The New Math for Pricing

It represents one of the most difficult decisions you will make: What price do I charge for my products? Many people, including myself, have always held that pricing should be based on covering all of your costs with some allowance for profits. However, thanks to Robert Dolan of Harvard Business School, there is a new math for calculating price that goes beyond the financial numbers.  

Welcome to a World of Structural Change

It used to be economic change would run in cycles. We would experience periods of high inflation followed by tight monetary policy that led to an economic slow-down. Today, we have cheap money, no inflation and below average economic output that is continuous. Economists and the Federal Reserve are perplexed about a key question: Will we ever experience a full recovery? The answer is No – we are in an age of structural change where there are clear winners and losers. It’s like having an economic boom for some and a depression for others.    

Focus on the Process - Part 2 of 2

The words “business process reengineering” still leaves a negative impression for many in the business world. Years ago companies rushed to reengineer their processes to improve quality and efficiency. However, the end result was less than desirable – new processes were layered on top of existing processes resulting in more work with fewer people. Costs were temporarily lowered benefiting investors. However, other stakeholders in the process, such as employees, were victimized by reengineering.

Focus on the Process - Part 1 of 2

All businesses require processes for the creation of products and services. A process is a collection of activities that consumes resources and adds value to the consumer (in the form of products / services) with some form of benefit paid to the producer. Additionally, all processes have variation – in business we call this risk. As H. Edward Deming, pioneer in the field of quality management, points out – If you can better understand variation in a process, you can plan for it and do things to prevent it.

Machines of Loving Grace

Machines of Loving Grace is the title of a book written by John Markoff. Markoff is a science writer for the New York Times who has followed technology for the last 30 years. In the last few years, we have seen an escalation of technologies, ranging from drones and robots to Artificial Intelligence and the Internet of Things. This has prompted some of our best thinkers to challenge what is happening. Stephen Hawking has remarked: “the development of full artificial intelligence could spell the end of the human race.” Bill Gates and Elon Musk have both voiced concerns about the birth of super intelligence or machines that can think.

Why Customer Retention is so Important to Growth

For many businesses, the challenge of growth has become exceedingly difficult. Larger companies seem to grow through acquisition since internal growth above 10% is not possible. One of the keys to good internal growth is through retention. Granted, it’s not easy, but if you can somehow retain your customers and get them to come back, you have created a platform for growth that is much easier to manage then a growth strategy predicated on acquiring other companies. Acquiring and integrating other companies is very challenging and requires expertise that most companies lack, not to mention the very low success rate even if you do have outside help. Therefore, a growth strategy rooted in retention can be more viable and sustainable over the long run.  

Let's Define Best Practices

One of the most overused terms in business has to be: Best Practices. It seems everyone (including myself) is always labeling something as a “best practice.” Thanks to Hackett Benchmarking, a common definition has emerged for best practices. According to Hackett Benchmarking, a best practice must:

1) Place the company in a top percentile ranking within its industry.

2) Leverage and take advantage of technology.

3) Improve quality and speed, and also lower costs.

4) Give management more control and influence.

5) And finally, it has to be working; i.e. it can't be planned but not implemented.

The Three Most Important Skills

It was said some 20 years ago by the Education President, George H. W. Bush that everyone should be able to: Speak, Write and Think. These are the three most important skills everyone should have. Why are these skills so important? Because they are the most transferable skills a person will use throughout their life. These skills also create the widest range of opportunities for people in a world where specific job related skills can become obsolete. And if you don’t think you need transferable skills, then consider that the average American will go through 10 to 14 jobs by the age of 38. One out of every four workers has been on the job one year or less according to the Department of Labor.    

Why Link Pay to Performance

If you expect to attract and retain the best people, you must have market competitive pay. Additionally, you have to be willing to accept some level of employee turnover. The key is to design your pay so that you have targeted turnover; i.e. you induce turnover of low performing personnel while re-enforcing a culture of high performance, enabling you to retain top performers. This is why every company should consider linking pay to performance.

The problem for many companies is the minimal spread between high and low performers. Most companies design their pay around a merit matrix that looks like this:

Performance Level	Highest	Above	Below	Lowest
Exceptional	3.5%	3.5%	3.0%	3.0%
Exceeds Expectations	3.0%	3.0%	3.0%	3.0%
Effective	2.5%	2.5%	2.5%	2.0%
Development Needed	2.5%	2.5%	2.0%	2.0%
Unacceptable/Poor	2.5%	2.0%	2.0%	2.0%

In the above example, the spread between the best and worst performers is a mere 1.5%. In today’s world where companies are fighting to attract and retain top talent, you must be much more aggressive with your merit matrix so that it looks more like this:

Performance Level	Highest	Above	Below	Lowest
Exceptional	6.5%	5.5%	5.0%	4.0%
Exceeds Expectations	6.0%	5.0%	4.0%	3.0%
Effective	5.0%	4.0%	3.0%	2.0%
Development Needed	2.0%	1.0%	0.0%	0.0%
Unacceptable/Poor	0.0%	0.0%	0.0%	0.0%

In this example, people who don’t perform get no increase. This sends a strong signal to everyone that performance matters and for those who do perform, you will get a serious merit increase. This is one of the most powerful statements any company can make when it comes to retaining the best people. You should also think about the limited money you have to spread around. You want to allocate your limited resources to those people who deliver results. A merit matrix that has distinct differences between low and high performance will do more to communicate and create a culture of high performance than any speech or memo you will issue. 

“Variable pay budgets and spending have nearly doubled in the last 20 years, subsequently emerging as the pay-for-performance vehicle of choice now and for the foreseeable future. In a more robust job market, competition for talent exists in every sector. As a result, we are seeing industries that have traditionally shied away from providing bonuses, such as agriculture, higher-education and the federal government, realizing they must establish variable pay programs to compete for and retain the best talent.” - Ken Abosch, Compensation Leader for Aon Hewitt.

Trying to retain the best people is becoming increasingly difficult. According to a 2015 survey conducted by WorldatWork, over 80% of the people surveyed indicated they plan to leave their job. Contrast this to five years ago when the percentage was 60%. High performers are not going to stick around for the usual 3% raise while others get 1%. 

A final point concerns the traditional performance review. If you link pay to performance, you need to rely more on 360 degree feedback that has some anonymity. This provides an objective, open and honest review process that serves as your basis for administering your merit matrix. Additionally, your review process has to be on-going and not just once a year. It should be a cumulative reflection on how well someone has helped the company meet department and company goals. And the review process should be both quantitative and qualitative. For example, the Marketing Manager was able to help the company meet its sales targets (quantitative), but he also mentored and grew the capability of our marketing team (qualitative). If you can have a robust back-end review process coupled with a serious merit matrix (as described in this article) and combine this with a competitive benefits package, then you have established the foundation that should enable a high performing workforce.

"It is very difficult, but not impossible, to put a price tag on losing key people and their smarts. As if to emphasize the intangible yet dire nature of these costs, some executives were unable to provide a dollar figure, but simply responded 'incalculable' or 'priceless.' So even if you can't quantify the costs of knowledge loss, you might agree that the cost is often a lot, enough that you would like some options to avoid or minimize these costs. Despite the acknowledged threat, a surprising number of organizations are doing nothing or little about it." - Critical Knowledge Tools by Dorothy Leonard, Walter Swap and Gavin Barton

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Recognizing Intellectual Capital

The traditional accounting model with its financial statements is increasingly inadequate in helping us understand what drives value in our business. These value drivers are highly intangible and the accounting model is not setup to measure and report these critical assets. Part of the problem is simple – it’s hard to measure intangible drivers of value. They can include things like:

• Your ability to retain and have loyal customers
• The fact that your workforce is highly motivated and requires minimal supervision
• Having strong leadership that creates the right culture for performance
• Obtaining brand recognition that makes it harder for others to compete against your company
• Turning ideas into real product improvements for continued market leadership
• Leveraging your know-how against the assets of others in a shared economy