This approach to offering employees rewards also gives us a way to re-think how to structure an individual employee’s monetary compensation.

Looking at the framework on page 139 in Chapter 37, at the individual level, for example, a company can give a share of product royalties to those employees who create value-added outcomes. Most major research universities share royalties with the faculty who develop products or patents that are licensed to outside companies.

In the private sector, Bill Atkinson developed the HyperCard (a predecessor to the development of the internet) when Apple was introducing its very first Macintosh computer. It was widely rumored in Silicon Valley that Apple wanted to pay him a half-million dollars for it. Instead, he turned down the offer, negotiating that the product be bundled in every Mac and that he received a royalty of a few dollars for each Mac sold. Early Mac users loved the HyperCard, and two million Macs sold in the first year.

Atkinson put all his HyperCard chips on the Mac’s value-added outcomes, and there’s no doubt it was a shrewd bet. If Apple paid him $2 for every HyperCard inside the Mac, his yearly return increased 8 times—from $500K for his result output of developing the product to $4 million for bottom line outcomes—with more to come each of the following years.

Movie stars, like Meryl Streep and Tom Hanks, work out similar arrangements. They take a lower fee for starring in a movie in return for getting a percentage of all ticket, merchandise, and distribution rights sales that the movie studio collects. If the movie bombs, they collect very little from these deals. If it sets box office records, however, they make multiple millions above what their fee would have been.

In a different example, an international bank motivated that their bankers to make a very high number of loans to businesses in Third-World countries. However, after a couple of years, many of these loans soured. The bank realized that it got the incentives all wrong. They paid the entire commission to the bankers upon the making of the loans, not for making loans that were re-paid.

The bank decided to pay the bankers a percentage of the loan each time it was repaid. So, for a 5-year loan, the banker now received one-fifth of the commission upon making the loan and another 16% for each year as it was repaid. In other words, the commission became an annuity that was paid over the lifetime of the loan. If the loan stopped being repaid, the bankers did not receive their annuity. When the client paid off the loan in full, the bank then paid a percentage of the loan’s interest to the banker as a reward. Not surprisingly, the quality of the loans improved dramatically.

In a final real-life example, Paulson & Company, a New York–based niche hedge fund, was not making much money compared to its peers. In 2004, John Paulson, the firm’s CEO, went against advice from his staff and hired Paolo Pellegrini, a desperate analyst with a checkered employment record who had recently been let go from another firm. With two high-profile divorces behind him, Pellegrini was living in a one-bedroom apartment with little money to his name.

Pellegrini thought that the housing market was overheated. His research and analytics showed that housing prices in the USA had typically risen 1.4% annually from 1975 to 2000. Yet, during the housing boom from 2000 to 2005, prices shot up over 7% annually. He believed that prices would fall sharply and convinced Paulson to bet against the booming housing market when everyone else was bullish. Not only did he provide the data behind the outlook, he also orchestrated the investment strategy. He figured out a complex method and got Paulson to create an investment fund to make it happen.

Long-time investors in Paulson & Co., however, were unwilling to put money behind the bet. They believed that the housing market was priced correctly and that, by looking at housing, Paulson & Co were operating outside of their field of expertise in mergers and acquisitions. Other firms, like Goldman Sachs, were eager to bet against Paulson & Co.

Paulson did eventually raise a modest $147 million, mostly from friends and family. In 2006, Paulson & Co. executed Pellegrini’s strategy. By 2007, the bet paid off to the tune of $15 billion, with John Paulson personally taking home $4 billion, the largest one-year payout in Wall Street’s history. In 2008, he made another $5 billion betting against financial firms that had huge exposure to the housing market.

As for Pellegrini, the Wall Street Journal reported, “In late 2007, he took his new wife on vacation in Anguilla, an island in the West Indies. Stopping at a cash machine in the hotel lobby to withdraw some cash, she checked the balance of their checking account. On the screen was a figure that startled her: $45 million, newly deposited in their joint account. It was part of Mr. Pellegrini's $175 million bonus that year.”

For Pellegrini, the $175 million represented his reward for his value-added outcome to the firm’s critical path.

Critical Path Action Items

  • What individual value added outcome could you help produce for your company either on the cost side or the revenue side?

  • Should you be compensated for it? If yes, how and how much?

  • If you are the owner or manager, how and how much should you compensate for individual value added outcomes?