Aligning Compensation Incentives with Next Generation Business Growth Initiatives

The old adage that people do what they get paid to do is never more true than in today’s business world. Most incentive compensation programs at major corporations are designed to support the current year’s performance objectives from the company’s established lines of business, which makes perfect sense over all, but which creates problems for leaders of next generation business growth initiatives that are not designed to pay off in the current year.

When the new business growth initiative is still in its R&D stage, most companies believe that MBOs are an acceptable set of metrics, but when the initiative gets into a go-to-market stage even though its revenues are still not able to deliver any material impact on the company’s top line, the current year’s performance metrics get applied.  The problem with this approach is that these metrics incent the wrong behaviors and, in fact, they undermine the potential of the next generation business ever making a material contribution to the company’s revenues and profits.

Overcoming Current Compensation Constraints:

Basing the majority of business unit leaders’ comp on either the company’s overall revenues or its overall earnings per share (EPS) is normally great for uniting executive behaviors but in the case of driving a new business to scale, they are actually dividers.  In order to successfully launch a next generation business, companies have to make tradeoffs in go-to-market resource allocation to drive the new business, trade offs that, at the margin, can put the current performance metrics at risk which is not easy to do. But, that is the price a company must be willing to pay in order to get a new franchise successfully on-boarded so that it can deliver material new revenue and profits.

To overcome these compensation constraints on next generation business growth initiatives, a company must give top executives the leeway to override the standard comp program metrics, specifically at the division leader level, and to introduce performance metrics that correlate with birthing a new business and driving it to scale. Next generation business growth metrics do not correlate with traditional company performance metrics like earnings per share or short term margin growth.  Instead, they correlate with rapid revenue growth driven by expedited customer adoption, accelerated shortening of sales cycles, and at the appropriate time, rapid and effective integration of one or more acquisitions.  Since these types of metrics are not part of any standard EPS system, the company must use the MBO framework as a flexible vehicle for framing “proxy metrics” that incent the right behaviors and outcomes.

New Compensation Incentives:

In fact, a company with a total commitment to delivering a successful next generation business growth initiative must actually advocate and put in place compensation incentives that would comp all executives from the CEO on down on the success of any new business achieving its materiality metrics during the compensation period.  The reason is that it takes a bit of sacrifice from everyone to achieve “escape velocity” on these efforts.

A compelling example for new compensation incentives:

A very compelling example of the benefits of aligning your compensation incentives with your next generation business growth initiatives can be seen by comparing the actions of Apple and Microsoft over the last decade. From 2000 to 2004 both companies were primarily engaged in supporting their established businesses – for Apple it was the hardware and software to support the Macintosh Computer and for Microsoft it was the software to support Windows and Office.

In mid-decade, Apple broke ranks and launched a whole new next generation business in music with the release of the iPod. That was followed later in the decade by the launch of a second next generation business in mobile phones with the release of the iPhone. As the decade was coming to an end, Apple launched yet a third next generation business in tablets with the release of the iPad. While all this was going on, Microsoft continued to pour the majority of its resources into its existing Windows and Office businesses. During that time the primary compensation incentive for Microsoft business leaders was to keep delivering good quarterly earnings from their current businesses which they did very well. By contrast, the primary compensation incentive for Apple business unit leaders was to make whatever tradeoffs they needed to successfully launch three next generation businesses.

As the chart above illustrates, Apple’s approach was linear in that it launched each next generation business sequentially and not until the prior business had established materiality. It prioritized the new business ruthlessly over the incumbent businesses never allowing fears that the new business would cannibalize the established businesses. Microsoft by contrast was unable to escape the massive internal resistance to resourcing next generation businesses from its two established business franchises that were delivering the majority of the company’s short-term revenue and profits. The market has rewarded Apple’s approach by pushing its stock price up 1500% in the last 8 years while Microsoft’s stock has remained essentially flat over the same time period.

In order to escape the pull of the forces toward short-term performance, a company must free its senior leadership team to disengage next generation business growth initiatives from the current year’s performance and compensation metrics. It may not be easy to break these old habits but as the Apple versus Microsoft example shows if you can do it the rewards are extraordinary.

~ Peter

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