Don Sull's blog

Market turbulence increases the value of agility–an organization’s ability to identify and seize opportunities to create economic value faster and more effectively than rivals. Organizations must align several features, including information systems, culture, and priority setting, to achieve agility. This post focuses on how incentives can help promote agility, using the case of consumer goods maker Reckitt Benckiser (RB) to illustrate the argument. If executives want to promote agility, they should ensure that their performance management system achieves the following five objectives.

1) Attract the “right” people in (and weed the “wrong” people out). Companies (including RB) often state that their incentive system attracts the “best” people, but this is not quite right. “Best” implies a rank ordering of candidates along a uni-dimensional spectrum from worse to better. Staffing an agile organization, however, is not about hiring the “best” people in an absolute sense, but rather finding the candidates who are the best fit with the organization’s modus operandi. A marketing manager who craves process discipline might thrive at P&G or Unilever, but struggle in a more entrepreneurial culture.

Agile organization require employees who strive to achieve, and crave recognition for their accomplishments. Instead of relying on a grand strategic coup, agile companies win by out-executing rivals, which requires key employees achieve ambitious results, year after year. The most attractive candidates value achievement above stability, status, or power. The incentive structure should attract achievement-oriented individuals, typically through large rewards linked to performance of pre-agreed objectives.

In RB, executives earn a base salary bench marked to the median of peer companies, but they can double or triple their salary through cash bonuses provided they hit ambitious performance targets. Such a pay for performance incentive system attracts employees who will risk linking their bonus to performance, work very hard to hit their numbers, and are confident in their ability to get the job done. Employees who prefer a more egalitarian approach to compensation or a better work-life balance typically avoid companies like RB or Goldman Sachs, and will not last long if they make it in the door.

2) Evoke extraordinary effort from employees. Organizational processes identify opportunities and align effort, but the motive force for agility comes from a single source–employees who exerting extraordinary effort to achieve objectives. The threshold for extraordinary effort, in my mind, is the amount of work entrepreneurs dedicate to making their start up work. In many large companies, people work reasonably hard (or at least appear busy), but limit extraordinary effort to the periodic crisis. Agile organizations, in contrast, win by evoking that energy from employees, quarter in and quarter out.

Incentive systems can evoke extraordinary effort by setting ambitious targets that are nearly–but  not quite–impossible to achieve. At RB, the Remuneration Committee of the Board consists of three outside directors who establish challenging performance targets for executives. The committee links revenue and profit growth targets to the median of performance by industry peers, while defining outstanding performance as approximately twice the industry’s level of growth.

Linking targets to industry benchmarks means that RB executives must out-execute some pretty impressive competitors (including P&G, Unilever, and Henkel) to win their bonuses, rather than simply ride industry growth. Expressing performance as a multiple of industry averages also mitigates the temptation to set arbitrary “stretch” targets that are so ungrounded in reality they breed cynicism rather than unleash energy.

3) Focus effort on what really matters. Agile organizations resemble a guerrilla force, which wins by exploiting opportunities rather than grinding their opponents down in protracted war of attrition. For companies like RB that compe against much larger rivals, doing more with less is not a luxury, but a competitive necessity. To succeed, they must focus effort on must win battles and avoid dissipating scarce resources on peripheral skirmishes. At RB, senior executives’ incentives are linked to growth in revenues and profits to maintain their focus on key outcomes. Lower in an organization, incentives should focus on the actions that managers and employees can take in their specific areas to achieve overall corporate targets. The objectives should also shift as market conditions and corporate priorities change.

4) Balance short term urgency with long-term considerations. Rewards for achieving short-term goals induce effort and focus attention, but they can also encourage actions that boost short-term performance at the cost of long-term value creation. Many companies avoid this risk by socializing variable compensation, paying small bonuses that tightly hug the average. A better approach is to reward short-term performance, but counter-balance bonuses with compensation linked to long-term performance.

Incentives for senior executives at RB encourage a longer time horizon in two ways. First, a portion of senior executives’ compensation consists of share options and stock grants, which only fully vest if the company’s earnings per share growth averages 9% per year over three years (versus a 5% average EPS growth per year for industry peers between 2003 and 2008). Second, the 37 most senior executives are required to own significant chunks of RB shares, ranging from 600,000 shares for the CEO (worth £19 million at current share price) to 30,000-75,000 shares (£1-2 million) two layers down. Executives have eight years to accumulate these shares, and if they fall short risk losing future option and stock grants.

5) Balance individual performance with collective success. Large bonuses for individual achievement can focus employees exclusively on their own success, and undermine the cooperation required for collective success. Shared-destiny incentives that link individual rewards to the success of the corporation as a whole counter-balance excessive individualism. In RB, the company must achieve corporate targets before executives receive their individual bonuses. Significant shareholding encourages a collective viewpoint, because equity is valued on firm, not individual, performance.

Incentives are part of the equation, but not all. My next post will discuss how corporate culture supports agility.