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How to Pay professional Employees

post # 227 — October 31, 2006 — a Managing post

An accounting student writes in to ask:

I interned with an accounting firm that paid everyone (except for partners) by the hour. Under this system employees made a lot of money during tax season. People seemed to work much longer hours than at another firm I had worked in which paid straight salaries. It really did not seem they had so much more to do, but time-and-half wages were a huge opportunity cost of going home. “Time-in-seat” seemed to be a motivation which could only lead to a lack of efficiency.

I don’t blame the firm on this one—a lack of efficiency seems to be a fundamental problem with billable hour work in general because more hours translate to more pay. I can’t blame the employees either—why not use this incentive structure to their advantage? The partners encouraged people to work as much as they wanted.

At school, we studied a manufacturing company (Lincoln Electric) which pays its workers a piece rate. Lincoln requires a quality standard for each piece (no pay if the standard isn’t met and the employee has to fix things up on his/her own time). Teamwork is factored into a score that determines bonuses at the end of the year (and importantly, employees are held to the teamwork and other requirements). With year-end bonuses having the potential of 100% of the whole year’s wages, the employees take these rules seriously.

Obviously, you can’t really pay piece rate for a tax return (and I’m not even sure you would want to). Paying by the hour must inevitably put dollars ahead of excellence (at least slightly. Paying a salary currently seems like a best bet.

How should employees be compensated?

The Lincoln Electric case study is very famous in business schools, but I’m not aware of any professional firm that uses piece-rate wages for its employees. Does anyone else out there know of an example?

As a lot of people have discussed, paying people by the hour builds in lots of discincentives and poor behavior. Nevertheless, many firms do this, even if it is only in the aggregate form of paying bonuses annually for those juniors with the most billable hours.

I think this is a terrible system because junior employees don’t really get to control their own workload. It’s a partner who decides whether or not give a piece of work to junior person A or B. So getting more billable hours may just be a matter of being chosen more often. (Although you could argue that such a system serves as a quality screen — only the good juniors will be sought out by the partners who allocate work, so they will end up busier.)

There have been some firms that create a “free market” for work allocation — to get assigned to a job, juniors can offer to work for a discount off their salary, and partners can pay a premium over normal salary rated. That way, partners only sought out either the :best” for their jobs” or the cheapest internal resources for the basic work. I know firms (elite firms) where this lasted a long time.

In spite of its creativity, I’m against such models. All quantitative incentive schemes backfire (we’re dealing with smart people here!) Ultimately, I think you have to do what Alfie Kohn said “Pay people well (a salary) and work like mad to get them to forget about the money.” If you want them to work to higher quality, more collaboratively, with higher productivity, then you must MANAGE them to accomplish this. You can’t just design a scorecard and then say “go!”

One thing in the Linoln Electric system is worth contemplating. A significant annual bonus for everyone based on company results and teamwork makes a LOT of sense to me.

Anyone else got different views?


Carl A. Singer said:

I’m 30 years past B-school, but as I recall Lincoln Electric’s claim to fame (or infamy) was a bonus earned w/ a 6-month payout stagger — so should you quit you’d loose your bonus (actual or credits towards.) The key — and this may go back to “Spunky” Meredith who taught a labor management course at my undergrad — Case Tech, was that this was the union busting tactic: higher pay & bonus — as long as no union.

Going back to “piece-work” as it was called. (I recall my father, a tailor, went to work in a metal fabrication factory during the Korean war, as that’s where the money was.) Piece-work requires a uniform measureable output and easily communicated / measureable standards of (output) acceptability. The faster you worked (i.e., the more output you produced) the more money you received. And, since, corporate profit was correlated to output, the more profit for the corporation.

There may be limited “white-collar” situations that might lend themselves to such measures — but it’s usually a stretch.

The subjective allocating of work is really an interesting topic (not to be confused with resource leveling, etc.) I recall the cultural difference when IBM’s Global Services consulting and PWC’s consulting wed. Overstating — and there’s plenty of gray area — utilization is key for the individual’s (personal) success — in the IBM model, to a great extent it was self-managed. The individual contributor needed to manage their own utilization by doing great work and demonstrating same so project leaders would pick them — but they also (sometimes) had to avoid short-term assignments that might land them on the beach / Bench should they miss the beginning of a major new opportunity, etc. The PWC model was that utilization was more of a partner’s responsibility — he or she was responsible for the members of their team (family.)

I may have overstated — but the perhaps I’ve identified the two extremes — bottom up (the individual tries to manage their assignments) and top down (the manager does ….)

I recall a specific example when I was an facilitating account planning session for a major client — We needed a key expert to parachute in for 3 days — getting him was extremely difficult because (despite pulling rank) team leadership couldn’t assuage his fears re: being on the bench after a short assignment. Clearly a conflict between what’s best for the client / project and what’s perceived as best for the consultant.


posted on October 31, 2006

Brooks Gould said:

So far, this discussion has only barely touched on the most important factor in compensating employees: client satisfaction. The focus on piece-work or hours turns us inward instead of where our focus should be – externally on the client. The client does not benefit if we figure out a way to charge more hours to his matter.

I would suggest a three-tier compensation system: a) modest salary as base pay, b) an individual bonus based on feedback from clients for whom the person worked, and c) a second bonus based on the overall profitability of the firm or group. A simple client satisfaction questionaire could be developed for use after each engagement, supplemented with periodic personal contact by the person responsible for the client relationship to validate the questionaire results and dig deeper.

The two bonuses would be significant amounts relative to base pay and would be paid monthly/quarterly so that there is continuous feedback to the individual on his/her performance.

There could be a business development component as well.

posted on October 31, 2006

David (Maister) said:

Sounds smart, Brooks. Are you able to publicly identify any firms that do it this way?

posted on October 31, 2006

Mike said:

There are a couple of problems with Brooks’ client satisfaction questionnaire pay scheme. One is that different geographies have different “set points”. Several years ago I worked for a firm that tied part of their service tech’s bonuses to customer satisfaction. The guys in the Midwest loved it because their customers never gave them anything less than great reviews, but the guys in New York hated it because their customers hammered them as a matter of customer/vendor relationship principle. Working with both groups, I knew that the New Yorkers were as good if not better.

The second problem is the card dealer quality problem. It seems like every car purchase now comes with a lecture about how the salesman’s family will be left penniless outcasts if the dealership gets anything less than superlative marks from you on the manufacturer survey! Employees will game the system to their maximum advantage.

I guess I’m with Alfie Kohn on the compensation question.

posted on October 31, 2006

Arnoud Martens said:

One interesting scheme I heard off is coming from the IT application hosting services industry. When certain service levels are not met customers can get a refund on their fees, but the customer has to ask for it. With this company refunds requested by clients were taking directly taken out of the bonusses for the staff working for this client. And the client is aware of this. This creates a trade-off for staff and client as to thier levels of commitment.

posted on November 1, 2006

Shaula Evans said:

David, Carolyn Elefant has a piece up at My Shingle that might interest you about an Oregon law firm that has bolstered its revenues by converting to flat fees.

posted on November 2, 2006

Michelle Golden said:

Great question (by the student writing in) and it illustrates—EXACTLY—the problem with with hourly wages for knowledge workers AND with using hours to charge customers for the work done.

HA! Two birds with one stone.

If a firm, as an employer, doesn’t even TRUST its very own (personally chosen!!) people to be “efficient” with their time when paid by the HOUR! and looks at time instead of EFFECTIVENESS (what is accomplished and how well) then why on God’s green earth would the firm’s clients want to pay for ANYONE in the firm based on hours spent working on their account???

Guys, if you don’t like it for yourselves (firm partners) then why, oh why, do you force this ridiculous pricing approach on your buyers??

posted on November 2, 2006

Michelle Golden said:

Darnit, posted too soon. One other thing.

Student said: “Obviously, you can’t really pay piece rate for a tax return (and I’m not even sure you would want to).”

And why not?? Couldn’t a firm fairly effectively separate returns into, say 3 or 4 different categories of complexity and have a fairly accurate idea of the value of the completion of that return both to they firm (by the employee) and also to the customer?

Don’t firm managers presently “judge” the complexity of a return by looking at income, investments and forms needed and then rather summarily decide (in retrospect) if the “time spent” seems reasonable relative to the above?

You guys significantly underestimate your present knowledge/awareness of “what it takes” to get your most common sorts of work done. In other words, you know far better than you think what inputs will be needed to achieve the output. But remember not to apply the faulty logic that something that needs a LOT of input will be “worth” what it takes to get it done.

I could certainly hire someone to scrub every square inch of my home’s floor with a toothbrush—and that would take days—but paying someone by the hour to do it would not be worth it to me. Just cause something CAN be done doesn’t mean it should be. That’s why pricing should not be based on time spent, it should be based on the buyer’s perceived value.

Again, whether the buyer is the firm “buying” the employees time—i.e. allocating precious resources to a given project over another possible project) or the customer buying the output of that employees work on their account, it doesn’t matter.

We ALL WANT VALUE for what we spend.

posted on November 2, 2006

David Kirk said:

One of the most interesting bosses I ever worked for had a comment about money. It usually came out when discussing pay for new hires, or increases for junior staff.

Sometimes I would get slightly carried away with the idea that there was a large supply of new graduates with the necessary skills, and not massive demand, which equated in my head to the idea that we shouldn’t pay large salaries since it would be difficult to justify that (apart from the occasional exception, of course) one brand new hire with zero experience would be worth that much more than the next guy. (Whether I was right about that is a different debate).

My bosses comment was that paying people gives them a sense of worth. Even for people who don’t grab after money, being paid decently is still a “hygiene factor”. His point was that paying people what we needed to wouldn’t give them the right impression about how we perceived them and their value to the team.

So, after this long-winded introduction, my point is:

If one chooses to pay someone (particularly a professional or “knowledge worker”) by exactly what they produce in a specific period, one is being very clear that there value to the organisation is what they produced in that period. Period.

While this takes a step back from my usual quantitative, hard-edged view of the world, I’d prefer to work with people and in an environment where my worth wasn’t stripped down to the bare production value of my body and mind.

Anybody want to explain what I’ve said in better terms, or better yet, disagree?

posted on November 3, 2006

Michelle Golden said:

David Kirk offers an excellent perspective. Though I hope people don’t equate their “worth” as a person, or even as a contributor through their job to society, to their earnings (i.e. why do our childrens’ teachers make so much less than professional athletes!), I think Mr Kirk is exactly right about paying people for production being counter to the notion of value from a knowledge worker.

In fact, production mentality SHOULD remain in the factory where it began and thrived. Problem is, though, PSF workers who use their minds, not hands, ARE usually measured, paid, and promoted (rewarded) for their production (chargeable hours). In fact they are “in trouble” when their production drops which is exactly what happens when they market, innovate, learn, or train others. This is seriously handicapping firms when it comes to developing new prospective leaders (gee, I wonder why they don’t have good marketing and managing skills and they don’t delegate…) if they can even keep people long enough to become future leaders. Often the smartest ones defect from this screwy environment.

It’s not just a problem that pay is too closely equated to outputs, and that hours are not appropriate indicators of output and value (clearly evident). But it’s a bigger problem that pay by piece OR hour discourages development of the skills and behaviors that are necessary for the posterity of the profession. PSF workers are not production line workers, they need “time” to think (on behalf of clients, the firm, and themselves), create and grow.

When will firms “get” this??

posted on November 5, 2006

David (Maister) said:

Michelle, I love your analysis, and I am also eagerly looking forward to the day when firms “get it.” But you know what? I think a lot of individuals don’t get it either. There are a lot of “solo” practitioners who do not invest in their own asset, and judge their success each month by how much they produced.

I also think your phraseology may be unfair to production settings. The mentality of balancing today’s production and tomorrow’s improvement is needed in factories too (maintenance, R&D, efficiency,etc.)

There’s a whole philosophy here that a lot of people don’t get. And I agree with your conclusion. Salary plus profit share plus management is the way to go, not pay on production.

posted on November 5, 2006

David said:

You write in the original post “It’s a partner who decides whether or not give a piece of work to junior person A or B. So getting more billable hours may just be a matter of being chosen more often. (Although you could argue that such a system serves as a quality screen — only the good juniors will be sought out by the partners who allocate work, so they will end up busier.)”

One major problem with this as a quality screen is that the partners who allocate work do not always chose the “good juniors.” Often personal preferences and biases come into play. For example, I think one could show a historical pattern of male partners being less likely to assign work to female juniors. As a result, if a firm uses this method as a quality screen, it is likely that it will cement into place its pre-existing biases.

posted on November 6, 2006

David (Maister) said:

David, you’re absolutely right! Tou’ve given us another reason why it’s stupid (even though amazingly prevalent) to pay bonuses to junior people based on their utilization, chargeability or billable hours.

It’s all a flawed attempt to put in place a metric so we don’t actually have to manage and know what’s going on in our own shop!)

posted on November 6, 2006