Let's now tie these economic rewards together within the framework.

Let's begin by comparing two examples as we did in Lesson 36, but this time with different splits. Consider Ben, our most conservative, risk-averse employee with the 90 - 10 - 0 profile and our value-added, outcomes-oriented employee, Arriya, with the 20 - 30 - 50 split. Let's assume that they both have the same market value of $100,000. In keeping with our earlier analysis, let’s say that every $100,000 employee’s true full cost is $300,000. So, as with our earlier example, these employees must generate $345,000 in value to keep their $100,000 jobs.

Let’s look first at Ben, our conservative employee.

As we saw in the earlier table, Ben desires $81,000 dollars in salary for his individual effort. He hopes to get another $9,000 for team effort, another $9,000 for individual results bonuses, and $1,000 from the team results bonus. He receives nothing additional for any value-added outcomes above the required $345K to which he might contribute.

Now let’s turn to Arriya, our more outcomes-oriented employee.

Arriya receives only $20,000 for her effort at all three levels. She receives another $30,000 for all the result outputs that she helped make successful. Finally, to obtain her market value salary of $100K, she must produce a minimum of $345K in value-added outcomes to the bottom line that will yield her the additional $50K in salary. In other words, for every $6,900 of value she creates, she earns $1,000 in value-added outcomes salary ($345K/$50K = $6.9K).

If Arriya doesn’t produce the expected $345K in value, then her income will suffer accordingly. If she only produces 80% of her target, i.e., $276K, then she will only earn $40,000 in value-added outcomes compensation, bringing her total compensation to $90K (assuming she gets the $20,000 for all her effort and the full $30,000 for all her result outputs). If, however, she doesn’t produce any value-added outcomes, then she only makes $50K for the year (again assuming she gets the $20,000 for all her effort and the full $30,000 for all her result outputs).

That’s the downside. However, let’s say Arriya’s and the company’s value-added outcomes bear fruit during the year. Her individual outcomes add $1 million to the company’s bottom line, of which she receives the 20% for which she negotiated, or $200K. Her five-member team outcomes produce $5 million for the bottom line, of which each member can claim an equal share of that outcome. Accordingly, the five team members get equal cuts of the $750,000 from a 15% gainsharing plan ($5 million x 15% = $750,000), or $150,000 each. Finally, the company awards her 1,500 shares of stock, valued at $100/share, for another $150K in compensation. So, her value-added outcomes yield her an additional $500K in income.

Combined with the $50K for her effort and results, she will take home $550K this year compared to her $100K counterpart.

Looking at this from the company’s point of view, which employee would you rather have? Do you want Ben, the conservative 90-10-0 employee, who is guaranteed $81K to $90K of his $100K salary for putting in the effort to produce $345K in value-added outcomes? If he doesn’t, your investment is lost. On the other hand, if, similar to his outcomes-focused colleague, he produces $2 million in value-added outcomes, you get to keep the entire $1.655 million that is above and beyond his $345K target.

Or would you rather have Arriya, the more value-added outcome-oriented 20-30-50 employee who is willing to risk her salary for greater participation in the value she creates? She only gets $20K for all her effort to produce $345K in value. If she produces nothing, the company loses that $20K, which is 4 times less than what it will owe Ben, her more conservative counterpart. However, if she produces $2 million, she takes home $550K (not counting any stock appreciation)—or 5.5 times what her counterpart does. The company only gets to keep $1.205 million ($2 million minus $345K minus the $450K above and beyond her $100K salary).

Going back to Steve Kerr, the company must decide if it wants to bet $81K to $90K on the conservative employee’s effort in hopes that he will produce at least $345K in profit and maybe even $2.0 million, of which it gets to keep $1.655 million. Or, pay Arriya $20K for effort knowing that she only makes more if she actually produces bottom-line outcomes. When she produces $2 million, the company gains $1.205 million.

Do you pay for effort, while hoping for value-added outcomes? Or do you just pay directly for value-added outcomes? Think about it, but don’t answer just yet.

Now, let’s fast forward 10 years.

Because our conservative employee Ben produced $2 million in outcomes that first year, the company labels him a star performer and gives him a 15% raise when the average raise is 3%. They also give him 150 shares of stock, valued at $100/share, for a total of $15K to show him how much they appreciate his work, even though he didn’t negotiate for it and was not entitled to any organizational outcome rewards. Feeling happy with the company’s positive view of him, he works hard and produces $2.3 million in outcomes the second year, i.e., a 15% increase, commensurate with his raise.

This pattern of 15% raise, 150 shares of annual stock, and a subsequent 15% increase in outcomes continues for 10 years. After 10 years, his salary will be $404,855 (not counting any inflation effects), he will own 1,500 shares of company stock, and he will be producing $8.08 million in value-added outcomes in his 10th year. His cost to the company will not increase at the same rate since much of that cost, like overhead, will stay stable or, like Medicare and Social Security, will be capped (again assuming no inflation). So, in year 10, the company will make about $7.33 million off this employee ($8.08 million minus $405K minus $345K). Not bad!

Now let’s look at our other employee. Arriya, our outcomes-oriented colleague, being very pleased with her first year income of $550K, pushes even harder in the second year at the firm. She continues to work for a 20% split of her individually produced outcomes and proceeds to send $1.2 million to the bottom line, of which she receives $240K. Her five-member team aims higher, too, and produces $5.75 million for the bottom line, of which each member can claim an equal share of $1.25 million as their fair share of that outcome. Accordingly, the five team members get equal cuts of the $1,250,000 from a 20% gainsharing plan, or $250,000 each. Finally, the company awards her 1,500 shares of stock valued at $100/share for another $150K in compensation.

So, her value-added outcomes yield her an additional $640K in income. Add in her $50K from her effort and results, and she is now making $690K in all for the $2.45 million in value she has produced for the company, which is a 22.5% increase from the prior year. Continue this out over 10 years, and she will be producing $15.2 million in value-added outcomes for her employer and collecting around $5.3 million in compensation in her 10th year. So, the company will make $9.55 million ($15.2 million minus $5.2 million minus $345K).

Again, ask yourself: If you owned the company, would you rather make $7.33 million or $9.55 million off a single employee?

That’s an easy one. Still, you might be thinking that this is an apples-to-oranges comparison. What would it look like, for example, if Ben produced 22.5% more each year, as did the value-added outcomes employee, contributing $15.2 to the bottom line in year 10 rather than a relatively paltry $8.08 million? Then the company would make about $14.45 million ($15.2 million minus $405K minus $345K)—$4.9 million more from Ben over Arriya (whose $9.55 million contribution now looks paltry compared to her colleague’s $14.45 million of value generated)?

My answer is a question: which employee is more likely to produce those outcomes in all the years between years 1 and 10? Would you bet on the one who gets a mostly guaranteed salary every year, whether the outcomes materialize or not, to produce an annual year-over-year outcome increase of 22.5%? Or, would you bet on the one who must produce in order to get her $5.3 million outsized compensation? Would you bet on the one who has 1,500 shares of stock to work hard throughout the entire organization to increase the value of that stock—or the one who has 15,000 shares?

How you bet says a lot about you and your rewards philosophy.

You might also be thinking that it’s crazy to give over 1/3 of the value created to the value-creator. Fine. How much do you think you have to give to get the equivalent out-sized performance? What is fair to the person and you? What would it take for you to perform at that level?

As you ponder these questions, think back to our earlier example of Paolo Pellegrini at Paulson & Co. He helped create $15 billion in value for the firm in 2007. His boss took home $4 billion, or 27%. Pellegrini got $175 million—a huge amount of money, to be sure, but only 1.1% of the value created. He quit the next year, partly because, even though $175 million is a heck of a lot of money, he didn’t feel like he got his fair share. Since Pellegrini left, Paulson & Co. has never come close to this type of performance. Maybe this was all just a lucky bet that paid off. Or, maybe they should have paid him more to keep him and see if he could repeat those results.

Pay the Talent.

As a final piece of this puzzle, consider how Netflix doles out its compensation. They let each employee decide how much they want to take in cash vs. stock options. The decision is up to the individual to choose how much risk and upside they want. The stock options are fully vested, and employees get to keep them should they decide to leave Netflix. The company does not believe in golden handcuffs that force people to stay to get their money. How many employees choose what percentages is not disclosed. However, like all good managers, Netflix allows employees to choose the risks and rewards they’re comfortable with. Linking the fortunes of the employees to those of the company, Netflix can be confident that employees will then be properly incentivized to work hard along the critical path.

Critical Path Action Items

  • What is your risk reward profile? Are you more risk averse or a risk taker?

  • How do you feel when you do not get rewarded sufficiently for your value-added contributions?

  • As an owner or manager, do you prefer Ben or Arriya? Why? Which do you expect to produce better value-added outcomes?