Performance-Based Incentive Compensation Plans - Part 2

By Kenneth J. Hedlund, CPA

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

Determination of Incentive Allocations

An incentive compensation plan is designed to tie pay to performance and achieve gains in worker productivity. Such plans incorporate various incentives including but not limited to cash bonuses, commissions, profit sharing, deferred compensation, phantom stock and corporate stock ownership. The incentives can be paid current or deferred to some time in the future. An incentive compensation plan can be purely discretionary and may be targeted to individual employees, work crews, branches or profit centers, the organization as a whole or a combination of these groups.

A performance-based incentive compensation plan takes it a step further—it is more predominately objective and designed to specifically identify and incrementally reward the top performers.

We strongly recommend putting in place a system of performance measurement to provide a model of accountability and identify high performers. Employees should understand what’s expected of them to qualify for the incentive compensation. You should clearly spell out minimum performance standards that link corporate goals to managers’ and supervisors’ performance objectives in order to earn incentive compensation. Incentive compensation plans are customized to a company’s specific needs and goals.

A performance-based plan employs objective criteria to determine incentive pay.  These plans establish clearly identified objectives that the manager must accomplish in order to receive the compensation.

When Somerset works wtih architectural and engineering firms in the design of performance-based plans, we employ the concept of Critical Success Factors (CSFs) and Key Performance Indicators (KPIs).  CSFs are those integral processes that you must absolutely get right to achieve management objectives and ultimately success in your business. KPIs are specific activities that are measurable and, when achieved, result in desired performance to achieve CSFs. CSFs and KPIs are well-documented, time-tested and proven concepts that we have been able to successfully apply to the Architectural and Engineering industries.

For example, KPIs for a project manager in the critical area of operations include routinely (i.e., monthly) updating costs to complete on contracts to identify as early as possible project cost overruns, potential scope issues, implement timely change orders, minimize project profit fade, maintain project profitability, etc., all of which can significantly impact the bottom line. Such specific KPIs for project managers can be utilized to hold them accountable to timely and effectively manage this aspect of their responsibility.

In the design of such a plan, architects and engineers typically focus on five critical areas:

1.   Operations/project delivery

2.   Financial

3.   Business development

4.   Employee satisfaction

5.   Customer satisfaction

Routinely monitoring employees’ progress towards meeting the objectives set in the performance plan in these critical areas will maximize company success measured as overall return on investment (ROI). It’s the concept of what you can measure, you can manage.

As we indicated, these performance-based plans are predominately objective. However, we will be the first to agree that there is no perfect, 100% objective plan. Plans we design always allow for some discretion and subjectivity. This allows for some flexibility. This is necessary because it’s not always possible to assess the contributions of top performers solely through a set of objective criteria. Since these individuals are often put in charge of the most complex projects, the need to have a component of subjective analysis of their performance may be warranted.

A pure performance-based plan could end up undervaluing a key employee’s overall contributions, particularly on difficult or unusual projects where certain skills may be difficult to measure. A discretionary and subjective component of the plan will allow the ability to reward an employee based on your own assessment of the value of the employee’s various contributions.

Finally, the plan must be not be an administrative burden.  This is one of the critical issues that often results in plan failures. The plan must be easy to routinely (typically monthly) monitor and track.  We encourage you to use tools that can streamline and effectively administer such a plan.

Somerset AE Industry Best Practices:

If you believe your company might benefit from introducing a performance-based incentive compensation plan, or if you are dissatisfied with your current plan’s operation, you can reach Ken Hedlund from Somerset at:  khedlund@somersetcpas.com or 317.472.2103.

Somerset CPAs AE Team will continue to contribute articles in the areas of architect and engineering firm management best practices as well as AE financial and tax updates. This exclusive industry-specific series was created to provide 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 your AE firm’s return on investment (ROI).