Getting the most value out of your bonus dollars.

    In September, the FPA released the latest Moss Adams/SEI compensation study. Any of you who participated in the research will get a free copy of the report, and many others will purchase a copy of the results. When you open your copy, I encourage you to focus not on how much people are paying, but how. The danger of compensation benchmarks is that so many people open the report, pinpoint a number and say, "That's it. That's the number. That's how much we are going to pay our paraplanner or our owners or whatever." They miss the real value of the report, which examines not just the numbers, but how people are paying and for what.
    It is notable to recognize that the 464 firms participating in this year's study (The 2005 FPA Compensation and Staffing Study, conducted by Moss Adams LLP and sponsored by SEI Advisor Network, from which data is cited throughout this article) spent a total of $315.2 million on compensation in 2004, almost $680,000 per firm. On average, 62% of their revenue was spent on compensation. This is a significant amount of money, which I believe many firms could be spending better.
    A very positive trend that we saw in this year's research is the increased use of performance-based pay, with 42% of firms paying advisors performance-based incentives, compared with 25% that paid discretionary bonuses (33% had no incentive pay). Among lead advisors (the most senior level), the use of incentive pay was even more prevalent, and has demonstrated a very positive trend since 2001.
    The results of the advisors who participated in the different types of plans were notably different. The advisors who were on a performance-based incentive compensation plan managed, as the primary advisor, an average of 72 client relationships and generated $435,000 in revenue. Advisors with discretionary bonuses managed an average of 70 clients and generated $330,000 in revenue. Advisors with no incentive compensation managed an average of 110 clients and generated $335,000 in revenue.
    The difference between these terms I am using-"incentive" versus "bonuses"-is not just an issue of semantics. By incentive pay, I am referring to performance-based pay-compensation that is earned for specifically defined and measured behaviors and levels of job performance. Bonuses, on the other hand, are discretionary payments made for an undefined reason or for undefined "good performance." This is the holiday bonus approach. As I frequently remind advisors, there is nothing wrong with a holiday bonus; you just need to recognize that it is just a gift. It does not motivate or reinforce behavior, and you cannot expect it to drive performance. In fact, it typically comes to be an entitlement. Employees don't know why they got the bonus, so they don't know under what conditions they would not get one.
    The most important requirement for developing and utilizing a performance-based pay system is having an effective performance management system. That's also the reason why so many firms settle for discretionary bonuses-they aren't quite sure how to define good performance, or exceptional performance, or how to structure an appropriate incentive plan.

    The need to define performance objectives is critical, whether you intend to relate it to pay or not. If you want to get premier performance from your colleagues and your staff, you need to define what the performance is that you are looking for. If you want to get the most impact out of the dollars you pay, then you need to specify the performance required to earn the dollars, and the performance that has been demonstrated to earn incentive when you pay it. As I mentioned in an earlier column ("How to Be a Good Boss," Financial Advisor, May 2005), think hard about each position in your organization. Ask "What kind of performance in this job would just be meeting my expectations?" and "What kind of performance in this job would I really consider exceptional?"
    Although every firm's performance-based incentive plan is unique to the firm's goals, financial condition, culture and employee mix, the process that every firm should go through to consider its options in developing a plan is the same. I have broken the process down into some simple steps that can guide you in your plan development:
1. Define what is a successful year for the firm.
  Revenue growth?
  Profitability growth?
  Penetration of target client base?
  Level of presence in community?
  Client satisfaction?
  Investment returns?
2. Define the behavior and results you want to evaluate and reward for each job and ideally for each individual.
  Performance evaluations will drill into areas such as:
    i. Technical skills
    ii. Efficiency and productivity
    iii. Client presentation/meeting skills
    iv. Marketing and business development
    v. Client service
    vi. Development of people
    vii. Management of business
    viii. Professional and community involvement
    ix. Integrity
    x. Initiative
    xi. Leadership
    xii. Support of firm culture
    xiii. Teamwork
    xiv. Communications skills (written, verbal, interpersonal)
  Specific goals for each individual and/or team
  What will/can you measure? How comfortable are you in evaluating subjective criteria and relating that to pay?
3. Determine the amount of available bonus.
  A fixed amount
  A percent of base pay
  In either case:
    i. It may or may not be tiered, based on firm performance (i.e., can they earn more if the firm does exceptionally well?)
    ii. Do they earn anything if the firm does not have a good year (as defined in #1 above)?
  A portion of a firm incentive pool
    i. How will it be defined?
      1. A percent of revenue?
      2. A percent of profitability?
      3. Is there a hurdle that has to be cleared above which the incentive pool is created?
    ii. How will it be allocated?
      1. Per capita?
      2. A function of individual salary as a % of total salaries?
      3. Equate the level of performance to a level of bonus to be distributed.
  Is there a minimum standard of firm or individual performance that must be met?
    i. Firm budget must be met
    ii. A minimum number or percentage of individual performance goals must have been achieved
    iii. A minimum composite performance score must have been achieved
  Is it all-or-nothing, or can incremental amounts be earned? (i.e., "If you achieve 60% of your performance goals you can earn 60% of your target bonus.")
  If a firm bonus pool is used, determine whether unrewarded bonus for one individual will be reallocated to other individuals
5. Evaluate the individual's performance according to the defined standards and goals outlined in #2 above.
6. Translate the performance evaluation into a scoring system.
  % of goals achieved
  A score of 1-5
7. Translate the score into an actual incentive amount.
    A few words of guidance on the performance management process itself. Performance reviews for everyone on your staff (owners of the firm included) should be conducted at least once a year, preferably twice. The purpose of performance evaluation is to acknowledge areas of strong performance, provide reinforcement and discuss areas for development. Make sure that you:
    Reinforce areas of strength by commending good performance.
    Identify areas needing development and provide specific examples.
    Establish a measurable goal for primary areas of performance where improvement or additional experience is needed.
    Evaluate behavior and job performance (some categories suggested in #2 above) with really specific questions. Instead of asking people to evaluate from a general statement list-"Does this person effectively develop other people?"-ask them to evaluate specific statements like:
    "Acts as a role model and mentor to others and contributes to teamwork and maintaining high morale in the office."
    "Demonstrates the ability and desire to be accountable and take ownership of people and projects. Leads by example."
    "Is dedicated to recruiting and hiring the right people."
    "Demonstrates a commitment to the development of people. Has the ability to train, to mentor, delegate to and effectively supervise staff. Provides honest, timely and constructive feedback regarding performance. Recognizes staff members for good performance and coaches them when improvement is needed."
    Don't rate people's performance on a 20-point scale. Make it simple, and give everyone that is evaluating the performance of others a very simple and understandable guide to what the scores mean. For instance, if the performance evaluations are based on a scale of 1-5, don't say 1=Excellent, 2=Great, 3=Good, 2=Not Good, 1=Bad. Be more explicit about what the scores mean. Though you don't have to speak this casually, be this clear:

    5: Exceptional Performance. This person is doing this as much as they possibly could. I almost can't imagine someone doing it better. They really have exceeded my expectations in this area, and have distinguished this as one of their strengths. I would point to this person as an example of how to do this exceptionally well. .
    4: Demonstrating High Performance. This person is doing this even better than I would expect and I am quite pleased at the extent to which they are exhibiting this behavior/quality. They clearly have made this a priority and have demonstrated their commitment to doing this even better than the guidelines outline.
    3: Satisfactorily Meeting Expectations.  This person is doing exactly what I expect in this area. They have demonstrated their ability to do this consistently, though on average they rarely exceed my expectations in this area. I am content, but not overjoyed, at their performance in this area.
    2: Needs Improvement. This person is not doing this as well as I expect. Though they may have demonstrated this skill/behavior/quality on occasion, they do not do so consistently at the level I expect. I have suggestions for this individual on how they might be able to improve in this area, and I expect them to improve in this area in order to meet the firm's expectations in this area.
    1: Unsatisfactory. This person is not exhibiting this behavior even close to as much as I expect them to. They need to make vast and deliberate improvements in this area, and coaching them here should be a priority.
    N/A: Not Rated. Not enough information or first-hand experience to evaluate performance.
If you are using performance-based pay, the performance review time is the appropriate time to discuss compensation as well. The general conversation would go like this:
    "Let's review the goals and performance objectives we discussed in your last performance review."
    "Let's talk about how you performed against those expectations over the past year. Here is the self-evaluation you completed before this meeting, and here is feedback from the people you work for and/or the people who work for you."
    "Based on that feedback and these specific metrics we track as an organization, here's how it looks like you did compared to the expectations for your position over the last year."
    "Given your performance, you have earned $X of incentive for your performance. Let's review the method we use to calculate that incentive."
    "Now, let's talk about next year. Here is how we envision your role evolving next year and these are the additional responsibilities we would like you to take on."
    "Because your job responsibilities will be increasing, your base pay (salary) will increase to $x,xxx a month beginning xxx." [Note: You should express this as a monthly salary, not an annual salary, to protect yourself against any implication of a guarantee of ongoing employment.]
    "Based on where you are in your development, and the specific areas of development outlined in your performance reviews and self-evaluation, here are some potential goal areas for next year. What do you think?"
    "If you accomplish those performance objectives, here is the incentive you will earn next year."
    "Let's meet in six months to see how you are progressing on those goals and how things are going. In the meantime, you will be receiving active coaching, mentoring and training from us because we care about you and your development. You are a great contributor and we are delighted to have you on our team."
    People management obviously is a complex area, and one where most advisors are looking for guidance and development. But don't shy away from defining performance expectations for the individuals in your firm and paying them based on their performance. They are looking for your direction and management in this area, and the dollars you may have been spending on discretionary bonuses will be much better spent if they are used in support of specifically defined behaviors that will move your people and your business forward. 

Rebecca Pomering is a principal in Moss-Adams LLP, and may be reached at [email protected].