Tuesday, December 14, 2010

THE BONUS BUBBLE.

It’s that time of the year again: bells, baubles and bonus bubbles. I’ve called the latter bubbles because they are not unlike those much feared fragile things that happen in stock and other investment markets: inflate to catch the attention of all and sundry and then … pop!.

For many, bonuses are a routine “13th cheque” factored into “entitlements”. I employed a day worker for 2 days a few December’s ago to help clear some refuse. After paying him the agreed rate plus a bit extra, he became extremely agitated at not being paid double for a “krismis” bonus.

Then there are those bonuses based on “merit”, leaving some angry, most petulantly envious, and a handful a bit embarrassed by their good fortune. Very few, if any, see their bonuses as the outcome of a deliberate effort by themselves to improve performance during the year: it’s the luck of the draw based on a tedious annual assessment where things are said that should have been dealt with routinely and regularly during the year. Then there are those that follow good profit performances as a gesture of gratitude and sometimes on top of the “entitled” 13th cheque or incentives.

Executive bonuses are in a class of their own and I dealt with them last week.

In writing the “Planet of the Apes” article a few weeks back and in a general review of the theme on incentives and fortune sharing, I recalled some strange quirks in the field of bonuses. One that caught my eye recently came from Australia.

clip_image002The owner of the Yabulu Nickel refinery, Clive Palmer was so enamoured with the company’s performance this year that he has given the 800+ staff some incredible goodies: the best performing 55 got a Mercedes Benz each, 700 a five-star Fiji holiday for two; and the worst performing 55 received week-ends at a 5 star luxury hotel. Incentives have worked well for Palmer, who was able to turn around the previously BHP Billiton owned refinery from a loss into success on a staff incentive drive.

Clearly there’s more to it though. Palmer has been able to get everyone enthused and involved with the saving and sustainability of the venture. The size of the rewards reflects a large measure of “fortune” sharing with the variable part of the total package higher than the norm. Its sustainability, of course, is going to depend on staff expectations and the extent to which these can be tempered by the involvement that made the payouts possible in the first place.

I saw something similar, although on a much smaller scale, while consulting to a gold mine on the West Rand some years ago. I arrived one morning to find the General Manager very animated. He had received an envelope with about R40 in cash. So did everyone else at the mine. The camaraderie that day was tangible and transcended all hierarchies. This mine had a simple bonus calculated quarterly on gross revenue, which was close to a value-added measurement. The results were shown on a huge “thermometer” at the entrance gates, and when it “spilled over” everyone knew a payout was due. This seldom exceeded R100. It was a unique “common effect” trigger which became part of my thinking on fortune sharing, and at the time I thought it was an ideal involvement tool.

A few months later, I arrived at the shaft to find the place in a mess. Rubbish was strewn everywhere. I was told that news had leaked that management were mooting staff cuts to reduce costs and that the surface cleaners were the first in the firing line. So in solidarity with their cleaning comrades the surface was trashed to preserve jobs. It makes one wonder whether municipal workers have the same thing in mind during strikes. It reminds me of that Bastiat satirical sketch in which the 19th century French economist suggested that all workers should tie their right hands behind their backs because it would make work more difficult. This would create more work and in turn more wealth.

What the mine incident taught me was that involvement cannot be achieved by incentives alone, even if they are structured to affect everyone equally. The key to involvement is more about sharing understandable information than it is about sharing wealth.

At another mine some months earlier, incentives for underground workers were structured to promote production. The base was meters mined very much like my father’s high speed developing days. Month after month teams were called into “lo-offees” to receive their production bonuses. Until out of the blue, they were all called in and retrenched. Both the gold price and the ore grade had dropped and the bonuses being paid were simply unaffordable, leading to the closure of the shaft.

Fruit farmers here have a similar problem. They pay pickers according to volume, leading to an indiscriminate handling of the fruit that causes bruising which surfaces days later. So they have to employ overseers that cost them as much as the pickers themselves. A team of pickers often contains a group that, to avoid being embarrassed, put peer pressure on the star performers to curtail their efforts. Others again, having earned enough to fund a few days of “moss” consumption, simply slack to zero effort or disappear to re-surface at another farm.

I did some work at one of those curses of modern business – a call centre. The incumbents were paid according to number of calls handled with little regard to the content of the call. Needless to say it had a devastating impact on client service, and the system was changed. One financial service company I know of stopped paying their agents commissions on products but rather bonuses on clients recruited and maintained. There was also an interesting twist on executive bonuses. It was pooled and the group had to decide on each share.

The need for a thorough understanding of the workforce before structuring reward systems is a universal rule. Our class at the Oxford Centre for Management Studies was exposed to a case study in which an electronics component manufacturer in a small Scottish town paid the assemblers a bonus over a certain quota of components produced. It lifted production for a while but quickly returned to the standard. Apart from the same negative peer pressure, they also discovered that the employees, mostly young girls from the village, lived with their parents and had to hand over their full pay without benefitting from the bonus.

Then there’s Keith, a Johannesburg accountant who fled the Gauteng rate race to move to the Overberg. Pursuing his first love of gardening, he bought an ailing garden service and within months was not only able to overcome local prejudice against “inkommers”, but had the books substantially in the black. He provides excellent service through personal supervision and by ensuring that each of his team (of which Jan Rasta was one) shares his passion for the job. After each job, Keith runs through the financials with his workers and where every cent goes. He then includes a share of the weekly profits in their pay.

It is dangerous to relate all performance to a “work ethic”. I would challenge any Korean worker to perform better under the conditions that our mineworkers have to -- conditions of which I have first hand experience.

A willingness to give the best of oneself is nurtured by much more than pay or incentives. It has to include a measure of virtuosity, a common contributory purpose and a sense of common fate, involvement, information sharing and leadership styles based on care and individual development.

Our largely Anglo Saxon inspired bonus systems have arguably become dysfunctional and counter-productive. “You get what you pay for”, they say. Often it is not what you expect.

Wishing my readers a festive season filled with contentment. May your choices in the New Year be the correct ones.

Sunday, December 5, 2010

EXECUTIVE PAY REVISITED.

While the media feed on the supply of daily snacks of executive pay disclosures and regular comment, there is a growing impatience with pay disparities in South Africa.

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The latest include the report on Sasol executive pay increases, Sizwe Nxasana’s remuneration as First Rand’s CEO, Ebrahim Patel’s NGP suggested capping of high income bonuses and P.E. Corporate Services’ research that showed that S.A. executives are the best off of 850 companies indexed world wide in terms of disposable income and working conditions.

Pay disparity has two perspectives: a rational one that relies on empirical and quantitative supply and demand theory; and an emotional one based on ethics, morality and socio-political premises. These perspectives have become part of immovable ideological stereotyping.

But even the rational argument has major flaws. For one thing, it assumes that there is a functional “market” in executive skills and that a severe shortage explains the mind boggling levels of pay for these positions.

The fact is that the broad term “executive” is far too vague. In my years of dealing with business leaders, I came to identify three distinct, albeit sometimes overlapping groups: the creators, or virtuosos; the Corporate builders or real entrepreneurs, and the professional managers or deliverers.

The creators or virtuosos are the real and more tangible value creators. They mostly bring something completely new or a much improved product or service to the market. Apart from the IT legends, South African examples are Raymond Ackerman, Koos Bekker, and Adrian Gore, to name but a few.

clip_image004The corporate builders are those who create big “empires” sometimes from scratch or from a modest organic company. They may not get the acclaim of their virtuoso compatriots, but I would argue that they are as talented, awe inspiring and significant. They add considerable value in mobilising capital, giving virtuoso’s a platform for vast expansion, and promoting efficiencies and global competitiveness. Corporate builders very often have a strong sense of ethics and a very clear moral compass. Names such as Warren Buffet, Johann Rupert, Brian Joffe and G.T. Ferreira, come to mind.

Others, such as Donny Gordon, Bill Venter and Richard Branson have elements of both creators and builders. Unfortunately the latter category can also attract rogues such as Jeff Skilling, Bernard Ebbers, and our own Brett Kebble, who put together a paper circle of capital conveyor belts with huge spillages filling their own bank accounts.

We should not begrudge people in the above categories their wealth or rewards (apart from the rogues of course). Given its popular definition, we should not demean them by calling them “executives”. They are autonomous, independent and beyond the reach of any head hunter. To think that you could “recruit” them is the same as believing you can get Oprah Winfrey to open the Swellendam High School fete. There is no “market” for these people.

However, there is a “market” for the third category – the professional managers or deliverers. In most cases, they are the captains of a ship and sail to the co-ordinates of shareholder value. Without detracting from their contribution, their “price” should be thoroughly scrutinised against supply and demand because, unlike creators or builders, they are recruited and appointed as employees.

Implied in demand for them is that they have the same passion, fortitude and aptitude as the builders or creators. This is seldom true. Creators and builders attract investors by their independent and creative thinking, not by submitting to shareholder whims. By exception do they stay in the corporate cocoon. If a deliverer possessed the same qualities as a creator or builder, he or she would most likely leave to become that. Indeed many do.

It’s been said that deliverers are offered the same rewards as the others to make them “think like owners”. The logic of paying someone huge amounts to think like an owner, escapes me. You can only think like an owner if you stand to lose everything, not merely a part of a fortune where the remainder is enough to retire comfortably. The most telling attribute of creators and most builders is their ability to take risks and look beyond immediate self interest. Executive incentives do the opposite and will attract opposite attributes.

Incentives divided into short and long term deliverables or guided by Balanced Scorecards and Triple Bottom lines have arguably had little effect, certainly not more than public pressure or Mervyn King have had. As Alan Greenspan discovered, people orientate towards short term rewards. In any case, much of shareholder focus is on short term results. Generally, there is a growing perception of a disconnect between reward and actual performance, seriously eroding the credibility and validity of incentives themselves.

The modern large corporation seldom relies on the outstanding attributes of one person, but on a whole team who can legitimately claim to have contributed as much as the CEO without sharing in the rewards to the same extent.

The third fallacy of demand is that there is a “global” market for executive skills, so called “peer-group benchmarking”. This is really by exception and most of our executives are simply not exportable, even in our multi-nationals. The “brain drain” of professional and technical skills is far more serious. The tendency to make peer comparisons in all sectors, right down to local government, spreads inflated pay like a computer virus.

Then there is the grey, if not murky area of cronyism, where appointments are made on the basis of who they know rather than what they know. Some see it simply as buying significant lobbying skills, especially with government. I may be a bit na├»ve, but I see a very thin line between this and “tenderpreneurship” or even corruption. Such attributes should be restricted to non-executive directorships at best.

The biggest distortion in the executive skills market is on the supply side. It is common cause that BEE has failed. In addition, by putting a premium on available black executive skills it not only narrowed supply considerably, but generally inflated executive pay structures. Perversely, one of the main intentions of BEE of narrowing the income gap has had the opposite effect.

But the real problem in the supply of executive skills is the artificial walls against entry. This was brought home to me by the pod-cast Alec Hogg had with leadership recruitment expert, Johan Redelinghuys. The insistence on a “track record”, sometimes not even an impressive one, excludes not only the many senior and talented people from other ranks such as academia, but also the thousands of qualified and experienced younger talent from both within and outside the company. The best way of bringing down a price is to open the gates of supply. Head hunters and selection committees can play a significant role in honing their aptitude finding skills, casting their nets a lot wider and finding those less costly but equally talented gems beneath the surface.

It is clear that the rational response to pay disparity in South Africa has some severe flaws. Unfortunately it has gone far beyond an interesting topic for columnists, conferences and academic treatises. The emotive and behavioural dimensions have pushed the issue to crisis levels and the negative perceptions around the more transparent levels of executive pay have to inform remuneration policies. We simply don’t know what the cost of pay disparity and its often accompanying “bling” is in social unrest, crime and distrust. It must be significant.

History has shown that classism, whether by blood, status or economic circumstances, is a highly dangerous condition in any society. Add a perceived or real racial context and it becomes explosive.

Something clearly needs to be done if we wish to avoid enforced economic egalitarianism. It is far better to address imbalances by correcting supply or demand than it is by fixing a price.