The Comp Doctor

Bonus Plan for a Small Company with Multiple Lines of Business

This project illustrates some key points in designing a bonus plan that will capture the imagination and support of a business owner, which is the key to making the right impact. The challenge was to find the right balance between simplicity and accuracy.

The business is an upscale facility for pets. The owner had originally designed a bonus plan which paid out when total weekly revenues reached a target number. The plan was not in effect for more than a month before it was clear that it couldn’t be sustained.

Professionals will immediately recognize that the one week performance measurement period was too short. It’s entirely too easy for a good week to be surrounded by poor weeks, triggering the bonus while the business was still “in the red”.

But more needed to be done. There are four main lines of business; boarding, day care, training and grooming. There is a fifth line, pet accessories and incidentals sold at the counter. While these didn’t account for much of the revenue, they needed to be included as well.

One simplification would have been to trigger the bonus on profit, in effect a non-deferred, non-qualified cash profit sharing plan. For this sort of plan to work two critical elements need to be present: 1) the owner must be comfortable with an “open book” policy regarding the financials of the business and 2) the employees must be able to see the connection between their efforts and the “bottom line”. In my experience only about 10% of small businesses meet both of these criteria. In this case, if for no other reason, the “line of sight” with the multiple lines of business and cost accounting for each, meant this was not a viable solution.

Most of us in compensation come from a strong analytical orientation. Our passion is for the analysis to be accurate and complete. The temptation was to perform a detailed cost accounting of each lines’ profit margins and create a bonus plan with five parts, each with separate triggers and target bonus awards.

The owner, like most entrepreneurs (and C level executives), is a “big picture person” and not someone who would embrace a plan with a great deal of detailed administration and complexity. In addition, the hours that it would take to create such a plan would have put the work well beyond the cost they were willing to pay. But how to find the right balance between simplicity and accuracy?

Looking at the financials of the business and doing a bit of “big picture thinking” provided the answer. The majority of the facility, and its main expenses, were associated with the boarding and day care. The rent, utilities and a minimum level of labor are required to maintain those functions. The profit model of that part of the business is similar to the hotel industry. There are fixed costs for maintaining facility with “X” capacity, there is a breakeven point of occupancy and above that, incremental labor costs (more hours for the part time staff) are more than offset by revenues. In fact, the profit margin grows until it reaches a maximum at full occupancy. Day care is essentially like a non-over night stay. So for purposes of plan design, boarding and day care could be treated as essentially the same line of business, with the same cost factors. Grooming and training require little space and are handled similar to barber shops, where the business takes a fixed percentage of the fees. Consequently, grooming and training could be combined and are always at a fixed profit margin. The accessories, toys and treats sold at the counter did not take the sort of space that a full line retail store would have, so the cost of maintaining inventory could be safely ignored. Although the profit margins on the various accessories varied, they averaged in the same range as that of grooming and training and could be lumped together for purposes of the plan. In other words, the percentage of the revenue from accessories that would go into the bonus pool would always be far less than the profit margin.

Now that the major simplification of reducing five lines of business to two (“lodging” and “all other”) had been accomplished, the detailed analysis could proceed more easily. The big picture is that boarding and day care are the primary lines of business. So the “master” trigger for the bonus plan is “lodging” revenue reaching breakeven for all expenses. One of the problems with the old plan was that revenue from grooming, training and accessories (“all other”) could push total revenues into the bonus range when they were really needed to make up for shortfall in lodging.

Once lodging revenues reach the threshold a percent of those revenues fund the bonus pool. In addition, at that point a percent of “all other” also funds the bonus pool. It’s true that profitability overall could be reached with a certain level of “all other” revenue coupled with a short fall in lodging revenue. However, two reasons argue against constructing a formula based on that scenario. The first is that it would be much more complicated to communicate. The same total dollars in revenue (depending upon the mix) could one time result in a bonus and not another time. The second reason goes back to the primary focus of the business – if it was primarily a grooming and training facility then it wouldn’t need 90%+ of its space or expenses. Now the employees eligible for bonus have simple objectives: focus on customer service for the repeat business, inquire about future stays and ask for referrals to the lodging; and to soft “upsell” training and grooming. Priorities are in concert with the business, first lodging then all other.

The performance measurement period still posed problem. Maintaining a desirable frequency of award meant having the potential for payout at least quarterly, but the seasonality of the business argued against a stand alone quarterly measurement. The solution was to construct year-to-date bonus pool computations at each quarter’s end. Any bonuses already paid are subtracted from the calculation of the pool at each quarter. If first quarter was below threshold, then at the end of the second quarter year-to-date revenues had to be above threshold for the pool to be funded. If bonuses were awarded at the end of one quarter and later results fall below what has already been paid out, there is obviously no bonus and no recapture. Roughly second and fourth quarters are the seasonal peaks, and employees know that those must be good quarters to carry through the first and third. There is incentive to make every quarter as good as possible and cost control for the business so that performance that is too poor in the off quarters has to be made up in the good ones before a bonus can be paid.

The eligible employees are happy, the owner is happy and credits the plan with helping double revenues in six months.

2005 by Robert T Culmer, all rights reserved

Bob Culmer

Fulminata Associates

Mr. Culmer has spent over 30 years in compensation. He has worked for Lone Star Gas, ENSERCH Corporation, KPMG (then known as Peat Marwick Mitchell) and Santa Fe Minerals. He has developed successful compensation plans in a variety of industries, from base pay through incentive reward programs. The hallmark of these plans has been effective use of resources and support for the business’ strategy.

Bob authors a newsletter and wrote and produced an hour long instructional tape and CD, Basics of Better Pay Policies. He developed the curriculum for Richland College's Introduction to Compensation and Benefits classes, which he also taught. He has been a speaker at many groups, including the Southwest HR Conference, North Dallas and Plano chambers of commerce, Texas Association of Businesses and Chambers of Commerce, Dallas Business Association and the AMBUCS business service organization. He was a regular guest compensation expert on The Business Place, a Dallas Community Television show.

He is an Ambassador with the Plano chamber of commerce (Past Co-Chair of the N Dallas Chamber Ambassadors), and Past President of the Dallas Business Association.

He has had his own consulting business since 1991. Clients include companies in stainless steel fabrication, public relations, health care, restaurant, energy, and internet service provision.