BONUS QUESTIONS

MARK HAMSTRA

Wal-Mart Stores may be the ultimate number-crunching retailer, but for about 400 officers at the Bentonville, Ark.-based company, earning a bonus requires more than attaining profit and sales goals.

The company is among those that have built compensation plans requiring certain executives to meet some non-financial objectives - in this case, attaining targets for diversity among employees in their business units.

"The objective is to have a company that looks like the communities we serve in every area," Wal-Mart spokesman John Simley said.

The company may also have a financial incentive to encourage the expansion of diversity, as it faces the largest ever class-action lawsuit alleging discrimination based on gender and is under never-ending attack for many of its employment practices.

Although the vast majority of bonus incentives in the supermarket industry are based on achieving strict financial metrics, some food retailers have begun incorporating measures other than sales and profits when crafting executive pay packages.

"Most retailers have moved to a system that's looking past sales and profits," said Neil Stern, senior partner, McMillan-Doolittle Retail Consulting, Chicago. "They are starting to take into consideration things like customer service, mystery-shopping scores and customer loyalty.

"While retailers are certainly trying to achieve profitability, most are also looking to achieve customer loyalty or provide a good experience for the customer. If compensation is solely about profitability, sometimes those things get lost a little bit."

Kroger's Plan

At Kroger, David Dillon, chairman and chief executive officer, will get part of his bonus this year based on how much improvement he will be able to attain in certain customer survey scores, according to a filing late last year with the Securities and Exchange Commission.

Kroger declined to discuss the plan in any further detail, and few details about exactly how such bonuses are calculated are available for public scrutiny.

"Most companies believe these programs are proprietary to them," Stern said.

Many companies outside the industry also incorporate other non-financial metrics into their bonus plans, including such things as staff development, worker safety and turnover reduction.

Although they don't disclose details about such bonus plans, Stern said at least three of the top 10 supermarket chains in the country incorporate some non-financial metrics into their bonus calculations.

Others said it is something they would like to do, but they either have not yet figured out how to incorporate such measures into their bonus formulas or have not yet persuaded top management to sign off on such programs.

Mike Gantt, senior vice president of human resources at Bashas', Chandler, Ariz., said the company has been moving toward building non-financial measures into its bonus programs.

"We talk a lot about it, but we haven't incorporated it yet," he said. "We have been tracking turnover, and we think we have got to the point where those numbers are pretty reliable, and we use mystery shoppers, and do focus groups with customers and employees, so we think we could measure these areas pretty well. I think it's more a matter of accepting the whole notion of doing it that way."

After the recent loss of some veteran operations personnel to a competitor, Gantt said he thinks it is more important than ever to get creative in the construction of compensation packages.

"I think increasingly, the environment is one in which we are looking for things we can use as points of difference, both from a recruiting and from a retention standpoint as well," he said.

Bashas' does have a store-level bonus program of sorts based on mystery-shopper scores, where stores that achieve a certain score become eligible for cash rewards. Each quarter one winning store is selected from each of the company's 11 divisions, and a party is given for the employees, and Bashas' senior executives do the cooking.

Tax Restrictions

One of the constraints for rolling out compensation plans for executives that incorporate such features as mystery-shopper scores or other non-financial metrics could be in the nation's tax code, according to one compensation specialist who asked not to be identified because the person's firm does not allow its employees to conduct interviews with the press.

"A bonus plan that is not based on financial measures and is based more on some type of discretionary input would not quality for [certain tax breaks]," the compensation specialist said. "I'm not saying it can't be structured this way, but many of those plans that are non-financial and discretionary would not qualify."

The Internal Revenue Service, under Rule 162(m), prohibits businesses from deducting from their tax base more than $1 million in performance-based compensation, and bonuses based on measures other than quantifiable financial results may be harder to classify as performance-based, the specialist explained.

Still, some retailers have managed to include metrics such as staff turnover, diversity goals, peer assessments, customer survey scores and shopper behavior patterns derived from loyalty-card data as a small part of their bonus.

At Wal-Mart, the 400 executives whose bonuses are tied to meeting the company's goals for expanding diversity receive 15% of their bonuses based on meeting those goals, Simley said. Assuming all other goals are met, failing to meet the company's goals for diversity results in the total bonus being multiplied by 0.85, he explained.

"In the case of the diversity objective, it is not an adder, it is a reducer," Simley explained. "If you don't meet your diversity objective, it will reduce your bonus.

"There is a strong incentive to meet diversity goals," he added. "The reason for that is that we believe diversity is part of your job - it shouldn't be a reward. It's something you should be held accountable for if you don't meet your objective."

The executives who are held accountable for expanding diversity are all among the "top echelon" of the company, Simley said, with most being corporate officers and some being regional managers.

Wal-Mart also incorporates some non-financial metrics into the individual performance reviews that take place between managers and their subordinates, but those are not used to calculate bonuses, Simley said. Those non-financial objectives are primarily related to mentoring, project completion and staffing.

The company's overall philosophy in awarding bonuses, however, is to keep them in sync with the company's financial goals, which means awarding bonuses based almost exclusively on financial criteria.

"Diversity is really the only non-financial bonus factor," Simley said. "They are all financially based, and the reason for that is that it puts everyone on the same level, programmed toward the same goals."

Margin Squeeze

In the supermarket industry, the intense competitive climate may discourage companies from providing incentives based on measures other than the company's financial results, said Jose Tamez, managing partner, Austin Michael Executive Search, San Antonio.

"The contemporary times are much more about performance - companies are looking at keeping their costs down," he said. "It's certainly something that would be welcomed by human resources professionals and personnel as a whole, but it could end up being a tough sell. This is a low-margin industry, and that tightens up the belt in a lot of areas, and it may not allow the supermarket companies and wholesalers to do too much of that."

Gary Preston of the Philadelphia office of executive search firm Preston-Reffett said supermarkets tend to be very conventional in their approach to executive compensation.

"While there are many companies which allocate a small percentage of the bonus target to measurable criteria such as customer satisfaction surveys, employee surveys, improvement in diversity employment and turnover reduction, most companies still weigh improvement in sales and operating earnings as the major component of their incentive plans," he said.

John Brown, managing partner of Preston-Reffett's Retail-iQ search firm for mid-level managers, said he has seen an "upward trend" of companies using bonus criteria tied to events that they personally can control.

"This includes such things as development of their staff, increasing diversity representation of their group and increasing the 'perceived value' of their department as measured by the stores they serve and their corporate peer groups."

Preston said he has seen "a few very creative companies" craft specific bonus awards geared toward rewarding specific results.

"The message to the manager is simple: 'You want an all-expense-paid trip to Europe for your family for two weeks, accomplish X, Y and Z and we'll make all the arrangements for the trip of your dreams,'" he said.

Stern of McMillan-Doolittle said supermarket companies increasingly track non-financial metrics such as percentage of customer loyalty card usage, in-stock conditions on sale items and customer satisfaction scores, but one of the biggest challenges to implementing such factors into the bonus formula is objectively calculating such things as customer satisfaction.

"Shrink and sales are concrete and relatively easy to measure, but when it comes to customer satisfaction or providing good service, those soft attributes are a little more difficult to measure," he said.

Companies often use mystery-shopper scores and data derived from phone and email surveys of the customer base in order to calculate such metrics for the purposes of awarding bonuses, he said.

Typically, he said, between 10% and 30% of an executive's bonus is dedicated to what he called the "softer measures," with the rest made up of "typical productivity measures."

"What gets played with constantly is what's the percentage - what's the balance of the softer goals vs. the financial productivity goals," he said.

More Disclosure

Although companies tend not to publicly disclose the details of these plans, shareholder pressure may be forcing companies to report more than they previously had on such programs.

According to the compensation specialist who asked not to be identified, public companies beginning next year will be required to disclose much more information about how a bonus is calculated.

"There is extensive scrutiny right now on companies and their boards in terms of how compensation is paid," the specialist said. "I would anticipate that starting next year you are going to be able to get much more information about compensation of executives at public companies, particularly their bonus plans, and it might be easier to see their weighting between financial and non-financial measures."

Margaret Worford, a human resources consultant and owner of The HR Edge, Nashville, Tenn., said the time may be ripe for companies to consider incorporating more non-financial metrics into their bonus calculations because companies are realizing the bottom-line benefits.

"You are seeing a lot more of it," she said. "We are coming off an era where everyone was focused on financial performance, and what has happened is that everyone squeezed the expenses so hard, that in the short-term they would great results, but long term it had a disastrous effect on morale that affected performance."

One example she cited of an area that is emerging as a non-financial goal tied to bonus compensation is in development of subordinates. She said she is aware of a banking company that awards 20% of managers' bonuses based on how well they are developing the talent pool below them.

"In other words," she said, "are they producing bench strength, or the depth of talent in the organization?"

Worford said she always tries to include development of subordinates as a piece of performance reviews she develops for clients, and often such measures are included as a piece of the bonus calculation.

Although managers sometimes balk at having part of their bonuses tied to the performances of those who report to them, she said such a measure can be a key indicator of the effectiveness of that manager. Less-skilled managers often end up at the bottom of the list in terms of development of subordinates, she said.

"That's the essence of management," she said. "People should be getting better by working for you. We tell people, 'Not only do we expect you to manage this department, but we expect you to produce the leaders of tomorrow.'"

Cutting Turnover

Reducing turnover rates also is used as part of the bonus package at some companies, she said. In such scenarios, turnover rates are tracked over time and goals are set to reduce those rates. At one of Worford's clients, reducing turnover counted for 10% of a manager's bonus.

As far as the ratio of non-financial metrics to financial ones, Worford said she strives to structure bonus plans so that 50% of the bonus is based on non-financial criteria. Basing too much of an employee's bonus on financial performance could allow some workers to reap the benefits without making much of a contribution themselves, she explained.

"It's not fair if the person next to you, who is just riding the wave and not doing anything to help the performance of the company, gets the same bonus you do," she said. "That's pretty demoralizing."

If half of a person's bonus includes non-monetary goals customized for the individual, she explained, those workers who excel stand to make a much bigger bonus.

"You want everyone to work together as a team, but you want to be able to recognize stellar individual performance as well," she said.

Bob Kelley, president of PureCulture Consulting, Richmond, Va., said he thinks there is a trend toward companies focusing more on the behaviors that generate the outcomes they seek rather than the specific outcomes themselves.

"Whatever you reward should tie back to your value proposition as a business," he said. "If you are generating business based on innovation, then you will incent the behavior that will help you generate new products. If you are in a nuclear power plant, then you might incent the behaviors that ensure consistency and safety."

In the case of companies like Wal-Mart that are seeking to expand the diversity of their employee base, Kelley suggested that they should create incentives for managers to do things that lead to a more diverse workforce.

To measure the performance of workers on "soft" performance metrics, many companies are using peer assessments to fulfill that need, he said. In such so-called "360 evaluations," an employee's performance is based on interviews with several co-workers based on a list of behavioral goals.

"Outside the industry, they are being used a ton," he said.

Jim Fox, chairman of Fox Lawson & Assoc., St. Paul, Minn., said the supermarket industry could be an ideal environment for bonus programs that take non-financial metrics into account.

"Some of those non-financial goals would make sense in an industry that's not growing rapidly," he said. "It makes sense to look at operational measures like turnover and other things that have an impact on profit. They speak to the quality of the business.

"You could measure return customers, dollars spent per customer, customer frequency - that's just ripe for that kind of non-financial measure."

Food Retailing Salaries - 2006

Small Co. ($500M-$2B); Medium Co. ($2B-$10B); Large Co. (More than $10B)

Position

CEO/President: $605,000; $950,000; $2,000,000

CFO: $260,000; $475,000; $750,000

VP IS/CIO: $170,000; $250,000; $325,000

VP Marketing: $175,000; $245,000; $290,000

VP Operations: $165,000; $215,000; $250,000

VP Grocery: $145,000; $190,000; $220,000

VP Perishables: $150,000; $195,000; $220,000

VP Nonperishables: $145,000; $200,000; $225,000

VP General Merchandise: $140,000; $185,000; $225,000

VP Merchandising: $150,000; $205,000; $230,000

VP Meat/Seafood: $135,000; $165,000; $200,000

VP Produce/Floral: $135,000; $170,000; $200,000

VP Distribution: $150,000; $205,000; $230,000

VP Real Estate: $140,000; $195,000; $230,000

VP HR/People Resources: $140,000; $185,000; $215,000

VP/Director Diversity: $100,000; $130,000; $165,000

VP Loss Prevention: $ 110,000; $155,000; $200,000

VP Risk Management: $110,000; $155,000; $190,000

Director Advertising: $100,000; $120,000; $135,000

Director Training: $95,000; $120,000; $130,000

Director Warehouse: $105,000; $125,000; $140,000

Director Transportation: $95,000; $120,000; $135,000

Director Meat/Seafood: $100,000; $125,000; $135,000

Director Seafood: $85,000; $100,000; $120,000

Director Produce: $100,000; $115,000; $130,000

Director Floral: $85,000; $110,000; $125,000

Director Deli/Bakery: $95,000; $120,000; $130,000

Director Grocery: $100,000; $125,000; $140,000

Director General Mdse: $100,000; $120,000; $140,000

Director Operations: $105,000; $130,000; $145,000

Director Real Estate: $110,000; $125,000; $140,000

Director Internal Audit: $110,000; $135,000; $150,000

District Manager: $110,000; $120,000; $135,000

Category Manager: $90,000; $95,000; $110,000

This table excludes bonuses, special incentives or other compensation factors. This is a sampling of the industry based on the salary ranges at firms seeking to fill vacancies, the salaries of job candidates and filings with the Securities and Exchange Commission. Figures are rounded off to the nearest $5,000.

Source: Austin-Michael Executive Search

Bonus Tips

Incentive-based bonus programs that look beyond the bottom line and reward employees for things like customer survey scores or turnover reduction require some special considerations.

While financial performance metrics like profit and sales growth are easily quantified and translate readily into bonus calculations, other targets need to somehow be made quantifiable and weighted to reflect their importance to the organization, human resources experts told SN.

Some of their advice follows:

Eliminate Subjectivity

Behaviors must somehow be defined in measurable terms by making the goals as specific as possible.

"If it is subjective, that's very dangerous," said Margaret Worford, owner, The HR Edge, Nashville, Tenn. "Then you could have employees trying to wheedle more money - they can say, 'That person hates me, that's why I didn't get my bonus.'

"These kinds of things work well in many different environments, but you have to wrap your mind around the fact that you can quantify it."

Ease Into It

Performance-based bonus programs can be created from traditional performance evaluations.

Bob Kelley, president, PureCulture Consulting, Richmond, Va., said he is working with clients who are implementing behavior-based performance review programs now that are looking at tying them into a financial bonus program down the road.

In many cases it is also important, experts said, to make sure there is an adequate historical record of the metrics being measured before tying them to bonuses.

Measure Results Over Time

Create targets that are based on improvements on previous results.

"You should be measuring improvement one year to the next," said Jim Fox, chairman, Fox Lawson & Assoc., St. Paul, Minn. "The true measure of a customer satisfaction score is not whether you got a 9.5, it's whether last year you got a 9.2."

All or Nothing

Employees should only receive a bonus if they meet their goals fully, according to Worford.

"Don't give half credit," she said. "It needs to be an all-or-nothing sort of thing. If you incentivize half measures, they can turn a blind eye and know they will still get part of the bonus."

Provide the Right Tools

Make sure managers have the right resources to accomplish their goals.

"Once you've given them the tools, and they don't perform, then that's their choice," Worford said. "It's not that you've robbed them."

Celebrate Success

As Bill Reffett of the Seattle office of Preston-Reffett said, "If you want to drive a specific performance metric, define it in measurable terms, create the incentive to be as personal as it can be, report against it over time and celebrate the success when it is achieved."