Many professional athletes have incentive-laden contracts based on performance.
Last month, NFL quarterback Michael Vick signed a new $100 million contract with the Philadelphia Eagles, making him one of the highest paid athletes in football. When the contract amount was announced, it was not immediately apparent (unless you dug a little deeper) that only $40 million is actually guaranteed. This “base pay” is only 40% of the compensation package, leaving 60% at risk, based on performance. In even simpler terms: for every $1 of base pay Vick can earn an extra $1.50 based on results.
This ratio provides the proper risk versus reward for both parties. Vick will earn his whopping $100 million only if he stays healthy enough to lead the team for the next six years and only if he achieves certain on-field results. The variable amount in his contract must be “re-earned” each year. This demonstrates that organizations are willing to pay a high premium for great performance.
This athletic analogy describes the concept of variable compensation (a model where an employee receives a low base and dramatically higher performance bonuses), and how risk-sharing (in this case between athlete and team) can be applied to help encourage more hiring by employers at a time when job creation globally is arguably our biggest economic challenge.
The most common type of variable pay today is the commission model. Sales reps make a low base salary, but are primarily compensated for their results (not their time). However, in most corporations, “pay for performance” is not a common compensation model. In 2009, variable pay represented only 12% of overall compensation, and the number is expected to be 25% of white collar pay by 2030.
With U.S. unemployment stuck at 9% and job creation on everyone’s mind, why aren’t more companies looking at this model?
While compensating employees like professional athletes–albeit on a smaller scale–might sound like a crazy concept, it has the potential to help overcome the current fears held by companies and the unemployed alike.
Today, businesses won’t hire permanent workers while they believe there is a risk of another economic downturn. They are afraid that normal fixed salaries and benefits will quickly drag down profits and lead to more layoff pain if demand for their goods and services falters.
Fear is also causing many of the long-term unemployed to refuse jobs that actually pay more than unemployment, but less than what they were earning in their last job. Some employees fear that if they take a job as a security guard, it will be hard to convince someone they’re qualified to be a VP.
Companies will indeed have to share more of their future profits, but in exchange for lowering their short-term financial risk. Unemployed workers take a short-term cut in pay, but gain guaranteed income that is higher than unemployment, access to benefits, the opportunity to be productive, and the potential for substantially higher earnings.
Critics of the variable pay revolution will say this is just a sneaky way for companies to pay workers less. But remember the Michael Vick formula: $1.50 of pay-for-results for every $1.00 of fixed pay. Applying this to a $100,000 a year salaried worker, a variable program might pay the worker $60,000 base (plus benefits) with performance bonuses up to $90,000 per year–more than their actual salary! Employees taking part in variable pay programs should be willing to give up $1 of fixed pay in return for at least $2 of additional at-risk pay.
If you are a company leader or manager who controls your team’s compensation, you should consider shifting pay-for-time to mix of base salary and pay-for-performance. Make the variable based on not just individual results (which would encourage selfish behaviors), but also on team and company results.
Compensating employees like professional athletes can enable individuals to potentially earn more money while their employers reduce short-term risk and gain valuable intellectual and human capital. Done right, both employee and employer can feel good about their contribution toward stimulating job creation efforts. The end result just might be more players on the field.
Kevin Kruse is a serial entrepreneur and co-author of The New York Times bestseller, We: How to Increase Performance and Profits Through Full Engagement. Download a free chapter from We at KevinKruse.com.
[Image: Flickr user PetitPlat – Stephanie Kilgast (in dolly mood)]