Performance-Based Incentive Compensation Plans for AE Industry

Posted by Kenneth Hedlund on January 31, 2013

incentive compensation for ae

Part 1:  Performance-Based Incentive Compensation Plans for the Architecture and Engineering Industries

By Kenneth J. Hedlund, CPA

NOTE: This article is the first in a two-part series related to the implementation of a performance compensation plan for Architectural and Engineering Firms. This part will provide a big picture overview of a corporate incentive funding formula, further supported by a firm-wide chargeable hour budget. Part two of the series provides information on how to implement an accountability model to determine allocation of incentives based on performance.

One of the most effective financial tools and certainly best practice concepts is the use of a performance-based incentive plan. Many owners are looking for that key ingredient to maximize their company’s success. We always hear owners say that their employees are the company’s most important asset. Attracting and retaining employees whose skills and commitment contribute significantly to the growth and profitability of the business should be a priority.

While high-performing employees are typically driven by their own high standards, a performance-based incentive compensation package can often motivate them to continue performing at optimum levels. Often we see companies have profitable years and allocate bonus and other incentive payments on an arbitrary and subjective determination.

However, wouldn’t it make sense to put an objective reward system in place to identify high performers and provide them with the highest level of incentives and truly reward them for their contributions?

There are several key components in the design of a performance-based compensation plan:

1.   A corporate level funding formula

2.   Individual staff and overall company production budget and incentive

3.   Determination of incentive allocations based predominately on employee performance

Corporate Level Funding Formula

For architecture and engineering firms, there is a minimum level of profitability that should be achieved before any incentives are considered. This minimum level of profitability considers many variables, including equity and working capital needs for banking, investment in capital assets, debt service, owners’ return on equity, etc. Upon achieving this minimum level of profitability, employee incentive pools are then funded. For each incremental higher tier of profitability, incentives are funded at an increased percentage.

This structure motivates employees to continue to reach for that next higher level of profitability.  See graphic illustration:

corporate funding formula

Individual Staff and Overall Company Production Budget and Incentive

To accommodate the company in achieving its target production we recommend the implementation of a plan that incentivizes staff to meet both individual and company-wide production goals.  Designed appropriately, this plan will result in motivation to create, delegate, manage, supervise and properly spread the workload to the appropriate staff level and experience.  Maintaining target production and chargeability and leveraging work at appropriate levels will ensure financial success.

See below an illustration of such a production model.

performance incentive comp plan

Since this illustration is a production-driven model, there must also be systems and procedures in place to set staff expectations regarding specific architect and engineer project budgets and the anticipated hours it should take to complete tasks.

The final piece of the plan is determination of incentive allocations based predominately on employee performance. We will cover that aspect of the plan in part two of this series that will be published in an upcoming Axium411 blog post.

I welcome your comments and questions on this blog post.

Read Part Two of This Blog Series Now!

Somerset CPAs – AE Industry Best Practices

Somerset CPAs’ A&E Team will continue to contribute articles in the areas of Architectural and Engineering Firms management best practices as well as financial and tax updates. This exclusive industry-specific series provides readers with practical application of the subject matter focused on: financial success, operational efficiency and risk management, optimizing employee performance, developing a culture of business development and maximizing customer satisfaction. Success in these key areas will maximize return on investment (ROI).