How to align pay and ownership with the mission

1 The bottom line

Pay people in the thing that moves when customers and the company win, and match the form to the work: equity, profit share or high wages. When pay and mission pull apart, people serve the pay.

2 Key takeaways

• Give people a share of the outcome they influence. People you cannot watch act like owners only when they own something.
  • Walmart6:20 paid store managers around 25% of store profit in the early days.
  • Home Depot1:44:30 let hourly staff buy stock at a 15% discount with a guarantee against loss.
• Match the form of reward to the kind of work. The wrong measure steers effort to the wrong place.
  • Bob Noyce, Intel40:33 found options beat profit sharing in a research business.
  • Henry Singleton, Teledyne38:38 paid unit managers on the average of cash return and profit.
• Where turnover is costly, pay well above the market. Higher wages buy loyalty, lower training spend and less theft.
  • Costco32:26 has 7% attrition after year one versus about 20% for typical retail.
  • Trader Joe's22:00 turnover is about 5 to 6% a year versus 65 to 70% in grocery.
• Pay every partner in the chain to win when the customer wins. Sellers push what pays them, so make the right product pay.
  • Coca-Cola4:23:53 let fountains earn about $6.40 on a gallon that cost $1.30.
• Put the leader in the same position as the employees. A CEO paid regardless of results breaks the promise made to everyone else.
  • Frank Blake, Home Depot3:24:00 took 90% of his pay in stock options.

everyone who has anything to do with Coca-Cola should make money.

Robert Woodruff, The Coca-Cola Company

2.1 Share ownership with the people who run the business

People you cannot supervise will act like owners only if they own part of the result.

• Give managers a cut of their own store's profit, as Sam Walton, Walmart6:20 did.
  • At J.C. Penney, Walton saw a manager on a 25% bonus contract wave a $65,000 check in 1940. The trainees ran faster.
  • Walton paid his own managers around 25% of store profit. That kept them committed in stores he could not be in at the same time.
  • From 1952, with Willard Walker in Fayetteville, Walmart1:01:05 made each new store its own partnership with the manager holding a stake. Existing managers could invest in each new store, so everyone gained from the whole network and shared information freely.
• Extend equity to hourly staff, and teach them the link to customers.
  • Home Depot1:44:30 gave salaried staff options and let hourly staff buy stock at a 15% discount with a guarantee against loss. Onboarding taught how serving customers drives store sales and the stock price.
  • Howard Schultz, Starbucks1:05:10 gave options to every employee, including part-timers, against two venture board members who objected. The grant was 14% of base pay, made in 1991, a year before the IPO.
  • Home Depot stock compounded at nearly 25% a year for 45 years, and thousands of early associates became multi-millionaires Home Depot1:44:30.
  • Starbucks' $6 strike price grew roughly 800x including splits. Employee tenure ran about 2x the industry and turnover about half Starbucks1:05:10.
  • After its IPO, Walmart added profit sharing and a stock purchase plan with a 15% discount. Some hourly associates made millions, and Home Depot modeled its plan on it Walmart1:01:05.
• Offer real stakes to the partners and people you need most.
  • Bill Gates, Microsoft1:36:40 offered Steve Ballmer 8.5% on a handshake in 1980. When Paul Allen objected to the size, Gates took the extra 3.5% out of his own share.
  • Joe Coulombe, Trader Joe's20:15 was $11,000 short on his Pronto buyout. He sold employees shares at book value, below what he had paid, to close the gap.
  • Because the employees' entry price beat Joe's, they earned almost twice his multiple Trader Joe's20:15.
  • John D. Rockefeller, Standard Oil1:14:44 decided no one would take a salary, so everyone focused on dividends and the growth of the whole enterprise. Standard later paid dividends of 50% to 200% of invested capital a year.

2.2 Match the form of reward to the work

Options, profit share, cash-flow measures and membership rights each steer behavior differently, so pick the one that points where you want people to look.

• Use stock options where the work is long-term research.
  • Bob Noyce40:33 learned at Fairchild that people sharing profits focus on products that already make money, not on risky advanced research.
  • From the start at Intel he gave options to the engineers and most of the office workers.
  • Jensen Huang, Nvidia43:00 gives special one-off grants vesting over four years to top contributors. He can award stock directly without waiting for an annual review, so great work is rewarded in the moment.
• Pay unit heads on a measure that cannot be inflated.
  • Henry Singleton, Teledyne38:38 used net income plus cash flow divided by two to evaluate and pay every general manager.
  • A division with $1 million of profit but only $500,000 of cash scored $750,000. That stopped managers from inflating earnings with inventory or generous credit.
  • In 1979 Teledyne had about 130 profit centers and only one lost money Teledyne38:38.
• When members are also customers, tie ownership to how much they use the network.
  • Dee Hock, Visa1:18:20 made ownership an irrevocable, non-transferable right of participation, proportional to volume. A bank could not sell out and lose its reason to participate.
  • A bank contributing 17% of transactions was entitled to 17% of the profits. Visa was always for-profit, not a nonprofit later converted Visa1:18:20.

2.3 Pay wages that make people stay

Where people are the product, high pay is cheaper than turnover, theft and constant training.

• Pay the same for the same work in every location.
  • When Fedmart opened in San Antonio, local employers paid about 50 cents an hour. Sol Price29:00 set a dollar, because paying less for the same work seemed unethical.
  • It also kept pay simple, with no formula to debate at each new store.
  • Everyone wanted to work at Fedmart, the same pull Costco later showed when 22,000 people applied for 200 jobs Sol Price29:00.
• Count the savings from turnover and theft against the wage bill.
  • Costco32:26 chose higher wages and good benefits, including health care and a 401k match. The higher labor cost buys low turnover, lower training spend, staff who do not steal and promotion from within.
  • Joe Coulombe22:00 set pay 40 to 150% over what retail roles normally earned. Employees rotate through all jobs, so they know the products and become part of the product.
  • Costco's average hourly wage is 26 dollars versus 19.50 at Walmart. Attrition after year one is 7% versus about 20%, and shrinkage is 0.15% of sales Costco32:26.
  • Every Trader Joe's captain is promoted from within Trader Joe's22:00.
• Treat wages as families, and still demand output.
  • Henry Ford1:01:50 wanted low prices and high wages. He said wages are "bread boxes and coal bins," so people should tread carefully with them on the cost sheet.
  • In the same breath he was ruthless about waste. Everything and everybody must produce or get out Ford Motor Company1:01:50.

2.4 Pay everyone in the chain to win with the customer

Sellers, partners and salespeople push whatever pays them, so make the customer's win the paying one.

• Let every partner make money on your product.
  • Robert Woodruff's4:23:53 system paid bottlers, soda fountains, gas stations, billboard owners and early coupon-passing salesmen.
  • Fountains earned about $6.40 on a gallon that cost $1.30. Gas stations made more on Coke than on gas.
  • Billboard owners put up free Coke ads during the Depression rather than leave boards blank Coca-Cola4:23:53.
• Design offers that are worth it for nearly every customer.
  • Costco1:55:36 charges 60 dollars extra for executive membership, which returns 2% capped at 1,000 dollars. Break even is 3,000 dollars of spend, about the average household, and unused fees are refunded.
  • Costco gets the money up front, and executive members spend and renew more, instead of the company profiting from breakage.
  • Executive members are 45% of paid members but 73% of sales, and 93% of US members renew each year Costco1:55:36.
• Audit commissions for rewards that hurt the company.
  • Larry Ellison, Oracle10:44 found reps discounting to make customers buy early, such as a $2 million purchase planned for next year offered at $1 million. Customers learned the best time to negotiate was the last day of the quarter.
  • Another scheme paid more commission on partner deals even though Oracle got less revenue.
  • One partner deal paid $120,000 in commission when Oracle got $600,000. Breaking the discounting habit took years and many management changes Oracle10:44.

2.5 Hold leaders to the same deal

If employees are told that good work lifts the stock, the CEO's pay must rise and fall with it too.

• Never exempt the CEO from the equity promise.
  • At Home Depot, associates had been told good work lifts the stock and makes them rich. Nardelli2:19:10 argued the stock price was outside his control, and the founders called it "pay for pulse."
  • He collected roughly $200 million over six years, plus a $150 million equity package to join. Same-store sales stayed flat, and $20 billion of buybacks and dividends did not move the price Home Depot2:19:10.
• Repair a broken pay deal by taking on the risk yourself.
  • Frank Blake3:24:00 asked the board to cut CEO pay sharply and make 90% of it stock options.
  • That put the CEO back where the associates stood, rewarded only when the company created value. It helped end the pay controversy.

2.6 Where they differ

The right reward depends on the work, and each form has a weakness.

• Profit sharing versus options.
  • Walton6:20 paid managers a share of store profit, which suits running stores. Noyce40:33 found profit sharing pulls people away from research, so Intel used options.
• Cash wages versus stock.
  • Costco32:26 and Trader Joe's22:00 buy loyalty with high wages. Home Depot1:44:30 and Starbucks1:05:10 buy it with stock, which pays off only while the stock rises.
  • Under Nardelli, Home Depot's price did not move despite $20 billion in buybacks and dividends Home Depot2:19:10.
• Tradable stock versus non-transferable rights.
  • Dee Hock1:18:20 made Visa ownership untradable so a bank could not sell out and stop participating. Most companies here use ordinary stock or options, which employees can eventually sell.