Archive for February, 2010

"The absence of business logic is simply astounding."

Posted February 9, 2010 By Fletcher Groves

The intrepid, results-based consultant shook her head, partly in amusement, partly in disbelief. “Just when you think they get it, they don’t”, she thought to herself. It was another reminder that, early on, RB Builders was still capable of coming to bewildering conclusions, the latest of which centered around the company’s team-based performance compensation plan, known as the GIPP, acronym for the Gross Income Participation Pool.

McKinsey and Company

The GIPP was an early prerequisite for the intrepid, results-based consultant even agreeing to become involved with RB Builders, that stipulation, along with a mandatory transition to variable costing, and the subordination of all improvement initiatives to a more focused, constraint-management approach.

The GIPP was new. It was supposed to replace the company’s previous practice of paying individual bonuses based on multiple measures, and consisted of a team-based approach focused on performance related to a single business outcome, specifically, increases generated in Gross Income above a specific baseline.

Under the GIPP, the baseline performance was referred to as the Gross Income Baseline (GI Baseline), while the budgeted performance was dubbed the Gross Income Target (or GI Target). The difference between the GI Baseline and the GI Target was referred to as the Gross Income Reserve (GI Reserve). The GI Reserve was scheduled to be paid out progressively, based on the achievement of a number of predetermined “bonus buckets”, called Gross Income Milestones. The aggregate teammate share of the GI Reserve represented one-third of the GI Reserve, while the remaining two-thirds was split evenly between owners and retained earnings.

But, now, the GIPP was getting push-back, ostensibly from one of the Regional Vice Presidents. In fact, he wanted to cancel it. It was too late in the planning schedule to start changing the GIPP, let alone cancel and replace it.

The intrepid, results-based consultant was having none of it.

“We have credit facilities that we have to restructure, repay, and replace. We need the cash”, explained the Regional VP.

“Where did you get this idea?”, she asked.

“It is the best approach to a situation that is growing more difficult by the day”, he replied. “We cannot justify bonuses in this economy, in this housing market. We have nothing against bonuses in good times, but they are just not warranted now.”

“So, you just want to cancel the GIPP? YOU CANNOT BE SERIOUS!”

“Nice McEnroe impersonation”, said the CEO.

“Glad you liked it.” The intrepid, results-based consultant turned her attention back to the Regional VP.

“You are concerned that your division will be unable to meet its debt service obligations, if it rewards performance above its baseline?”, she asked, rhetorically. “Really? Where is the money going to come from?

“The GIPP will not pay out anything unless there is a reserve created by performance that exceeds the baseline. You do realize that the GIPP is designed to be completely self-funding, that it does not cost the division or RB Builders’ owners one red cent?

“You do understand that, right?

“With limitations on investment and work-in-process, and with management controls on non-variable expenses”, she continued, “is there any likely scenario under which additional Gross Income will result in less cash flow? Is there any likely scenario under which every cent of that additional Gross Income will not drop straight to the division bottom-line? Where it can be utilized for – oh, I don’t know, say – debt service, or distributed to teammates and owners before it became retained earnings?

“I can understand being careful with important decisions in uncertain times.

“I can understand increased diligence in determining a baseline that reflects current reality. I can understand having a more progressive structure to the payouts, so that each successive milestone is worth more. I can understand adjusting the distribution of the reserve between teammates, owners, and retained earnings, to 25-25-50, or 30-30-40, instead of equal shares, in order to provide more money to meet extraordinary debt service requirements.

“But, to deny yourselves – you, your teammates, your owners – the opportunity to do better? That, I do not understand.

“The absence of business logic is simply astounding.”