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Honeywell How Pay Launched Performance

September 1, 1996
Related Topics: Compensation Design and Communication, Variable Pay, Featured Article
The production floor at Honeywell's Commercial Aviation Systems division in Phoenix is the kind of place you'd expect to hear employees chatting about their families, last weekend's golf game or the latest Batman flick.

Nowadays, however, these assembly-line workers can be heard discussing such weighty matters as operating profit, economic value added and working capital. They chat easily about business goals and financial performance. In fact, all employees at the division have business objectives top of mind like never before.

The change in focus is due to the creation of an incentive compensation plan that links incentive pay with business results. Now, for the first time in the division's history, a percentage of each employee's yearly pay is based on the achievement of annual company objectives. If results fall short of expectations, so do employees' paychecks.

Normally when companies implement this kind of risk-sharing plan employees are skeptical. Money is an emotional topic, after all. But Honeywell's incentive program met with little resistance because it was the employees themselves, through a group of volunteers called the Participative Pay Team, who decided how the plan would work. In 1994, the first year of the incentive program's existence, the division beat its profit expectations by more than 10%. The program continued focusing employees on business goals in 1995—so successfully, they hit what Honeywell calls "the maximum performance range."

Employee involvement is crucial.
Honeywell's Commercial Aviation Systems division employs 5,500 people in the design and manufacture of state-of-the-art avionics systems.

In an effort to boost division performance, Honeywell also has spent a great deal of time defining and measuring the behaviors and outcomes expected from individual employees. In the process of making these changes, Honeywell's leadership realized the compensation plan was also in need of an overhaul. The old way of rewarding people was simply no longer working.

"There was a mismatch of messages," explains Eileen N. Ward, senior human resources consultant. On one hand, division heads were telling employees to focus on cost reduction and measurable productivity improvements—to perform, perform, perform, in other words. Yet the company still was granting pay raises based not on performance, but on an employee's progression in a job range. The longer employees stayed with the company, the more they were paid, regardless of whether they achieved company objectives. For the new performance-based strategy to work, the incentive compensation system would have to get in line.

Upon deciding to remodel compensation, Honeywell's HR professionals could have sat down and devised a new incentive strategy on their own. But that too would have been out of sync with the division's new participative management style. The only acceptable way to fix the incentive plan was to let employees do it.

In 1993, the Participative Pay Team was formed, and employees eagerly responded to HR's call for volunteers. Twenty-five employees, both exempt and nonexempt, were chosen to serve on the team. There were secretaries and machine shop workers, as well as engineers and department managers.

What motivated so many employees to volunteer for the effort? Team member Greg Wilkins, a nonexempt employee who has worked in a variety of jobs for Honeywell over the last 11 years, put it this way: "It got my interest because they were going to be doing something to my pay."

The first order of business was for HR to educate members of the pay team about the ins and outs of compensation and why incentive pay needed to be aligned with company goals. All team members attended a 2 1/2-day training session that covered the basics of compensation, including an overview of compensation trends at Honeywell, in the electronics industry and at other companies.

Armed with this basic knowledge, the team members then were assigned to additional research on their own. Some team members attended conferences hosted by the American Compensation Association. Others conducted literature searches for current articles on compensation trends or reported on books about new pay systems. Many team members also were involved in telephone- and site-based benchmarking efforts with companies both inside and outside their industry. Furthermore, to get even more worker input, team members also conducted regular employee focus groups.

Team members spent about six months getting up to speed on compensation issues, devoting approximately 20 hours a month to the effort. Because the time spent took away from workers' regular job duties, the company leadership saw to it that their individual managers understood the importance of the participative pay program and supported the employee's involvement.

The new participative pay program is "risky."
Upon its formation, the team was charged with determining who would participate in the incentive program, how the plan would work, how it would be funded and how incentive pay would link with overall business goals and the executive compensation plan. The HR department provided no guidelines as to how the plan should work. Instead, it was up to team members to make recommendations to the company's executive leadership.

The team's only ongoing link with the HR department was Ward, who served as team leader. Although John Hillins, vice president of benefits, compensation and employee information systems at the company's corporate headquarters in Minneapolis, provided some of the initial training, the corporate HR department also took a hands-off approach. "They called us when they needed us," he says.

The end result of the team effort was a self-funded gainsharing program introduced in 1994. It has two prongs: First, the program places a percentage of each employee's pay at risk pending the achievement of business goals linked to Honeywell's profitability. Second, employees also have the opportunity to earn more than their annual salary when the company has an exceptionally good year. Both payouts are made annually based on overall performance of the division.

Here's how the plan works: As a self-funded plan, a portion of the available merit budget used for pay raises is set aside each year to fund the risk-sharing amount. While most of the money is still used for merit raises, a percentage is put "at risk" based on business performance. If the amount available for merit spending is 3.5% of the salary budget, for example, 1% is set aside for the risk pool. If the division meets at least 80% of its annual financial objectives, then employees will receive 1% of their base pay in a lump-sum payout. If the division fails to meet objectives, nobody receives a payout, and the money remains in the risk pool. The amount set aside for risk-sharing will peak at 3.5% of an employee's salary at risk.

Under the new incentive plan, employees also can receive an additional sum called a success-sharing amount. This is awarded to all employees when the division exceeds its business goals. In 1998, when the program is completely phased in, employees will have the potential to receive 5% more than their base pay by exceeding business goals by 20% or more. The 5% success share, combined with the 3.5% risk-sharing amount, means that in a good year, employees can receive up to 8.5% more than their base salary.

"With the new participative management style, the only acceptable way to fix incentive compensation was to let employees do it."

The program is linked to the executive compensation program so that employees and executives are working toward comparable targets, with each receiving rewards based on achieving them. According to Ward, the incentive program was designed this way in order to:

  • Emphasize the direct stake all employees have in the continued success of the business
  • Emphasize the importance of executives and employees working toward similar business goals
  • Recognize and reward employees' impact on major improvement opportunities
  • Improve employee understanding of the division's financial performance
  • Support the culture of teamwork, employee involvement and participation.

Team members are key in communication.
Because the concept of participative pay was new to Honeywell, when the company launched the program, a lot of employee communication had to take place—not only about the incentive plan, but about overall organizational goals and how employees could have an impact on them. Here again, the Participative Pay Team took a lead role.

Members conducted two-hour orientation courses for employees to provide an overview of the participative pay program and the measurements needed to receive a payout.

The communication effort was supported by the HR department, which produced two publications about the new plan. According to Ward, one was a comic book that showed two employees having a dialogue about the new pay system, and the other was a typical HR document explaining the incentive pay structure. These were distributed in the orien tation course.

Because the incentive program uses high-level financial measurements, Honeywell also has had to educate its workforce on business fundamentals. It developed a course called Business Basics to provide general information on business goals and objectives, as well as specific information on how to calculate the three measures used to determine company performance: profit, working capital and economic value added (post-tax operating profit reduced by cost of capital multiplied by the division's investment). Conducted by Participative Pay Team members, the course also helps participants understand how their individual jobs impact company performance.

The biggest challenge in explaining the program to employees was communicating the concept of risk sharing. "Employees didn't like the risk-share piece," she explains. "We defended it by saying that they couldn't very well share in the success of the company if they didn't also share some of the risks. It underscores the partnership message." The other challenge was breaking the entitlement mentality of employees who were accustomed to receiving a standard raise every year.

The fact that the program was designed by employees for employees went a long way toward overcoming both challenges and creating the buy-in necessary to make the program a success. As team member Wilkins explains: "We had to have some reasonable justification for every decision we made because we had to face the people we work with every day."

Two years into the program, it appears the incentive pay plan is doing what it's supposed to - focusing employees on bottom-line business objectives. Although it's difficult to isolate the pay program from some of the company's other quality initiatives, Donald Schwanz, vice president and general manager of the Air Transport Systems unit, says he believes employees have much more knowledge about the business from a financial standpoint. "The pay program has focused employees on business goals," he says. "They see a distinct tie between what they do and the health of the business in general, and they're making better decisions as a result."

In 1994, the first full year the program was in place, goals for profit and economic value added were exceeded by 10%. In 1995, the workforce reached all its goals—employees received the full 3.5% of their salaries from the risk pool. That's $1,225 for an employee earning $35,000 a year.

To what does Honeywell attribute its success? Several things, Ward says, including extensive employee education and leadership support. But most critical was the employee involvement. "The team members not only gave the program good visibility in the workplace, they provided a richness of input that HR couldn't have obtained on its own."

Now that the plan has been in place for two years, the focus of the Participative Pay Team has shifted. Today, the team's primary role is to work with the finance department to monitor the books. They also attend monthly progress reports, conducted by the executive leadership for the entire workforce, to ensure what the leaders tell employees is in line with the financial statements. "The crux of their role is to provide a 'trust' message to the workforce," Ward explains. "In other words, to look at the books and validate what's being reported by management."

The team also continues to search for ways to get a better line of sight between individual jobs and overall company performance—because in the end, the participative pay plan is not really about money. As Vice President Hillins explains: "This isn't really a compensation program. It's a communication program." Honeywell just uses the paycheck to get everyone's attention.

Personnel Journal, September 1996, Vol. 75, No. 9, pp. 70-76.

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