We now tell the story of how my firm, L.E.K. Consulting, faced a business challenge, implemented an Eat-What-You-Kill pay system, and realized outstanding success.
Lawrence, Evans, and Koch founded L.E.K. Consulting in 1983, a time when there lots of consulting firms already competing. By 1987, there were 25 major consulting firms bigger than L.E.K. Consulting competing to hire MBAs at major business schools. Today (2015), there are only four of the 25 still around. L.E.K. trounced most of the competition. L.E.K. has grown about 10-15% per year over the last the 30 years, with only four down years in that period.
Compensation was one of the secrets of success, and here is the story of how we changed the compensation program to compete better.
In 1991 (a long time ago), the US operations of L.E.K. Consulting were hit hard by the US recession. Most best remember 1991 as the recession that hurt George H.W. Bush’s re-election chances, but it also caused losses and disruption throughout the economy.
LEK Consulting faced a triple-whammy based upon the recession and internal factors.
First, sales, profits, and employee utilization were down due to these external factors. Staff utilization (billable hours divided by total hours) was only around 50%. The firm was in cost control mode.
Second, employees recognized that the firm was in cost control mode. The prospects for bonuses and promotion seemed dim. We had a traditional “short swing” bonus system where bonus was about 15-30% of base. Employees knew that the firm was going to pay out at the low end of that range. Bonus payouts thus seemed both fixed and arbitrary. Poor managers got the same standard bonuses others got.
Given the dim prospects, many of the senior managers of the firm did not feel motivated. The company offered only a modest incentive to do a great job for current clients. The company give little incentive to look for opportunities for more work with current clients. The company gave little incentive to ask for client referrals to other potential clients. With the lack of motivation, many of the important senior managers were deciding to leave the firm, making it even harder to deliver good work.
Third, staff were miserable. The departure of capable senior managers had left the company with managers who were less capable. Senior and junior staff often worked all weekend reworking projects that should have been done right the first time.
It was not a pretty picture. Even though people were relatively well paid, the system was not working. Here is how the economics worked.
In that long ago time, the average senior manager had a $100,000 base and an arbitrary, qualitative bonus target of $15,000-$30,000. At the time, the revenue from each project ranged from $20,000 to $175,000. Each manager was managing a total of about $800,000 of client projects, ranging from $600,000 to $1,000,000. Some were more productive, some were a bit less, but none handled more than $1,000,000.
The pay did not differ much whether you handled $600,000 or $1,000,000. There was not much of a differential between the high performers and the low performers. L.E.K. underpaid our high performers and overpaid the low performers. As a result, many stars left and many non-stars stayed.
The partners at that time had a traditional view. For calendar year of 1991, they had implemented an old-style group profit-sharing plan for managers in our Boston office. It did not work for many of the reasons, including:
- It had complex financial targets that paid out only at very high levels of the Boston’s office performance (it seemed impossible to achieve)
- It was a group plan that did not reward individuals
- High-performers subsidized low-performers
- It did not pay out
It was a classic example of a compensation plan that did not work because “no one got any money”. Further, it had several key defects:
- The plan was not simple to understand (in other words, employees can’t be moved by a plan they understand or trust)
- The plan did not allow individuals to take control and make things happen (in other words, it was not actionable by the employee since low-performing staff members could thwart the plan)
- The plan did not give clear, mouth-watering incentives that really motivated action (in other words, it was not motivating because the targets were too high and the payouts were too low)
After the failed results in 1991, the partners tried again with a new plan for 1992 that was more creative.
The new plan was Eat-What-You-Kill. They reduced the qualitative bonus to $0-15,000, but added an individual performance bonus based on productivity. They said, “If you manage over $1,000,000 of work, you will have shown very high productivity and very hard work. The only managers that typically reach these levels are ones that have very happy clients that keep coming back for more work. As recognition for the hard work and business generation, we will give you 20% of every dollar of revenue you manage over $1,000,000. If you manage $900,000, you get a $0 productivity bonus. If you manage $1,200,000, you will get 20% of 200,000 or a $40,000 revenue bonus.”
From the manager’s perspective, this was very interesting. It reversed incentives dramatically. Instead of being unhappy when a new project was added to your basket of things to do, you fought to get that new project. Each new $200,000 project could be worth an extra $40,000 (at that time, $40,000 was equal to a terrific car for a manager). Even a small $75,000 project looked interesting.
When the partners announced the new plan, the feeling in the room became electric. It was like the moment at the racetrack when they say, “Drivers, start your engines.” The excitement was palpable. You could almost hear the horsepower gathering in the guts of the managers.
All the senior managers had breakthrough years. They busted their butts making existing clients happy. Existing clients came back for more. Existing clients also were happy to provide referrals. Mangers developed killer pitches for new work. They averaged about $1.8 million of revenue managed under the new plan.
The firm spurted profits as revenues climbed over 50%. The worst profit year ever (1991) was followed with the best ever in 1992.
Why was the new plan a success?
- The plan was simple to understand, and employees “got it”
- The plan allowed individuals to take control and make things happen (in other words, it was actionable)
- The plan gave clear, mouth-watering incentives that really motivated action (in other words, it was motivating)
After the fact, the plan looked “too rich”. The $160,000 bonuses that L.E.K. paid seemed excessive to some. Some might argue that the company could have created the same results with a “less rich” plan.
Then again, you might not have had success with a “less rich” plan. In 1991, L.E.K. tried a “less rich” plan in Boston, and it did not work.
It is worse for a business to pay too little and get no results than to pay too much and get terrific results.
Note also that the plan was self-funding. With increased business results, L.E.K. Consulting made more than enough incremental cash to pay the bonuses and have even more cash left over for the shareholders. It was “win-win” for both sides.
LEK Consulting has since tuned the plan a bit since to make it better. L.E.K. made several changes to improve the plan:
- We increased the relative size of the qualitative management bonus by increasing the qualitative bonus range to $0-45,000 to reward good management, team behavior, and adherence to company values.
- We made the qualitative bonus fairer with the use of objective data collection. In particular, on each project we asked staff to objectively rate the manager on 51 very specific qualities. We gave the manager a summary report every 6 months that show how he or she ranks versus their peers on the 51 different qualities (we average ratings to protect the anonymity of employees filling out the surveys). The items are very specific and actionable (not “Is the manager good?” but rather “Does the manager provide written workplans at the start of the project?”).
This survey process generated good data on who was a good manager and who was not. It provided a sound basis to give some managers zero bonuses and some the top end of the range. An excellent Eat-What-You-Kill pay plan gives good dispersion of bonuses based on objective data, even on hard to quantify items like management skill.
Even better, the plan provided excellent, actionable feedback to managers that helped them to improve and to become better managers.
If you want more detail on how to collect objective data on manager performance from employees, please go to EWYK.com.
- We adjusted the productivity or revenue bonus to make it fairer. Two managers with different seniority and different base salaries who did the same amount of work would get the same total base and bonus. This is another mark of a good EWYK pay system—it is performance that drives pay, not tenure or seniority.
The net result of the new plans was dramatic business success:
- E.K. Consulting tripled in size over the next decade
- Manager and staff attrition halved
- The work quality improved as measured by independent customer surveys
We now give you, the reader, a choice between two options.
Option 1: For Bosses (or People Who Want To Understand Details). If you want to learn the details of how to make these plans work, keep on reading. Chapters 8, 9, 10, and 11 cover:
- What Kinds of Pay Plans Work
- Tips, Tricks, and Traps for Managers
- How You Can Implement A Successful Eat-What-You-Kill Plan
- Getting a Bigger Piece of the Action for You
Option 2: For Everybody Who Wants a Bigger Paycheck. If you not a manager and just want to hear how you can get a better piece of the action, feel free to skip chapters 8, 9, and 10, and go directly to Chapter 11, Getting a Bigger Piece of the Action for You.
Also, even if you are not a boss, note that you might want to skim Chapters 8, 9, and 10 if you want some more background on how to handle any objections or arguments that your boss may have.
In the next chapter (Chapter 8), we will now turn to how you can implement Eat-What-You-Kill in your company— and how you can do it right the first time.