Chapter 3 – Why Your Pay Package Doesn’t Work For You or Other Employees

You are not alone. Very few people are properly and fairly rewarded for what they do.

If you have a year when you deliver 50% more product or profits than the year before, does your pay go up 50%? The odds are overwhelming that your pay does not match this value increase.

We will now look at the various ways you might be paid (bonus, merit raise, etc.) and see why you are likely not be rewarded for your contribution.

For most people in the U.S. that have an annual bonus, the bonus is only about 20% of base pay. It is impossible for most people to get a bonus of 50%. Worse yet, most bonus plans are not variable at all. Most people get bonuses in only a narrow range (say 15 to 20%) so the actual variation in wage each year may only be 5% of base.

If you add in the value of your fixed benefit package (generally about 33% of base), the math looks even worse. The 5% variation looks even smaller compared to base + likely bonus range + benefits.

Percentage of Base

           Base Salary                       100%

           Bonus                              + 15 – 20%

           Benefits                          + 33%          

           Total Compensation     148 – 153%

           Variability                         5%

The majority of bonus plans have only a 5% difference year-to-year.  As a result, there is little chance that it can properly reward you for your great results—even if the company awards bonuses fairly.

Of course, when regular employees get bonuses, bonus award processes are mysterious at best. Few can see the direct connection between value created and reward in most companies.

Merit raises are similarly ineffective. During the last decade, the average salary raise (as a percentage of base) was around 4% annually, and high performers might get 8%. This 4% swing (8% for a top employee versus 4% for an average one) is similarly not very exciting to you. A 4% swing does not reward a high-performer who creates value. A person making $100,000 per year would get an extra $4,000 in pay per year, but nets out to only about $10 per day net of taxes from such a merit wage. It does not seem worth your while to bust your butt or be excessive creative.

Profit-sharing plans and option packages are nice when they pay out, but are essentially random lottery tickets that have no connection to your individual effort or performance. Companies could buy lotto tickets to give to employees and get the same result. Even better, lotto tickets would be easier to explain, and employees would view lottery tickets as harder for the company to manipulate or “rig the game against the employee”.

Perhaps you have a compensation package that includes complex scorecards, management-by-objective plan, or a combination individual/unit/division/corporate performance plan. These plans do not work well because:

  • They require a Ph.D. to understand (and are thus not motivating)

  • They often do not pay out due to hidden triggers or hurdles (again, not motivating)

  • They are out of your control, and don’t reward you for working hard and delivering

What about special recognition plans that allow CEOs to single out a few people each year for one-time bonuses? Imagine the unlikely event that your company has a special recognition program and the CEO gives you a special 25% bonus this year. While you may be momentarily happy, this one-time bonus is more like a lightning bolt from above. The one-time, unusual bonus is unlikely to happen again. The one-time, unusual bonus does not motivate you to work next year. In addition, what about the other person down the hall that was overlooked? Employees do not view lightning bolts as fair or motivating.

Lastly, even getting a promotion to another job with a slightly bigger salary is not fully fair since your value creation may be far more than what you get. Most promotion raises are 4-8%, much less than the 50% increase in value that you delivered.

Worse yet, if promotion is the only way to make significantly more money, you will get several bad behaviors:

  • There will be a lot of competition for spots, creating a few winners and many losers. This kills teamwork and cooperation.

  • Companies promote high-performing employees to jobs that are far away from the jobs where they are most useful to the company.

  • Even if the above is not enough, many believe that the end-result of these promotion-based tournaments is that all are promoted to a level where they incompetent (the Peter Principle).

If you create a lot of value, the company should reward you for your existing job. If you need a promotion to a new job for increased compensation, you get the equivalent of great teachers departing classrooms to become principals (a job that may or may not be right for the teacher or for the school). Thus, the compensation system drives the best employees away from the jobs where they excel.

Surveys indicate that you are not alone in believing that your pay system is crap. Over 80% of people feel their compensation system is broken for many of the reasons discussed above.

Summarizing the above, pay systems generally fail because (among other things):

  • They are static

  • They are not motivating

  • They are not linked to a person’s results

  • They pay out too little (more on this later)

We have talked a bit about the problem from your perspective. We now turn to why this is important for companies in general. This section will also give you ammunition to discuss the subject of compensation with your boss.

Over 80% of people feel their compensation system is broken.

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