Thoughts on Employee Compensation

I have a very specific way I compensate employees, which I'd like to share. I've found that this method does a great job of aligning an employee's interests with the company's, which is a "nirvana" of sorts considering how misaligned an employees interests can often be with a company's.

I'm going to give you an example based on hourly pay, but this can just as easily be applied to annual salaries.

So let's say that I'm interviewing someone who wants to make $20/hour (roughly equivalent to $40,000/year).

First, I'll explain to them that one of my main goals is to align their interests with the interests of the company, and to do that I have a somewhat unconventional way of compensating employees.

Then, I ask them to tell me what percentage of their compensation they're willing to make "performance based." (Don't call it a "bonus" because it's not - this is different.) Let's say that a potential employee is willing to make $5/hr performance based, and wants the other $15/hr to be fixed (obviously the more an employee is willing to make performance based, the better it is for the company, and ultimately, the employee).

So, here's how I apply those two amounts:

The fixed part: This is the easy part, I just pay the employee $15/hour x the number of hours they've worked (let's say it's 40/week), paid every other week, meaning they get paid $1,200 every 2 weeks.

The variable (performance-based) part: OK here's where the magic comes in. Before I explain this part to you, let me tell you what doing this forces me to do. In order to pay someone based on their performance, I have to know what their performance is. This means I have to sit down with each & every employee that reports to me, one-on-one, at the beginning of every month (and some of those employees are doing this exact thing with the people they are managing). Once a month, at the beginning of each month, I review the progress on goals that were set the previous month, and we set new goals for the upcoming month. Having a once-a-month session also gives the employee the chance to express their highlights & concerns as well, which can be very therapeutic for all involved.

I tell employees that if they've achieved all the goals we set together the previous month, they'll be at 100% performance. If we have to re-date even one of those goals, they'll be under 100%. And if they went off on their own initiative and did some things that were not no our goals list, they'll be above 100%. So here's what this means: when employees see things that need to be done, they tend to "just do them" instead of being apathetic, knowing that those things will raise them above the 100% mark, which is great for the company. And even if an employee does something which might not be all that beneficial for the business, but they took the initiative to get it done, I'll still credit that, since finding motivated people is so difficult in this world (and I want to encourage that behavior as much as possible).

I've found that it's relatively easy to set goals for each employee. Some goals are ongoing monthly projects, and some are specific tasks. But they always have specific milestones to be met by specific dates.

So, by the end of the meeting, we've established a percentage at which an employee is for the month (Side Note: I've found it very illustrative to have the employee tell you first what percentage they think they are at, vs. you telling them. It's very telling to people's personalities to see what number they come up with, and it helps you understand how closely their expectations are tracking yours. If someone thinks they're at 110% but you think they're at 50%, then you have a problem. Conversely if they think they are at 50% but you think they are at 110%, you have a different type of problem; someone who's too hard on themselves. Both are worth knowing about).

So let's say this employee and I decide s/he was at 125% for the month. Then, they would be paid $5/hr x 1.25, or $6.25/hour for the number of hours they worked that month (in our example of 40 hours/week x 4 weeks, we have 160 hours total), meaning they get paid an extra $1,000 over their base. This performance pay is paid out once a month, at the end of each month, after the meeting with the employee.

And the difference to you as an employer isn't that vast. If you had just paid them $20/hour, you would've spent $3,200 that month. Based on this methodology, you paid them $2,400 base + $1,000 in performance money, for a total of $3,400. That $200 is well worth the aligning of interests, plus, the employee has control over how much they make, which empowers them to even further align their interests.

Think of this approach as the way a "sales guy" approached paying non-sales people. And I've found that it works very well.