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108 PRACTICE MADE PERFECT important than the others. It’s important to evaluate what moti- vates them—people, data, or things. In other words, do they tend to be more social or more attached to their computers? Are they hands on or hands off? It’s important to evaluate personality to ensure the candidate fits your benchmark for the position and is compatible with the culture you’re trying to create. Some critical criteria include: ! Self-reliance. Is she a collaborator or independent? Submissive or assertive? ! Process orientation. Is he innovative or orderly and predictable? Reactive or organized? ! Work style. Is she analytical and self-sufficient or group-oriented and outgoing? ! Social skills. Can he take criticism or does he overreact? Does he have passion or is he a dullard? Is he frank? Most leadership positions require a blending of these attributes. But before hiring, you should establish a benchmark of the optimal characteristics for that specific job, a blend that will suit the job, suit you, and suit your organization. Failure to establish measurable criteria for evaluating perfor- mance and to tie compensation to expectations. Being clear about what you expect your CEO to accomplish is vital both to the hir- ing process and to your ongoing management efforts. If you do not know specifically what you want someone to do, how can you know if you’ve found the right person? Sure, part of a CEO’s job typically is to help devise a strategy for your business and then to build the team to implement it. Those are specific tasks that require specific skills. But as the owner, you can’t delegate all strategic planning to a CEO; you need to have a clear vision of where you want the busi- ness to go. At this point, your challenge is to decide whether you should serve in the management role, the leadership role, or both. Between your vision for the practice and its fruition lies a long shadow: a shadow of doubt, of ability, of time. If your time is better spent on client service or on business development, then try not to let your THE CARE AND PREENING OF STAFF: PROFESSIONAL DEVELOPMENT 109 ego get in the way of effective management. If the role is not for you, come clean and focus your talents where you can make the greatest impact on your business. But if you engage professional management or delegate these duties to others within your firm, you may need to work on keeping your reactions in check. If you hired well and were clear about your expectations, you’ll be far better off allowing your managers to do their jobs than to insinuate yourself into the minu- tiae of their decisions. This page is intentionally blank A DVISORY FIRMS SPEND more money on professional and staff compensation than on any other expense. In fact, if these firms defined compensation appropriately, it would be clear that they actually invest more money in compensation than in any other area of the business. The challenge for advisers is to think of com- pensation as an investment, consider how they choose to allocate that investment, and determine what kind of return they expect on that investment. Developed deliberately, a compensation plan can be a recruit- ing tool, a retention tool, a behavior driver, and, most important, a communication tool for expressing what’s important to the orga- nization. A compensation plan defines the behavior the firm values and will pay for—and the behavior it values so much that it will pay extra for it. The mistakes advisory firms make in designing their compensa- tion plans are remarkably consistent: ! They pay as if they’re rewarding production, when they’re trying to create a firm culture. ! There is no consensus among the partners on the underlying compensation philosophy—what they believe and what they want to accomplish with their plan. ! They develop the compensation plan in a void, with no strategic context. ! They don’t relate compensation to performance goals or to a performance appraisal process. 111 THE PAYOFF FOR THE FIRM Compensation Planning 7. 112 PRACTICE MADE PERFECT ! They focus too much on the total dollars to be paid—the what — and not enough on how that compensation will be structured— the how—and what they’re trying to accomplish—the why. Many conversations we have with advisers who believe they’re struggling with compensation issues begin with a question like “I hired a new guy—just couldn’t pass him up. How much should I pay him?” Even more begin with questions like “Our turnover has been really high, especially among young advisers. We must have a com- pensation problem. Can you help us address it?” Both of these ques- tions, of course, point to issues larger than just compensation—issues typically related to strategy, culture, and career path. Compensation, however, is often perceived as the easiest problem to address, or the easiest way to address a problem, even if the problem is not actually related to compensation. The best firms in the industry have a formal compensation process —a deliberate way in which they structure people’s pay—and they have a clear understanding of where compensation fits into their larger human-capital plan. Most advisers are tempted to begin their human-capital plan with compensation. However, it’s truly impos- sible to design effective compensation until you’ve envisioned the organization you’re investing in and the desired performance you’re paying for. The most critical steps and conversations in developing a compensation plan arise before the issue of compensation is ever addressed. A meaningful compensation plan typically arises at the end of a process that looks like this: 1. Develop the business strategy. 2. Define the roles, responsibilities, and staffing model. 3. Define the desired behaviors and performance expectations. 4. Hire the right people. 5. Design a compensation plan to reinforce the desired behaviors. Developing a Plan There are four absolute truths about an effective compensation plan within a financial-advisory firm: ! It must be aligned with your strategy. THE PAYOFF FOR THE FIRM: COMPENSATION PLANNING 113 ! It must reinforce the behavior you desire. ! It must be affordable to the business. ! It must be in harmony with the expectations of your staff. Strategic Alignment In financial-advisory firms, the most common example of misalign- ment relates to both client selection and product or service offering. We once consulted with a firm that had a stated commitment to build its business around high-net-worth individuals. However, the firm’s incentive program was tied to the number of new clients each adviser obtained, regardless of the client’s profile. It happened that one adviser had a pipeline into a plan administration firm that referred him large volumes of 401(k) plan assets to manage. You might argue that assets are assets, but obviously the approach to servicing 401(k) participants is a whole lot different from the approach needed for wealthy indi- viduals, and the margins are usually not as large. The firm had built up its estate- and charitable-planning capability to be responsive to the complex needs of wealthy individuals, but the people filling these functions were idle because of the nature of the clients that were actu- ally being brought in. In this example, and in many advisory firms, the incentive plan in place was reinforcing behavior contrary to the firm’s stated strategy. The very process of defining a business strat- egy implies focus. The incentive plan supporting a business’s strategy must be likewise focused on the right behavior. Compensation philosophy statement. One way to ensure the alignment of an advisory firm’s pay practices with its business strategy is by articulating a compensation philosophy. As an example, Kochis Fitz, a large San Francisco–based advisory firm has a compensation philosophy statement describing the corporate and cultural values important to the company’s future success. This compensation philosophy statement ensures an alignment between the firm’s strategic direction and compensation strategy (see “Compensation Philosophy at Kochis Fitz”). Given this compensation philosophy, it’s relatively easy, even as an outsider, to imagine the kinds of compensation decisions this under- lying philosophy might drive and the kinds of compensation pro- grams that would contradict or undermine this philosophy. Often, 114 PRACTICE MADE PERFECT Compensation Philosophy at Kochis Fitz THE COMPENSATION PROGRAM at Kochis Fitz is guided by the following principles: 1. Team performance should be emphasized over individual performance. 2. Incentives should work to build and support a team approach and a team environment. 3. Compensation should be externally competitive and internally equitable. 4. The compensation strategy should be aligned with the business strategy and support the firm’s strategic initiatives. 5. The compensation system should be as simple to understand as possible. 6. The compensation program should not promote game playing or manipu- lation. 7. Compensation should be viewed as fair by the participants. 8. The compensation system should be affordable. 9. The compensation system should value group harmony more than the recognition of individual efforts. 10. The compensation system should recognize and value different individual skills. 11. The compensation system should treat all clients as clients of the firm, not clients of the individual. 12. The compensation system should value business development with exist- ing clients and community/industry involvement as much as new client acquisition. 13. The compensation system should promote camaraderie over internal competition. 14. The compensation system should support the redistribution of work as opposed to redistribution of pay. 15. The compensation system should recognize that we value a work/life balance. 16. The compensation system should emphasize client service. 17. The compensation system should value passive business development as much as active business development. 18. The compensation system should not warp people’s behavior, encourage self-interest, or create rancor in the organization. THE PAYOFF FOR THE FIRM: COMPENSATION PLANNING 115 one of the biggest challenges in developing a compensation program is gaining consensus on the underlying philosophy, but without it, no program design is likely to meet each of the principals’ expecta- tions. When there is a disconnect regarding the compensation plan, it is more often an issue of the underlying compensation philosophy than an issue of the numbers themselves. The power of the compensation philosophy statement as a decision- making tool is also significant. Every change in a compensation plan that an organization considers needs to pass through this filter. Beyond that, the statement can be an important measurement and eval uation tool. As changes to the compensation structure are envisioned, the management team may weigh the value and likely success of sug- gested changes against the stated philosophy. Presumably, compensa- tion components that conform to the stated philosophy should be considered. Changes that substantially deviate from the compensa- tion philosophy should either be rejected or cause the principles to be revisited. Reinforcing Behavior Among advisers who started out in corporate environments that rewarded top producers, a tendency to look the other way when top asset gatherers behave badly can linger. This bad behavior can mani- fest as abuse of staff, dishonesty with clients, disrespect of manage- ment, or any number of behaviors that put the firm at risk and strain relationships to the breaking point. When compensation—including incentive pay—is tied solely to revenue production, no natural con- straints on behavior are in place. Of course, compensation cannot substitute for active management, but it can be an important tool for keeping potential miscreants in check if you desire to keep them as part of your organization. Not only is it important that your compensation plan reinforce good behavior; it’s critical that it not reinforce bad behavior. Plan Affordability Many factors affect the appropriate level of base compensation and total compensation within a firm, including external benchmarks. However, one of the risks of relying on benchmarks exclusively, 116 PRACTICE MADE PERFECT without regard to the economic reality of your firm, is that you could spend yourself into oblivion. That’s why it helps to relate compensation to productivity standards as well as to the firm’s prof- itability needs. When it comes to advisory firms, the real answer to the question “How much are comparable positions paid?” is usually “As much as the business can afford.” Compensation is driven as much by the economics of the business as by the “market rate” for a particular job or for the individual in the job. When affordability is of particular concern—say, in a start-up business or in a flat or declining economy—more compensation should be shifted from fixed (base) to variable (incentive) compensation, thereby sharing the risk and reward more evenly between employer and employee. But regardless of the variable/fixed makeup of the compensation, you have to make a profit after fair compensation to all staff, includ- ing yourself as the owner. Staff Expectations We’ve found that when the reward structure is out of sync with what the staff is expecting, it’s usually for one of several reasons: ! The market dictates higher pay. ! The nature of the pay is not in line with the employee’s needs. ! The employee does not have a good understanding of the total pay package. ! The employer and employee are not in sync regarding the job and its expectations. More and more, we see disconnects between how the manager and the employee define the job and value the contribution, particu- larly when the employee is still in the process of building his or her skills. One midsize firm in the Midwest, for example, hired high-level employees with ten to fifteen years of experience in other branches of the industry (brokerage, insurance) at a $30,000 salary, with expectations of developing them into financial planners. Although the employer’s expectation was that the planners’ compensation and responsibilities would grow slowly over time, as they would for a brand-new planner right out of school, these experienced profes- sionals expected that they would be up to speed after the first year, THE PAYOFF FOR THE FIRM: COMPENSATION PLANNING 117 meeting with clients, and receiving much greater compensation, with the goal of making $100,000 within eighteen months. To avoid these detrimental disconnects, the career path, expectations, and resulting compensation need to be clearly outlined and communicated. The structure of the compensation—the how—can also be the source of a potential disconnect between employer and employee. One firm, for example, asked us to review its phantom-stock plan to make sure it related well to its strategy. In the course of our interviews with the staff, we found that most felt they were being paid at below- market rates and were more concerned about making mortgage and car payments than having a big payoff tied to their retirement or the sale of the business. As firms get more sophisticated, they’re often tempted to make their compensation plans more complex simply for the sake of sophistication. These plans are often devised without input from staff on their real needs or preferences regarding the nature and form of their compensation. Ask your staff what they need and what they want. This is always a good starting point and can be closely related to the considerations of affordability to the business, behavior reinforcement, and alignment with the business strategy. The Components of Compensation Compensation plans at advisory firms wander all over the map. Some are 100 percent variable; others are 100 percent fixed. But all com- pensation programs have five components, or five buckets (see Figure 7.1), among which each organization strikes a different balance: 1. Base pay 2. Bonuses and incentives 3. Benefits 4. Perquisites 5. Long-term wealth building Base Compensation Base pay is fair market compensation for the role the individual performs, based on job duties, regardless of whether the individual is an owner or employee. Later in this chapter, we’ll describe the process of establishing base pay. Base pay is typically fixed pay; com- . pro- grams that would contradict or undermine this philosophy. Often, 114 PRACTICE MADE PERFECT Compensation Philosophy at Kochis Fitz THE COMPENSATION PROGRAM. process. 111 THE PAYOFF FOR THE FIRM Compensation Planning 7. 112 PRACTICE MADE PERFECT ! They focus too much on the total dollars to be paid—the what