When Money Doesn't Motivate: What every leader should know about paying people

Episode #30 When Money Doesn't Motivate: What every leader should know about paying people

Marty: Today we’re going to cover off a great question from listener James, which has led me to produce the definitive ‘how to’ guide for managing remuneration as a leader. And of course, I’ve asked Em to join me to ask the questions. Em, how are you doing this week?

Em: Hi! I am good, I’m a little bit tired! We moved house this week, so it’s been pretty full on, and of course, we’re in week three of Leadership Beyond the Theory, so lots of communication with our students, who have been working on the ‘Build Resilience’ module. But, it’s all good, I’m having fun! What about you? What have you been up to?

Marty: Oh, you know me, I’ve just been lying in a hammock, sipping umbrella drinks!

But, actually, no. I’ve been working really hard on producing the book, The Seven Pillars of High Performance Leadership, and of course, keeping in touch with cohort one of Leadership Beyond the Theory. So, I’ve had a really busy one a well.

Let’s get on to James’s question. He asks:

“Marty, one of the topics I’d like you to cover is pay negotiations with subordinates. Money is a key motivator for staff. It’s great to be able to offer a pay rise or a bonus to staff to motivate and retain them in the organisation. The problem is that they start to expect a pay rise or a bonus every year. Eventually, you have to say no. But how do you do it without demotivating the employee? What else can you offer to an employee as an alternative?”

Marty: That’s a really good question, James. First up, let me say that I’m not an expert in compensation with benefits. But fortunately, as a leader, I’ve long lived by the principle that you have to know your strengths and weaknesses, and draw upon the expertise and capability of those around you in order to strengthen your own performance.

So, although I’m very comfortable around rem structures and their application inside organisations, I’ve called on the expertise of my sister, Brigid, who is a senior executive with one of Australia’s leading companies. She has a background in HR, with major global multinationals. So, there’s not much she doesn’t know and hasn’t seen in regards to remuneration, how it works, and how leaders handle it.

I can confidently say that these next 15 minutes will be one of the richest sources of information about the concepts and application of remuneration decisions for leaders, your one-stop-shop, so to speak.

Em: Yes, Brig is an absolute powerhouse, so I’m really glad she contributed to this. It’s right in her sweet spot. Okay, Marty. The whole pay rise and bonus thing affects many of our listeners, and it can be extremely complicated. Where do we start?

Marty: Well, let’s start with base pay and pay rises. In general, you don’t give base pay rises to motivate. This is a common misconception. You save this for the at-risk or bonus component of the rem. You also don’t give base increases to retain people.

Now, it’s interesting, most studies find that pay is really the number five or six issue in terms of what motivates people to stay, but it’s a hygiene issue that you have to get right. When you hear complaints, they tend to be things like, “I hate this. I hate that. I hate my manager. Oh, and by the way, you don’t pay me enough for this shit.”

So, it’s critical to realise that base salary is aligned to a role, not an individual. There’s normally a range or a band of salary outcomes for any role. Say, a graduate accountant might earn between $55,000 and $62,000, depending on their experience. They shouldn’t ever get more base salary than $62,000, unless they’re promoted to a higher-level role, of course, with more complexity, accountability, and authority. Equally, they shouldn’t be paid less than $55,000.

Em: Right. That makes sense. But, what other factors come into play?

Marty: Base salaries will generally be geared to market, and market movements dictate how people are paid at any point in time. Many industries have informal pay structures that are reasonably consistent from organisation to organisation, and most larger organisations use market data to set their base remuneration levels internally.

Whereas these provide some latitude for leaders to make base pay decisions, they also provide clear boundaries which should be considered and not be crossed.

But, let’s not forget the role of supply and demand economics in the labour market. That’s also a key factor.

There’s the example of the mining sector, where, at certain times, commodity prices are extremely high and labour is in a shortage, then the people who go and labour on mine sites get paid an extraordinary amount of money. In the leaner times, when commodity prices are down, they don’t get paid anywhere near as well. These swings can be almost 100% difference in their remuneration. So, we do have those boom and bust cycles that affect remuneration at the base level.

There are also sometimes certain skills that are just hot in the market at the moment. So, for example, these days, we have digital security. This is going to attract a premium at any given point in time.

But, as my microeconomics lecturer at business school said many years ago, “If you don’t remember anything else about this course, remember this one thing: All value comes from scarcity.”

Unless, of course, you’re a tech startup like Theranos, which I’m going to talk about next week, where value can sometimes come from vapourware and hype.

Now, in many cases, particularly with respect to lower-level roles, annual pay rises are designed to keep up with external factors, such as the cost of living or market movements in the job classifications themselves.

For employees on an enterprise agreement, so in other words, a collective bargaining style scenario, where employment conditions are set once every three or four years, base pay and progression is largely predetermined in an extremely structured manner.

Ultimately, most organisations have a policy on pay levels and structure for different job groups, and this depends on company size as to how rigid or how extensive that policy is.

Em: That does sound pretty rigid, Marty. Is there any flexibility at all for leaders when it comes to making those base pay decisions?

Marty: Yeah, Em, there generally is, but you have to remember the core fundamental of base pay. It’s aligned to the role, not the individual performance.

Now, great performance and experience will put someone at the top of the band for the role they’re in, and poor performance will generally result in, well at least, if there’s a good leader in place, an up or out mentality: Either meet the requirements of the role, or we’ll have to find you a less demanding role. We’re not just going to keep you at the low end of the salary band.

In cases where you do have some flexibility and autonomy to consider base pay decisions, think about the following things:

1. The value of the individual to the business. And when we talk about value, we talk about real value, value creation. Not just, “He’s a good bloke, they do their work, they work hard, everyone likes them.”

2. How well have they delivered the baseline objectives of their role? It’s not just the what, but it’s also the how they’ve delivered it.

3. What’s the relativity of their base remuneration to others in the business and in their role classification?

4. Are they new to this level of role? I.e. do they sit in the lower end of the range? Are they performing at the expected capability of the range sitting at the midpoint, or are they ready for a promotion to the next level, where they’d be sitting in the high end of the range?

5. Sometimes you do need to pay heed to the scarcity of the skills in the market and the individuals you’re dealing with.

6. If your organisation has implemented performance standards, then how the individual has been rated against those criteria can be important. And, of course, that has to be done on an evidence-based assessment.

Now, to be clear, performance standards are akin to position descriptions in that they articulate clearly what is expected of the individual as part of the baseline function of their role. So, they’re different to the KPIs you’d get in a bonus structure. They’re simply more focused on value outcomes than normal functional inputs to the role which will be described in a position description.

Just a note here. You should never use this discretion, if you have some, to circumvent the rem structure. Whenever you create pay anomalies, you’re opening up a can of worms. This can have really far-reaching consequences and create some historical anomalies. Equally, you should never use it to contrive a pay rise for a great bloke or an awesome woman as a retention mechanism.

Em: Cool. That’s pretty comprehensive. Lots of food for thought there. Is there anything else our leaders need to know?

Marty: Well, there’s just one basic leadership behaviour that we speak about a lot. Whatever your decision, make sure you have a one-on-one discussion with the individual about your rationale for making that decision, and particularly with base remuneration, it’s quite important.

First of all, make it clear what you’ve considered, what factors have you thrown into the mix? Make it clear why you’ve decided on their pay level the way you have, so relative to others, the market, individual value, etc. Make sure you share the data with the individual. You can’t, obviously, share the actual dollars, but certainly the concepts.

So, for example, “Jenny, you sit high in your salary band relative to your peers in the same role.” Or it might be, “Peter, you’re already above the market rate for this role.” Or perhaps, “Karen, you’re at 80% of the market rate for this role, as you’ve just been promoted to this level.”

Have the tough conversation if needed, but, the thing is, it shouldn’t be a surprise. An employee’s pay increment is an outcome of many things, but should be along with their overall performance in their day job. This always needs to be within the salary band for their role.

Em: Okay, so let’s move on to variable remuneration or bonuses. I assume the same rules apply from your last point about communicating the outcomes of a bonus decision to your people, but what else is different from base salary?

Marty: Variable pay components, or bonuses, are generally designed to motivate people to achieve a desired result by going over and above.

I’m going to stick mainly to short-term incentive payments for the purpose of this discussion, just to keep it simple. Long-term incentives, or LTIs, and the options that come with them, can be quite complex.

Just to give you a 30 second summary of LTIs, this is where the really big money that you see declared in the CEO and KMP salaries on annual reports come from. Now, of course, KMP is key management personnel. So, in other words, those executives at a business that have to have their incomes declared for shareholders and the public.

LTIs are generally awarded for the attainment of long-term goals. These are generally set on the basis of progressive improvements over a rolling three-year period. Normally, it results in share options being awarded. Now, that is shares in the company that the executive works for.

So, for example, if the company performs really well with measures such as total shareholder return or price earnings ratio, the shares could become very valuable over time. This is the greatest source of wealth creation for senior executives in large companies, particularly those whose shares are traded on a securities exchange.

Em: Right. I get that concept. I see how it can be pretty tricky. So, let’s stick with short-term incentives for now.

Marty: Now, STIs generally have an individual component, a team component, and an organisational component.

The team component is about team performance, and of course, organisational component is about those big-ticket items like the company’s financials, shareholder value, risk, affordability, things like that. And they’re normally paid on the achievement of predetermined annual KPIs, or key performance indicators.

Short-term incentives are very common, but there are often many issues with these. For example, in some industries, the STI earned can be as much as 150% or even 200% of base salary at the most senior levels. This can drive an inappropriate focus on a small set of rather narrow objectives. It can create short-term-ism, and push senior executives to ignore their role as a leader across a broad variety of domains.

So, the actual KPIs need to be set appropriately. They can’t be too easy. They have to be really clearly value accretive. They have to be very specific, and of course, you can’t be able to game them, which quite often happens.

But, for key management personnel, the KPIs are designed to align the interests of management with the interests of the shareholders, and typically tend to be financially driven. Sometimes, these are set without consideration for how the target is delivered, encouraging either ruthless or undesirable behaviour.

STIs are generally discretionary, and subject to board moderation and approval. We’ve seen recently some very big bonuses have been famously withheld by a board due to shareholder sentiment. But when KPIs are set well, and people can see a direct link from their performance or value creation for the organisation to their bonus, STIs can be a very effective form of motivation.

Em: So, what are the traps for young players, I know you love doing these, when it comes to short-term incentives?

Marty: When it comes to administering bonuses, as a leader, you need to ensure that they are actually earned. So, they’re not an entitlement. They’re actually a reward for performing over and above the business as usual or BAU component of your role.

They need to be diligently assessed, so they aren’t just considered an extension of the base pay packet.

They also need to be relative to others in the team. So, for example, you need to reward your top performers really well, and your low performers appropriately.

Try and avoid that clustering in the middle of your team. I mean, it’s just lazy. It’s a surprisingly common mistake, though, as many leaders want to be seen as a good guy, and not take on the hard conversations. It absolutely demotivates your real performers, and this is particularly important when bonus pools are small. So, you need to strongly differentiate for performance. This will motivate top performers and send a strong message to those who are not performing as well.

The target should do what they’re designed to do: incentivise the employee to create more value than they otherwise would, and then take a share of the value returned to the owners of the organisation.

Em: That all makes sense. Really comprehensive, Marty, thank you. We’ve covered a lot of ground here. So, can you summarise the answer to James’s question for us?

Marty: Sure, Em, no problem;

1. Pay increases are not an entitlement to be handed out every year.

2. Besides that, we know that they’re not the number one thing that will motivate and retain your people anyway, although they are an important hygiene factor that you need to get right.

3. Try and reward top performers through a bonus structure where you can, not through base pay moves.

4. Sometimes, and particularly with an employee that comes at you constantly on pay, you just have to say no. So, in other words, do what you’re paid to do as a leader.

5. Very importantly, always explain why. For example, position to the market for the role, position to peers, recent pay moves, but explain how they can maximise their financial position by moving into more senior roles, and how they can do that by developing their capabilities, broadening responsibilities, taking on leadership roles, etc.

Now, I find that people can take no for an answer, as long as you explain your rationale, you find other ways to recognise and reward them, and show them a clear path to the future and how they can maximise their personal financial return.

Alright, I reckon that covers comp and benefits 101. Talk to your HR department if you have one, as they’ll be able to give you the procedural and technical view of the rem structures in your organisation.

However, just remember, you need to bring the leadership component of administering this diligently, and making judgement calls, communicating all of that to your people.

Now, I do realise, Em, we haven’t dealt directly with the part of James’s question about, if it’s not pay, then how do you motivate? I think this episode was full enough, so I’ll do another one in a few weeks time on that topic, which is a subject of common questions from our listener audience.

Hope you’ll join me for that one too, Em.

Em: Absolutely. This topic is so layered. I’m looking forward to getting stuck into that conversation around non-financial motivation.