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PAY FOR PERFORMANCE AND THAT'S IT!

Today I'm asking you to totally erase your beliefs and habits in how you pay other people and how you get paid yourself. Our nation has grown from a capitalistic, entrepreneur, craftsman, shopkeeper founding to a socialistic, bureaucratic, pay by the hour, pay a fixed salary system. This transition began during the Industrial Age as workers left farms and local shops and services to enter the factories of the big cities and the railroads across the country. Henry Ford and Andrew Carnegie found it simpler and more profitable to pay the masses an hourly or daily wage.


Unfortunately, this compensation structure is diametrically opposed to human nature and mankind's genetic coding to pursue his own self interest. In today's Information Age, paying people by the hour, or by a fixed salary without significant incentives, is simply the product of lazy and uneducated management.


Years ago a famous Westinghouse study experimented with dimming the lights in their factory to see if worker production would decrease. Then they increased the lighting to see if worker productivity would in-turn increase. What they were surprised to discover was that worker production increased when the lights were both increased and decreased. What it proved was that the factory workers simply responded well to knowing that someone cared about their performance, someone was concerned about their work, and that someone was paying close attention.


This is why I say that paying salary or hourly wages is lazy. Creating a sophisticated compensation system which properly pays employees based on objective and subjective results requires thinking and effort and follow up by management. But, the result is exponentially more productive and profitable. Not paying your yard guy, your painter, or your attorney hourly fees, or upfront retainers which they request, will also create a likely uncomfortable conversation, but it will save you in numerous headaches and failures.


I believe I am an expert on this subject only because I have made more mistakes than anyone in paying my employees, partners, vendors, and contractors. In my companies, certain deals had long lead times until the agents were paid their fees and commissions, such as buying and selling companies or in commercial real estate transactions. So, I would get talked into paying draws which are technically advances so the employee could live on that income until the deal closed, at which time the company and the employee would settle up. But, what happens in real life is that the pay just becomes a salary which a C-Player expects monthly, and then not as much revenue is produced as expected. Then the C-Player leaves the company with a debt the owner never recovers, or the employee negotiates a new deal and promises it will work out better the next time, which of course it never does. I paid Bruce, an investment banker in our NYC office, $12,000 per month draw because every month our management team was fed a large stack of documentation showing the deals would be closing right around the corner. The CFO and the COO tried to slap some sense into me to fire Bruce, but I believed the large successes would finally arrive. Finally, once Bruce was over $200,000 in debt to the firm, he brought us a deal that went bankrupt and then even testified against the firm and myself in Federal Court! Is that the worst example you can even imagine?! It was totally the result of an over-generous, naive pay structure I had created.


Another time, a senior healthcare consultant pitched our firm to introduce him to the significant number of doctors and medical practices we had as current clients. He would help their practices be more successful, and we all would split the success fees.. He presented a financial model in which I would pay him a flat fee of $10,000 per month plus office space, support, and infrastructure, while our firm would reap a substantial profit on the bottom line. After many negotiations, I offered to pay the consultant no fixed salary, but instead a percentage of bottom line profit at a rate which would double his projected compensation to $20,000 per month if he performed on the model he presented. He wouldn't accept the deal, and we likely avoided another disaster.


I owned a restaurant in Newport News, Virginia, in a partnership with an experienced operator group, and this group took their management fee every month as a percentage of the top line revenue. Every month we would hit the top line projected number, but unfortunately, the Profit and Loss Statement (P&L) would show all kinds of problems or decisions which erased any profit for the ownership group - snowstorm, marketing campaign, the bartender was stealing! After six months I caught on and offered to pay my operating partners double the management fee as previously negotiated, but only as a percentage of the bottom-line profits their financial model had projected. They wouldn't take the deal, so I knew it was likely a sinking ship. I fortunately negotiated to be bought out at a very tiny profit, and a year later the restaurant closed its doors, with a fixed $14,000 monthly mortgage to be paid. Another narrow escape.


Hourly rates and fixed salaries by definition promote time, not results. Lawyers bill you what the market will bear and then fill in the hourly timekeeping system to add the names and tasks which make the numbers work out. Trust me, I have personally watched the process. The lawyers prefer the corporate clients because they know the market will bear even much higher fees as they are spending the company and shareholder's money, as opposed to the individual who might scream bloody murder if it was coming out of their own pocket.


Accountants look up how much they charged you last year, and then know that you will bear a 5-10% increase this year. They then back-end fill the hourly time sheets to justify the quoted rate they provided you. Trust me here also, as I merged in a 75-member accounting firm and was shocked at how inefficient and disruptive the billing process was for the partners. As much as possible, you must negotiate "a price for a result." You must think and act as an educated consumer and clearly lay out what you will pay for what result, and believe that their time is their own concern.. Many lawyers and accountants will balk at this structure, but then you must move on to find A-Players who will accept this performance-based compensation. If not, you will only have yourself to blame for incredible over-charging and continuous frustration. I have made this mistake more times than I can count.


If you pay the yard guy a monthly flat fee, his only avenue to increase profits is to reduce the mulch, skimp on the fertilizer, and spend a few less hours. If you sign a cost-plus contract with the homebuilder, his only incentive to increase profits is to increase the cost of the house. When the White House signs a cost-plus 15% contract with Boeing to build the next Air Force One, what incentive does Boeing have to build the plane cheaper, more efficiently, ahead of schedule, and under budget? They have zero incentive, as even President Trump was shocked with the price tag!


Everyone must be sitting on the same side of the table, and everyone must have skin in the game. In our investment company, even every receptionist had 1) a significant portion of their compensation based on the profitability of their individual branch, 2) another slice of compensation based on the bottom line profit of the entire firm, 3) their formula was a fixed ratio so they controlled their destiny - not a subjective allocation from me, and 4) the eligibility to make the exotic company rewards trip just like the top producers. This is why our receptionists leapt to their feet as a client entered the office, shook their hand, smiled, remembered their name, served them, and treated them as a personal guest. And if the branch's top producers didn't pick up their calls, or return their messages, you know who was the first one to give them hell! Some of my greatest memories are observing the receptionist and her husband enjoying a trip in Acapulco or the Islands, knowing that they would have never had that opportunity in "regular" companies.

Finally, don't let the kids get an hourly job at McDonalds. Although honorable work, it will teach them backwards economics. Encourage them to create lawn mowing businesses, build websites for a fee, give personal swimming lessons, and even higher their friends for a slice of the bottom line. Their future economic potential is limitless if we only help them understand their personal worth early on.


"Never mistake potential for performance." - Peter Drucker



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