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

Power Generates Performance but Performance Consumes Power

In 1997, when Amazon went public, its CEO, Jeff Bezos issued a manifesto – “It’s all about the long term.” Over the ensuing 14 years, Mr. Bezos has not only honored that manifesto he has become a leading practitioner of making investments in long term growth over decisions that favor short term earnings performance. The results speak for themselves with the company’s stock soaring 12,200 percent since its IPO.

By contrast, look at Kodak who has acted like a financial contortionist trying to find and deploy multiple short term gimmicks to keep a failed business model alive quarter after quarter and has finally had to throw in the towel. During that period of time, they missed numerous opportunities to capitalize on business growth innovations including the social networking potential of online photos. By staying exclusively focused on the short term, Kodak is in the process of systematically liquidating its entire business franchise.

What Amazon understood and Kodak didn’t is that power generates performance but performance consumes power. As such, when any company makes decisions that favor short term earnings performance they eventually liquidate their long term power to grow. There are two extremely strong forces within well-established successful companies that tilt the decision making scales toward the short term. The first is the company’s annual planning process which favors resource allocations to legacy businesses over new businesses. The second is the company’s incentive compensation plan which holds senior leadership teams accountable for delivering short term performance but not for making long term investments that increase the company’s power to grow.

Another good example of contrasting approaches to investing in the long term versus the short term is to look at Apple and Microsoft. From 2000 to 2004 both companies were primarily engaged in supporting their core 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. As the chart below dramatically illustrates, the market rewarded investments in long term growth from next generation businesses over short term performance from established businesses.

Can You Curate Innovation in Large Well-Established Companies?

This guest blog is by Karen Lippe who is a consulting partner with Wild Oak Enterprises.  As a veteran marketing technologist, Karen shares her view of the challenges of innovation within the corporate structure. ~ Peter

Innovation.  For companies, especially those in tech, innovation defines a company.  Throughout my years working in Silicon Valley, large companies seeking to become more innovative typically approach innovation creation using two distinct paths:  innovation from inside (aka creating a skunk works-like division) and innovation outside (aka creating an autonomous subsidiary).  Even with the brightest visionary creators, the smartest engineers, the savviest marketers and deep purse strings to support the corporate endeavor, the commercial results are marginal at best or the product is killed off before it goes to market.  This begs the question:  why haven’t more companies (I mean a lot more) been more successful with their investment of innovative products?

The answer is two-fold:  first, they did not define what success was to begin with (if at all), and second, they used the wrong measurements to define the progress of the product or solution.

Defining success.  Even with the best intentions, companies view innovation as a means to create a viable product or solution that would [you pick one:  redirect … reinvent … boost … even save] the mother ship and create a more profitable path.  Innovation is not a savior.  Innovation is the opportunity to leverage the companies own DNA; assess its strengths and weaknesses; view innovative ideas with a new lens (preferably not rose colored); and if good timing is on your side, disrupt the entire market.

A former colleague, Geoffrey Moore, touches upon the idea of success and innovation in his new book, Escape Velocity.  He lays out a smart systematic approach called the “The Hierarchy of Powers” that challenges organizations to look at the whole company from a success vector.  As he drills down, he shares tools and models that set the stage for large companies to be innovation friendly and carve a path that will ultimately garner greater profits.

How do you measure the progress of an innovative product?  Unfortunately new innovation typically dies before it comes to market.  Whether using the inside or outside path mentioned earlier, companies with good intentions embrace an idea and run forward.  To curate innovation from within a corporate environment a tipping point approach is recommended.  Moore discusses tipping point execution as a means toward success.  Simply described, step one  establishes  a model with set project indicators and metrics to measure progress, and step two, creates a milestone-based plan that is formulated working backwards from the desired end result.   If a tipping point approach is not considered, innovators typically enter a vicious cycle of reselling the idea to senior management whereas the effort becomes defocused then dies.  In addition, the tipping point methodology is quite versatile and can be applied to products entering markets where social media increasingly plays an influential role — tapping into peer communities.  Peer group influence can push products in or out of favor and move the “why to buy” to the “I have to buy” tipping point.

To harvest ideas into successful and commercially viable products is always the challenge and undeniable hard work.  If innovation remains the brass ring (what you grab) in technology companies then attaining innovation success is the Holy Grail (the ultimate quest).

Are the Sands Beginning to Shift in the Software Business?

Just before Christmas, Oracle announced its second quarter earnings which showed that revenue rose 2% against an internal forecast of between 5% and 9%. The company attributed the results to their customers delaying both software and hardware purchases. As one analyst said, “we haven’t seen a miss like this out of these guys in years.” The company’s stock price fell 9% and caused a selloff in other enterprise technology vendors such as SAP and IBM. Many speculated that this was the beginning of a category wide downturn.

Ah but wait, SAP announced their fourth quarter earnings last Friday the 13th which showed a 12% increase in revenues from software and related services. Not only did they outperform their traditional rival but their results clearly challenged the assumptions of a category wide downturn. So what’s up?

While it’s true that one quarter’s results do not make a long term trend, are we perhaps beginning to see the initial impact of what my brother, Geoffrey Moore, calls the evolution of enterprise IT from systems of record (SOR) to systems of engagement (SOE).   Here is a link [ ] to a talk he gave last year on this subject.  Some have called this the consumerization of enterprise IT but he likes to call it the “enterprization of consumer IT.” By the way, SAP has adopted this framework as its core go forward technology and product development strategy.

At the heart of this evolution is the fundamental shift from the old vertically integrated, hierarchically organized business model to the new horizontally structured, business network model driven by an increased demand for communication, coordination and collaboration. Systems of record, SOR,  were well suited to support the old vertically integrated model, but now must incorporate systems of engagement, SOE, to support the new horizontal business network model.  As this transition is still in its early stages, companies like Oracle are still almost exclusively focused on delivering software and hardware solutions that support SOR’s not SOE’s.

The emerging reality is that every dollar invested in SOR supported software produces a diluted return to a company in terms of competitive differentiation as the life time value of these investments are in the latter stages of the product life cycle adoption curve. By contrast, every dollar invested in SOE supported software offer a much higher future revenue and profit stream potential because it is in the early stage of the product adoption life cycle curve.

We are still in the very early stages of this evolution and upcoming earnings results may rebound but it just might be possible that we are seeing the start of the shifting sands in the software business. Stay tuned.

What are your observations?  Can large companies quickly embrace this shift in the market?

Peter Moore

Welcome to my One Step Ahead Blog

I will use this blog to periodically share with you my insights and thoughts on emerging issues and challenges that will confront established businesses in what for many is an unprecedented period of time. I will from time to time also include other people’s ideas and insights as I don’t begin to pretend to be all seeing and all knowing. The blog will address a wide range of issues including:

  • How companies can find the right balance point between funding their current businesses and making asymmetrical investments in next generation businesses.
  • What is the unique work of the CEO?
  • Why being able to distinguish between what’s important and what’s urgent is the single greatest predicator of CEO success.
  • The distinction between leadership and management and why making asymmetrical bets is the only way to deliver material new revenue and profits from next generation businesses.
  • Leadership 3.0 – what if everything you were taught about creating and sustaining competitive advantage is no longer true?
  • The Ugly Truth – 90% of all corporate wounds are self-inflicted.
  • How to create true alignment between the C-Suite and the Board of Directors on a company’s business growth strategy.
  • The power of full engagement and how to achieve  it in your business and personal life at the same time.

As I am a great believer in interactive dialogue, I will look forward to reading your comments and contributions to the blog whether they agree with or challenge mine.

Peter Moore

Wild Oak Enterprises Website