ago. Each store has set goals, including financial goals, but they’re balanced by overall customer satisfaction scores, known as O-Sat. If the stores meet their goals and their O-Sat score stays at or above their six-month average, they qualify for gain-sharing. If the company makes more than its budget, that money is put into gain-sharing, and the money is split relative to how the store performed compared to other stores — so stores that did better get more money to split among employees.
“Fundamentally, you have to incent the behaviors you want, so we incent the business side,” he says.
It’s possible for one store to make its goals, but that’s not enough — the company has to make its profit goals too.
About half of the time it’s been offered, the employees have reached the levels needed to earn gain-share.
“What it does is it creates a focus in the stores around, ‘What do we have to do?’” he says.
One store really rallied around creating a great customer experience, and it earned gain-share by recording 10 points higher than what it had ever done before, which was a huge accomplishment.
“It can have a significant impact, but at the end of the day, no matter what tools that you put in place, it’s the culture that drives the experience for the customer day-in and day-out,” he says.
Every CEO thinks he or she has an organization that provides great customer service, but there’s only one person that knows the truth (and is usually willing to share it): the customer.
Heinen’s uses a customer survey that focuses on three areas: overall satisfaction, likelihood to recommend and likelihood to return.
From there, it breaks down into specific departments, and then into product selection and helpfulness of staff.
“Again, product side, people side,” he says. “I’ve got to win on the product side; got to win on the people side.”
Spend time thinking through what belongs on your customer satisfaction survey. For instance, price questions don’t always yield useful results, because everyone always wants lower prices.
And don’t overload your customers with lengthy surveys.
“We want to keep it to five minutes, because if it’s more than five minutes, you aggravate the customer, and we don’t want to do that,” Heinen says.
To increase participation rates, the customer gets a certificate for 5 percent off an order of their choice within a given time period. But even customer service incentives are areas that might need some additional customer service attention. Initially, the discount was off the customer’s next order, which really irritated some when their next order was only $10. When they can use it within a given period, they can plan a larger trip and maximize their savings. Customers should be highly satisfied, even when it comes to giving feedback about customer service itself.
The goal is to get 60 surveys per month per store, and an outside company manages the process.
The results allow Heinen to compare not just how his stores are performing but also compare his whole company to other supermarket chains that the survey company has as clients. This helps him see how he’s doing in the industry as a whole, which happens to be very well — competitors are around 63 percent on overall satisfaction, while Heinen’s is at about 80 percent.
Driving these numbers up plays a key role in Heinen’s overall business strategy.
“This is so much part of how we run our business, whereas other companies that we know that have them, they’ll say, ‘OK, yeah, that’s information,’ but they don’t introduce it into running the business at all the way we do. And the associates, when you talk to them, they say, ‘Yeah, that’s some survey we do,’” Heinen says. “It’s a big difference.”
Walk into any Heinen’s store and ask what its O-Sat is, all of the leaders and most of the associates will likely know what it is and what it means.
Much like customers, every CEO thinks he or she has satisfied and engaged employees. But in a similar fashion, you have to take the time to ask them if they are happy and what would need to change to improve their outlook. Grumpy employees rarely deliver exceptional service.
The employee survey is administered about every 18 months, often with a shorter, “pulse” survey at the nine-month mark just to get a quick gauge. This survey focuses on whether employees would recommend Heinen’s as a place to work, if they would recommend it as a place to shop, and they rate themselves on a scale of 1 to 5 on how proud they are to work at Heinen’s.
Ninety percent of employees said they were satisfied or highly satisfied to work for the company. While it’s vital for customers to be in the “highly satisfied” category; for employees, “satisfied” is usually good enough. Why? Because customers have far more options and an easier time switching companies than an employee does, and most employees only leave a company when they are dissatisfied with how they are being treated.
The survey also delves into other issues related to employee satisfaction, such as how employees feel about their direct report, whether they feel valued, if they have the tools and equipment they need, does the manager accommodate their needs, how informed they are, how well their supervisor coaches them, how their manager values their opinion and how much clarity they have in their job.
“When we get these back, if we find out, for example, that we’re not doing a good job of coaching and that our managers aren’t communicating regularly, and they don’t understand coaching, then we say, ‘OK, this is an area we need to invest in,’” Heinen says. “It’s about taking the information and learning and applying it and putting it into place and really looking to get better. That process, we’re very married to.”
He says that as much as they want to improve things and make associates feel valued, if the store manager doesn’t get it and doesn’t want to improve, then nothing will happen.
“At the end of the day, it’s about the most important person in anyone’s life on all surveys, and that’s their direct report,” he says. “So whether you love or hate Jeff or Tom Heinen at Heinen’s, the truth is, the most important person is your department manager if you’re an associate. It’s building the relationships with them and coaching them with an effort to helping them get better, and it comes back to being as committed to their success as your own.”
Throughout all of this, Heinen has learned that it’s a long process to get improved results.
“If you strategically decide you’re going to differentiate yourself in the people arena, then that means that it’s all about, No. 1, believing and trusting in your people and then starting the journey that we started, and it takes a long time,” he says. “If you expect to see great results in a year, it’s not going to happen.
“You have to know what you’re trying to achieve, but I don’t think you ever get to the destination. You can take Nordstrom’s or any other really well recognized company for highly engaged associates, and I guarantee you that they never stop trying to get better, and they never think they’ve reached a destination. It’s just the nature of the beast.”
How to reach: Heinen’s, (216) 475-2300 or www.heinens.com.
When Marty Field purchased a money-leaking Chicago packaging company about a decade ago, he didn’t want excuses. In early production meetings, he learned the company, which was operating at 42 percent efficiency, was late delivering to more than half of its customers — because that’s the way it’d always been.
That wasn’t going to cut it.
“If we could create a manufacturing facility that would always be on time and if we were to meet every customer’s request, that would be a wonderful way to create sales,” says Field, the president of what is now Field Packaging Group LLC. “We couldn’t do that because we didn’t have an efficient manufacturing facility. That’s when we created our efficiency bonus program.”
He told his 80 employees they could receive monthly performance bonuses for hitting certain ranges of labor cost and efficiency, as well as delivering on time at least 98 percent of the time. They’d earn $50 for reaching 70 percent efficiency and an extra $10 for every percent over that — minus any deductions for quality incidents.
But first, Field had to define efficiency.
“The key was to find a way to accurately measure efficiencies and then determine what reasonable industry standard is,” says Field, who purchased industry-specific software loaded with standard machine setup times and run speeds. “Then communicate to your employees what’s expected of them, monitor their performance and then, at the end of the month, communicate to them how they performed.”
For transparency, Field installed chalkboards on each machine to track efficiency. Now, if the previous day’s numbers aren’t posted by noon, employees come looking for reports.
Sure, that breeds some peer pressure, but Field sees it as motivation.
“An awful lot of the increased efficiency is created internally by [employees] themselves,” he says. “If a crew is waiting for the paper, the guy in charge of the paper has a lot of pressure on him through his fellow employees. Peer pressure has caused people to act as a team. They’re able to perform together and to perform a lot better.”
Field brings employees together once a month to recap performance and other influencing factors, like the economy and competition. They also go over quality issues, discussing improvement opportunities.
All employees — from the receptionist to the customer service rep — attend those meetings and participate in the incentive program. Employees need to understand the connectivity of how each role must seamlessly set up the next to achieve overall success.
“Without teamwork from everybody, we won’t be able to get the efficiency,” Field says. “If the order goes out to the factory and all the information is accurate and provided, that saves time from a crew having to try to figure out what they’re supposed to do. If the people who are supposed to provide the tooling are not efficient in what they do, then the crew is waiting for the tooling.
“Everybody in the whole company affects efficiency, and everybody in the whole company should be rewarded for it.”
The reward itself is motivation enough — with some employees earning monthly bonuses of $220 — but it’s also the concept. Employees know they have a hand in controlling not just their bonus but the company’s overall success. Employees took the reins and led Field Packaging to 2009 revenue of $40 million and are still improving efficiency.
“They really are self-motivated, and it’s not only for the bonus,” Field says. “They need to see that the company is successful, especially these days where there’s so much unemployment.
“They have a greater desire to perform better because we’re creating more business. The more business we have means more work for everybody. People have really bought in to it, because it’s good for the company and it’s good for them.”
How to reach: Field Packaging Group LLC, (708) 594-5260 or www.fieldpackaginggroup.com
Never say no again
There’s one word Marty Field doesn’t want to hear.
“If a customer calls and has an unreasonable request for a delivery, a customer service person is not allowed to say no,” says Field, president of Field Packaging Group LLC. “We have to find a way to get it done.”
It was bad enough that late deliveries were the norm when Field bought the company. He envisioned the other extreme where they’d not only be on time but meet any request.
There are a few exceptions, of course — like acts of God or unavailable tooling. Aside from those, Field never wants to be in a position where he has to say no.
“The more efficient we are, the more capacity we have,” he says. “The more capacity we have, the more flexibility we have to be able to take care of customers’ requests. The more customer requests we have, the more successful we’re going to be.”
One machine used to take a half-hour to set up and another hour to run. Now, because Field’s employees understand efficiency goals and use teamwork to achieve them, they’ve cut out dead time. They can set up the machine in five minutes and run it in 20.
“We have put ourselves in a position where we always will have more capacity than we have business,” Field says. “We should never be in a spot where we can’t say yes.”
In the past, many employers have used a discretionary bonus system. However, the use of pay-for-performance compensation plans has become increasingly popular.
“The process is changing because boards of directors are getting more involved in setting corporate goals and want a mechanism by which those goals can be reinforced,” says Ted R. Ginsburg, CPA, JD, a principal with Skoda Minotti.
“The boards want to guide executive behavior. In that process, companies are tying the payment of bonuses to the achievement of distinct goals.”
Smart Business spoke with Ginsburg about how pay-for-performance plans work, and how to properly implement one.
What defines a pay-for-performance compensation plan?
A pay-for-performance compensation plan is a system by which annual and long-term bonuses are directly tied to the satisfaction of goals. If the executive does not satisfy the goals, then no bonus is awarded.
Pay-for-performance plans typically contain between three and five key milestones or tasks to be attained or completed throughout the year. These goals are typically measurable, quantifiable, and quite black and white so executives can see whether or not they met the goal and will receive the payment.
How does this system benefit employers?
This system benefits employers in three main ways:
No. 1: Clarity in explaining a bonus.
No. 2: Unless desired, the CEO/board doesn’t have to listen to other executives complaining about how they didn’t meet their goals but they still deserve a bonus. It’s not necessary, because all the goals are set in advance and are clearly explained.
No. 3: If the system works properly, the goals pay for themselves. If the company attains the goal — for example, stated earnings per share — it can afford to pay the bonus. The bonus is justified by the action.
The board of directors should be going to the company with input from management and saying, ‘Here are the goals we want to attain during the year.’ Of course, you should have long-term company goals, but usually these short-term goals fit into the long-term goals.
A pay-for-performance plan focuses the executive’s attention on attaining these short-term goals. So the company can tell its shareholders that it set these goals and attained them, so payment of the bonuses is justified.
Often, the perception of shareholders regarding discretionary bonuses is that the board just ‘rubberstamps’ them because they want to make sure their buddies are taken care of. Pay-for-performance eliminates that skepticism.
How does the system benefit executives?
To the executives, the main benefit is clarity. They know exactly what to do to earn the bonus. They know exactly what the board of directors wants from them. They don’t have to worry that if the boss is grumpy on bonus day, they won’t get anything.
The other issue that benefits executives and employers alike is clarity in the pay package. An executive looking for another job knows he or she might be giving up this bonus. An employer hiring an executive could say, ‘Here is your base pay, and you will get a bonus of this amount if you reach these specific goals.’ It adds clarity to the rules of the game in the job-seeking process.
What steps need to be taken to create a successful pay-for-performance program?
The first step is to get input from senior management. Determine short-term goals that are attainable, but that people have to stretch to reach. You should set up a series of three to five goals for the executives covered by the program. The goals have to be somewhat adjusted to make sure the person who will be striving to reach them has some impact in that process.
For example, you wouldn’t want to set a goal for the VP of sales to reduce waste in the manufacturing process. You want to set up goals that fit the executive’s role. If profitability is a goal, though, a goal for the VP of sales’ could be sales with an X percent margin. Or the VP of production’s goal could be keeping production costs low enough that the company makes money.
Once you have the goals, you conduct research to determine what the overall amount of the bonus should be. You can do that through market compensation data. Then, you should allocate that total amount of bonus between the goals. Are all goals rewarded in the same amount, or are some worth more than others? This gives the executives more guidance on the importance of their tasks.
Once that’s done, communicate with the executive to track his or her progress during the year, if possible. That’s motivational. We all want to know how we are doing.
How do employees react when the annual bonus program becomes pay-for-performance based?
Surprisingly, in my experience, the employees like this type of program because it does bring clarity. It eliminates the necessity to spend a lot of time praising oneself to generate payment.
You have to involve them in the process, because if they aren’t on board with the reasonableness of the goals, the program won’t work. If you set a goal of increasing profits by 40 percent this year and, over the last 10 years, you’ve never increased profits by more than three percent, the executives will say this goal is unattainable. That would serve to be a demotivator. But if you set a goal the board and the executives feel is reasonable and a bit of a stretch, it should be very well received.
Ted R. Ginsburg, CPA, JD, is a principal with Skoda Minotti. Reach him at (440) 449-6800 or email@example.com.