Compensation is a very tricky issue in a consulting company that sells its services by the hour to clients. In some ways, the clients dictate the salary by what they are willing to pay. Of course, it is indirect because the clients usually only care about the overall hourly rate after overhead and profit are added and then compared with like companies. If a company is willing to take less profit, or the company has very low overhead, they might get away with paying a higher salary.
The second way salaries are set is by what the market will bear. To attract new people to join your company, you have to pay what it takes to get them to say “yes.” What clients will pay and what it takes to hire people are related, but certainly not directly, especially with senior talent.
Relative to mid three- to four-level employees, you are selling their skills and experience, with the beneficiary being the client. It makes all the sense in the world that the client would be willing to pay for comparable talent from other companies. But when referring to employees at the senior level, the value of a person is not what they can directly sell, but their leverage value of selling teams. Senior people are often hired to open new markets or add key clients. They also start new business initiatives. So, for these people we set salaries not on what clients will pay but how they will affect our business platforms. When this happens, how do you set salaries compared to your existing base?
Each company’s HR department will show an orderly and gradually increasing set of raw salary brackets that is tied to your existing base as well as competitive surveys from other companies. But that is in a static world and deals with internal expectations. It does not deal with talented leaders outside your firm that you want to attract away from their current employers. In those cases, your guidelines can be invalid in that they assume replacement value instead of new business value.
Usually company acquisitions are priced on a discounted cash flow basis or a comparable industry multiple of recent transactions, but one very respected colleague once advocated to me that we should price deals on the number of entrepreneurial leaders in the acquisition times one million dollars to three million dollars each. What a different way to look at the value of an acquisition! After a career, I actually think the post three-year value-added of my historic acquisitions is better correlated to the “leader multiple measure” than traditional financial ones. The increased leverage of newly acquired leaders who can affect others, determines the real residual added value of any acquisition. When you do a deal you are trying to get 1+1 to equal greater than 2 so that the new company is accretive. The degree of key talent you get from the acquired company makes all the difference in whether that is possible.
So what happens when a company wants to recruit a competitor’s leader for the purpose of adding new value? What should they pay for that leader? On one hand, the HR department will want you to have them fit into your current compensation structure. But everyone knows that in a decent market even your current employees can obtain an average 10 to 15% salary increase by shopping around and switching companies. But this does not properly address the star recruit that could bring you new business, recruit their former colleagues to come with them and bring long annuity clients you’ve always wanted. What do you pay them?
An answer that could get you in trouble is: “Pay them whatever it takes.” The reason that solution will get you in trouble is that you have a serious obligation to current employees who are not job jumping and are counting on you to pay them competitively without having to shop the right price. You already have an established salary structure.
Some companies deal with this by cutting secret side deals, using hiring bonuses, promised performance bonuses, and even different fringe benefits packages. I think there is some legitimacy in all of these tactics as long as you are fair to your current employees with like skill sets—employees who are also leveraged leaders and have created something historically or are driving your base business. There is a tendency to treat a stranger with salary promises better than internal proven talent because you no longer have to attract them. That is not fair. If you are going to cut a super deal with a new employee, you need to back evaluate if you are treating your existing like talent the same way.
I call the management test for outsider compensation deals “the Bulletin Board Stink Test.” This test simply assumes that all compensation data is falsely confidential and will eventually get exposed. Thus management should ask, “If we put this new deal on the transparent bulletin board, would we be proud of it and could we defend it relative to our existing employees?” Companies usually don’t want to take this test because it implies they would need to go back and correct the inequities. EXACTLY! That is what they should do, or refrain from making the new deal. The cost of hiring a new leveraged star due to a “sweet deal” should cause a ripple effect of correcting the compensation for similar existing personnel.
Although this sounds expensive, I think it is necessary out of fairness. Why would you make your current employee shop for a new employer just to make you realize that you are under-appreciating them? Just as most mid-level employees can get a 15% salary increase by shopping around, you should be willing to match that 15% increase to keep them if they are that good. So why don’t you take the initiative to realize that new stars also set the price of your existing stars?
Now if you believe the reaction to this philosophy will be, “With that philosophy we can’t afford new stars because the cost is too high along with the risk that new stars look better than they actually perform. This is defeatist. New stars can be worth the price if you do the necessary research to increase the probability they really are leveraged stars. How do you do that? Well, football coach Bill Parcels reportedly said, “You can tell the quality of a trapper by the pelts on their pony.” Talent that you can prove has done it before has the greatest likelihood of doing it again. You are taking a big risk in someone who talks well without the historical track record that can be verified.
My bottom line is that you should assume that compensation levels of new hires will be transparent someday. Treating your existing talent equitably is a trusted responsibility of a good employer. Either pass the “Bulletin Board Stink Test” or ripple the effect of new compensation packages across your existing talent base.
© 2014 Robert Uhler and THE UHLER GROUP. All rights reserved.