How Higher Operational Maturity Drives Lower Payroll Costs
Many Solution Providers struggle with finding the right balance between how much it costs to hire and retain a great group of talented, enthusiastic employees vs. how to control costs to ensure profitability and growth. The Best-in-Class have found the answer. As you read, you’ll see that SPs of any size, location or business model can implement these practices.
Let’s drill down to examine how the behaviors and characteristics of the Best-in-Class performers (i.e., the top 25% of Solution Providers in terms of EBITDA % in their business model) differ from the rest of the pack in two key areas:
Variable Compensation (percentage of total pay that is variable/at risk).
The Service Leadership Index® breaks out the compensation measurements of staff from that of management; understandably, there can be significant differences between the two populations that can be obscured if they are blended together. In both cases, we look at the functional areas of Sales, Service, and General and Administrative. Let’s look first at staff compensation.
Total Compensation – Staff
It may not come as much of a surprise that Best-in-Class performers pay less for staff than lower performing Solution Providers. In fact, overall they pay 12% less for staff than Median performers, and 26% less than the Bottom Quartile (bottom 25% of SPs in terms of EBITDA %) performers. Paying less for staff is one of the factors that enables them to achieve higher profitability.
But it would be a mistake to conclude that paying less for staff means Best-in-Class companies are cheap! In fact, they pay the same or more for the same skill set as lower performing SPs. The secret lies in the Best-in-Class companies’ ability to hire lesser skilled staff to achieve the needed results.
Narrow the range of solutions implemented via Professional Services and supported under Managed Services,
Which means a well-defined and enforced technology stack with clients,
To reduce the range of skills needed,
Which enables them to drive process maturity to allow the hiring of lower cost employees,
And facilitate cross-coverage of tasks to drive higher utilization.
What a huge advantage in being able to achieve high Gross Margin! Indeed, in the Managed Services Provider (MSP) business model for example, Managed Services Gross Margin averages 52.4% for those MSPs in the Top (Best-in-Class) of EBITDA % profitability, but more than 6% lower (46.1%) for those MSPs in the Median profitability group. Lower cost wages and better utilization of those wages resulting from greater tech stack standardization, are a big reason why.
Lest you Product-Centric companies think standardization is harder for you to do, note that the Services GM% of those in your business model who are in the Top (Best-in-Class) of EBITDA % profitability average 42.2% Services Gross Margin, while your Median peers average only 30.6%. Clearly, the Top (Best-in-Class) in your business model have figured out standardization, which results in lower high, better utilized, technical staff.
Total Compensation - Sales
As far as Sales staff, the Best-in-Class pay 30% less than Median and a whopping 44% less than the Bottom Quartile. What are the behaviors of the high OML that are practiced by the Best-in-Class performers?
The company has articulated a specific Targeted Customer Profile (TCP),
One that can be supported with a singular technology stack,
Enabling sales reps to become experts at communicating that singular value proposition,
Only to those prospects who fit the TCP,
Thus, increasing close rates of higher Gross Margin business,
And reducing Sales expense as a percentage of Gross Margin.
The high OML SPs pave the way for Sales efficiency by executing the steps above. As a result, they are not trying to sell a wide array of offerings to any prospect who has a dollar. This leads to a simpler, clearer value proposition, one that can be learned and delivered by a less expensive sales resource than lower OML SPs require, and with lower subject matter expertise (pre-sales) costs as well.
Total Compensation – General & Administrative
General and Administrative (G&A) labor represents the smallest population within the SP (the highest being Service), and even here the Best-in-Class pay less: 2% less than Median and 14% less than the Bottom Quartile. One of the key factors in lower pay for G&A for the Best-in-Class is the high degree to which processes have been streamlined, articulated and documented. This means tasks are simplified and can be easily taught to less skilled staff.
The tale of the tape is similar when it comes to management compensation: overall the Best-in-Class pay 10% less than the Median performer and 22% less than the Bottom Quartile performer. And for similar reasons by function as identified above for staff.
So far, we have reviewed total compensation (TAE) above. Now let’s examine the differences in how the Best-in-Class handle variable compensation compared to other SPs.
What we can say, is that the proportion of variable pay (as a percent of TAE) is too low here for all three of the groups (Best-in-Class, Median, Bottom Quartile). A common failing of many compensation plans is that the employee gets 100% of market pay regardless of performance. There may be some incentive pay, but the only impact is that they get a bonus if they or the company performs well, but don’t get “hurt” if they or the company does poorly. Also, any incentive pay given, takes the position above market pay, meaning the Solution Provider is then at a competitive disadvantage in its cost model.
In high OML SPs, base salary is what you get for showing up and working, and incentive is what you get for performance, then the two total to market pay or just 1% or 2% above market. For staff roles, the percentage of TAE that is variable compensation runs 50% for Sales; 10% to 20% for Service; and 10% to 15% for G&A. Blend those together and you arrive at a weighted average of 15% to 17%, higher than is shown in the 2016 report.
Which means that the Best-in-Class could have had even higher bottom line results if they had more TAE tied to performance than they did!
For management, the 2016 report showed traditional results for variable compensation as a percentage of TAE: for Best-in-Class it was 14%; for Median 11%; and for Bottom Quartile 12%. Once again, all three groups would have been better served to have had variable compensation be a higher percentage of TAE. High OML companies usually show a range of 22% to 27% of management TAE as variable pay. This approach properly aligns management with shareholder objectives and produces a greater probability of achieving targeted results for the company.
Implementing a Best-in-Class Compensation Strategy
The numbers tell an important story and identify the outcomes achieved by Best-in-Class performers. What they don’t identify is how to achieve those outcomes.
The Best-in-Class arrive at incentive plans which are win/win/win: when the company wins, the employee wins, and vice versa. And when the company and employee win, the outcomes are such that the customers win. That’s the goal for your incentive plan design work.
If you need help designing a compensation plan that can help move you along the path to Best-in-Class performance, contact us to learn more about the tools and services available.
Service Leadership offers advanced peer groups for Solution Providers of all sizes and business models, and individual management consulting engagements for Solution Providers from US$15mm to US$3bb in size worldwide. In addition, Service Leadership provides global IT vendors with advanced partner enablement assets, partner ROI models, management consulting and advanced peer groups, as well as executive and industry best practices education and speaking.
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