In an increasingly talent-deficient market as fiercely competitive as construction, companies must explore all options to source and retain talent while simultaneously driving down the unit cost of doing business. In addition to a healthy culture, a comprehensive benefits program, and empowering leadership, companies must explore ways to share in the rewards of incremental and profitable growth with their employees.
The Role of Incentive Compensation in Construction
Over 40% of construction companies use a form of earned incentive compensation. When employees know what is expected, have clear measurements on a regular basis, participate in achieving these goals, and are rewarded for hitting their targets, everyone wins.
Effective Incentive Program Design
Designed and managed correctly, incentive systems can produce tangible results and better align owner and employee objectives. The right incentive model keeps focus on delivering quality while utilizing resources efficiently. Everyone wins with proper design and execution, putting the business in a better position to grow and serve customers, employees, shareholders, and business partners.
Risks of Poorly Designed Incentive Plans
Designed or executed poorly, incentive plans can rob resources, energy, and profits. At worst, poor design undermines trust, diminishes the credibility of the management team, and can result in costly turnover. A well-designed plan requires proper vetting by the leadership team, a reliable costing system, and reporting tools to ensure accuracy and real-time visibility.
Key Criteria for Incentive Compensation Programs
In order for incentive compensation programs to work effectively, they should address the following criteria:
Fairness
The program must arrive at a formula that accommodates the capital the business requires to effectively operate and pay employees appropriate bonuses for delivering incremental profit. If the program isn’t fair to employees, they won’t perform differently. Conversely, if it isn’t fair to the company, you’ll face higher overhead and decreased profits, hampering future growth or investments.
Control
The program must incentivize things within the control of the employee. For example, Project Managers control the contract, Owner/GC/Sub relationship, contract awards, overall project profit, and influence cash flow. They should receive a percentage of the overall project Gross Profit earned, with potentially larger weight given to any incremental profit gained over budget through tight contract management.
Transparency
The program must be clearly written in simple terms. Periodic reporting (weekly, monthly, or quarterly) needs to be shared based on objective results. Formulas for any metrics need to be clearly defined, with an agreed-upon methodology for capturing key data.
Negative Performance
Incentives for positive gains need to be offset by consequences for negative performance. A Project Manager who wins a bid at a 25% GP but finishes the job at 15% due to labor and material issues should not be rewarded. Establishing minimum guidelines for performance is critical so everyone understands baseline expectations.
Timeliness
Pay as quickly as possible based on average project length. Protracted payouts can hinder the motivating power of an incentive plan. A quarterly frequency may work best for longer projects, as monthly payouts may create cash flow issues due to billing cycles and retainage.
Consistency
While owners often enjoy the freedom to make changes, it’s important to consider variables that can impact incentive design. Resist modifying the plan unless there is a significant change in the economic environment or business cycle.
Implementing Group Incentives and Profit Sharing
Many companies are moving towards "open-book management," allowing the leadership team to see and better understand financial results, and participate in an annualized profit-sharing plan. Depending on the business lifecycle, it may be appropriate to show only the senior team more detailed results, while sharing higher-level summaries with other employees on a quarterly or biannual basis.
Profit-Sharing Models to Consider
After establishing budgets and a track record of achieving consistent results, you may consider implementing a profit-sharing model for the leadership team. Here are some formulas to consider:
Return on Equity (ROE): A baseline is taken from Equity on the balance sheet. Owners determine a minimum threshold of increase in equity and pay a percentage of the excess out to their team.
Net Income: A budget is established annually, and a percentage of the incremental amount over the budget threshold is put into the bonus pool and shared.
Return on Overhead: Share any savings over a minimum return on overhead, encouraging leaders to manage overhead while driving incremental profit.
Stock Appreciation Plan: Valuation growth is measured each year, and a percentage of the corresponding increase is shared in dollars, potential equity shares, or ownership percentages.
As your company grows, profits will need to be reinvested into people, tools, equipment, technology, expansion markets, debt retirement, and increasing bonding capacity. Leaders must also ensure that incentive and profit-sharing programs leave the business enough funds to meet expected profit and cash flow levels, satisfying shareholders, bankers, bonding companies, and tax authorities. A well-constructed incentive plan is essential for fostering a mutually accountable performance culture.
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