ISSUE 8 APRIL 2009

At the Family Business Network Global Summit our members heard how a leading Indian family business has built a reward system that helps employees think about building long-term value and not just short-term results.

The ideal would be to encourage employees to think of themselves as 'stewards' of the business, acting exactly as if each one was an owner of the business and wanted to make that business ever more valuable in the future. In reality, many employees inevitably think of themselves as 'agents' who are out for what they can get in the short period that they are working in the business - they want higher salary and benefits now, never mind about the long term. Since we live in an imperfect world, the best that a reward system can do is to encourage steward-like behaviour while limiting the worst aspects of agent-like behaviour.

The Godrej Group, which has 18,000 employees, is tackling the issue through a 'carrot and stick' approach. The carrot encourages employees to strive towards building long-term value while the stick ensures negative consequences if they fail to perform and achieve goals.

The 'carrot' takes the form of a bonus that is based first on the overall performance of the company, then the particular division in which a person works, and only 25% on results directly attributable to the individual and their team. There is no upper limit on the bonus. Since the business has aggressive growth goals it has been judged appropriate for the bonus to form a significant part of an employee's remuneration - perhaps even the majority of it.

To encourage long-term thinking, the full bonus is never paid out in the year after it is earned. Instead only one third is paid out while two thirds is kept in an on-going bonus 'bank'. The next year a further bonus may be earned and added to the bonus bank; again, one third is paid out in the following year and two thirds kept in the bank.

This encourages employees to achieve results that are sustainable for at least three years, rather than one-off boosts to profits that may harm longer term competitiveness. The results are very positive, according to the family business. Motivation is high and there is evidence of peer pressure encouraging weaker performers to work harder so that everyone receives a bigger bonus. People are more likely to stay with the company because if they resign then they lose their share of the bonus bank. People who retire keep their right to bonus payments.

A further 'carrot' is phantom share options for some of the most senior managers. These are rewards that are linked to the performance of the share price over an agreed time period, providing an incentive to make the business more valuable by the time the options can be exercised. But since they are phantom options they do not involve the ownership or disposal of actual shares. This is beneficial to the family because there is no risk that their shareholding will gradually be diluted by non-family managers.

The challenge
is to provide incentives for 18,000 employees to act in the best interests of the business

The 'stick' is the policy of shedding the 5% of people who achieve the lowest rating at any level. This happens every year so employees know that, to keep their jobs, they must avoid being in the bottom 5%.

Before this policy was introduced there was careful preparation. Employees were given two years warning of what would happen and managers worked with those at risk in order to give them every chance to perform to their potential and achieve desired results. The policy has now become an accepted part of the business culture.

What happens in areas of the business where talent is limited and managers don't want to lose any of their team? There is some flexibility in the 5% figure, particularly in areas where there is a shortage of skilled employees, but the policy is never completely abandoned.

The carrot and stick approach certainly seems to be working for the Godrej Group. It has grown rapidly and now has an annual turnover of more than 1.8 billion US dollars. Clearly it is possible to develop incentive structures that bring the interests of employees and owners closer together. As the world reviews old-style bonus structures in the new economic situation, family businesses are showing they have ideas that could offer different ways forward.

 

In this issue

The benefit of 'patient capital'
'In the good times it was easy to say that our priority was to build a long-term profitable business,'

Next Generation money training
Parents find it easier to
train their children in
money management if
they understand their
children's natural 'money
styles'.

Intelligent nepotism
Some entrepreneurs claim they do not want to be 'family businesses'.

A lesson from past economic crises
What values and approaches have helped long-lasting family businesses to survive through past booms and busts?

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