In an increasingly talent deficient market as fiercely competitive as Construction, companies must explore all options to source and retain talent while simultaneously driving down the unit cost of doing business. In addition to a healthy culture, comprehensive benefits program, and empowering leadership, companies must explore ways to share in the rewards of incremental and profitable growth with their employees.
Over 40% of construction companies use a form of earned incentive compensation. When employees know what is expected, have clear measurements on a regular basis, participate in achieving these goals, and are rewarded for hitting their targets, everyone wins.
Designed and managed correctly, incentive systems can produce tangible results and better align owner and employee objectives. The right incentive model keeps focus on delivering quality while utilizing resources efficiently. Everyone wins with proper design and execution, putting the business in a better position to grow and serve customers, employees, shareholders, and business partners.
Designed or executed poorly, incentive plans, at best; rob resources, energy, and profits. At worst, poor design undermines trust, diminishes the credibility of the management team, and can result in costly turnover. A well-designed plan requires proper vetting by the leadership team, a reliable costing system, and reporting tools to ensure accuracy and real-time visibility.
In order for incentive compensation programs to work for all, they should address the following criteria:
Fairness. The program must arrive at a formula that accommodates the capital the business requires to effectively operate as well as pay the employees appropriate bonuses for delivering incremental profit. If the program isn’t fair to employees they won’t perform any different. If design isn’t fair to the company all you’ll have is higher overhead and decreased profits, hampering future growth or company investments.
Control. The program must incentive things within the control of the employee. For example PM’s control the contract, Owner/GC/Sub relationship, contract awards/CO’s, overall project profit, and influence cash flow. Project managers should then receive a percentage of the overall project Gross Profit earned with a potentially larger weight given to any incremental profit gained over budget through tight contract management.
Transparency. The program must be clearly written down in as simple terms as possible. Periodic reporting (weekly / monthly / quarterly) needs to be shared based upon the objective results. Formulas for any metrics need to be clearly defined with an agreed upon methodology for capturing key data.
Negative performance. Incentives for positive gains need to be offset by negative performance. A PM who wins a bid at a 25% GP but finishes the job at 15% due to fade in labor and materials should not be rewarded and such fade should be applied against positive gains of properly managing a job. Blending the overall portfolio of contracts together can buoy a “bad job”. Establishing minimum guidelines for performance is critical so everyone understands their baseline performance expectations.
Timeliness. Pay as fast as possible based on average project length. Protracted payouts can hinder the motivating power of an incentive plan. Spreading payments out too long has the tendency to disrupt the connection between effort and reward. A frequency of quarterly may work best for longer projects as a payment frequency of monthly may create cash flow problems due to billing, receivable turn, and retainage amounts.
Consistency. Most owners enjoy the freedom to change things. After all, they put up all the risk and leave it all on the line. That said, owner’s need to carefully consider the many variables that can impact the incentive design and resist modifying the plan unless there is a significant change in the economic environment or business cycle.
Group incentive / Profit Sharing
Most clients we work with are edging closer toward "open-book management", allowing the leadership team to see and better understand financial results and work towards participation in annualized profit sharing plan. Depending on the lifecycle of business, it may be appropriate to show only the senior team more detailed results while sharing higher-level summaries with other employees on a quarterly or biannual basis.
After having established budgets and a track record of achieving consistent results, you may consider implementing a profit sharing model for the leadership team. These management team members receive their incentive compensation based solely on how well the company performs. Each team member can either receive equal shares of the total pool or have a prorata % based on their role and level of profit influence. Providing an equal share, however, gives equal responsibility and unites everyone to perform together as a team.
Formulas for consideration:
Return On Equity (ROE). A baseline is taken from Equity on the balance sheet. Owners determine a minimum threshold of increase in equity and pay a % of the excess out to their team. Equity growth correlates to increased value, reduced risk, increased bonding capacity, etc.
Net income. A budget is established annually and a % of the incremental amount over the budget threshold (say 10%) is put into the bonus pool and shared.
Return on overhead. If you’re uncomfortable with sharing your net income, you can use a return on overhead. Any savings over a threshold (let’s say a minimum 20% return on overhead) can be shared with the team focusing leaders to manage overhead while growing to drive incremental profit.
Stock appreciation plan. A baseline value of the company is assessed. Valuation growth is then measured each year and a % of the corresponding increase is shared in dollars or potential equity shares or ownership % in the company.
As your company grows, profits will need to be reinvested into people, tools, equipment, technology, expansion markets, debt retirement, and increasing bonding capacity. Leaders must also be certain that the incentive and profit-sharing programs leave the business enough $$ to demonstrate expected levels of profit and associated cash flows to satisfy their own constituents (shareholders, bankers bonding companies, tax authorities, etc.). While $$ isn’t typically the #1 driver, having a well-constructed plan to incentivize key employees is an important step in creating a mutually accountable performance culture.
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