Paul Giannamore: Lead, manage, do the hard work, do the analytical work of understanding what those various levers are within your organization, and then discuss that and communicate that with your team so that everyone understands that.
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Paul Giannamore: Hey, Fat Pat.
Patrick Baldwin: Late night, last night, it's Friday Night Lights here in Texas. Our team finally won a game. This doesn't happen very often.
Paul Giannamore: The Longhorns? What's the team?
Patrick Baldwin: No. High school football.
Paul Giannamore: I see. Okay.
Patrick Baldwin: It’s their fifth win in 3.5 years, it's not bad.
Paul Giannamore: Are you serious?
Patrick Baldwin: A little bit.
Paul Giannamore: Wow.
Patrick Baldwin: That was exciting late.
Paul Giannamore: What's on tap for this episode, PB?
Patrick Baldwin: Paul, I had a question a while back. This owner runs a great business and has family involved and he wanted to know more about succession planning. I've learned a lot talking to other Boardroom Buzz guests and other colleagues as far as the thoughts of even buying the business from their parents. Succession planning, is this something that they're coming to you most of the time to talk about?
Paul Giannamore: Fat Pat, we used to do a lot of valuations for those purposes. As the M&A market has gotten busier and busier in recent years, we've been doing much less non-M&A-related work. I deal with it all the time because when the industry's recovered, almost all of these things are family businesses in one way or another. There's a variety of different aspects of that. There's the aspect of passing the business down from an ownership perspective, which it should be, and it oftentimes isn't. It should be a separate consideration from management.
Most people who own a business, if their son or daughters working in the business say, “My son wants to run the business,” or, “I want him to run the business.” The fact that the son will be a manager of the business is somehow tied into ownership and those are two distinct things. Think about a publicly traded company, you can own shares in Rollins but you're not on the executive team, and vice versa. You, granted, will probably get stock if you're on the Rollins executive team. Those are two big distinctions.
There are uses for trusts and generational planning. That's a legal process. Whether you're in the United States or outside the United States, you should think about engaging legal counsel and how you pass shares down to the next generation in a tax-efficient manner. You should think about the variety of different trust vehicles that exist to do that. The management side is, of course, a little bit more complicated because there are 2nd, 3rd, and 4th generation managers who are extremely competent and should be running the business.
Of course, I can think of many that should not be. We've talked on The Buzz before about setting up either a formal board of directors or at least an advisory board that can help owners make those decisions. Sometimes, it's difficult for parents if they look and say, “My son's a moron. It's going to be hard for me. I don't want to destroy the relationship by not letting him run the business.” The next thing you know, they've got a moron running their business, which complicates their retirement plans.
If you think about that early and in discussions with the children disconnect ownership of the business with management of the business, you can still own a third of the company and be off doing whatever it is you want to be. You want to be a nuclear physicist, go off and do that. You don't have to manage the pest control business. Vice versa, getting third parties involved in your business to make sophisticated decisions as to compensation, hiring, firing, and promoting executives is a way for you to get some political cover while still making better decisions.
When people talk about, “I don't want to destroy the relationship with my children,” and vice versa, one of the biggest issues that I see is children, who in their mind, forgo other opportunities and stay and work for the business, whether they want to or not. They are working for the business, they might want to ultimately own and run it, or they might not do it but they feel that they need to do it because that's what their parents want to do. Collectively, they haven't set a clear path.
What ultimately happens is the son or daughter is a poor performer. The parents or the owners say, “Multiples are fantastic. We're getting a great opportunity to sell this thing.” They “sell it” out from under the child. Of course, you hear things like, “Over the last decade, I could have done a million other things but I didn't do that, I stuck with the family business, and here I am. Now you're turning around selling it to Rentokil and I'm going to be a Rentokil manager making $85,000 a year. You've ruined my life.”
Communication, of course, becomes important. I have learned over the years that if you're going to do this and you're going to do it right, it's important to, number one, engage legal counsel so you understand how all of those transitions go and get somebody who focuses on this stuff. It's not a bad idea to get a psychologist involved who deals with family systems, that's a segment of social psychology that deals with family.
It’s basically how families operate. In those that I've seen do it over the years, it is helpful in communicating parents goals and objectives. I guess it's like any relationship, even in a marriage, for example, a lot of goals and objectives aren't spoken because one party believes that the other party should just know this naturally. That's one issue.
The other issue is that they feel like it's something that they shouldn't say. If you've got a father who, since you were a little kid, was talking about, “One day, you're going to run this business, tiger,” you might feel compelled to do it. It’s getting outside professional assistance early and often to help you have those discussions because a kid will oftentimes tell a therapist something that he won't say to his own father and vice versa. At some point, we can certainly go through more detailed succession-type issues but that's a high-level overview.
Patrick Baldwin: I love it. It's like thinking about, “Timmy, come mow the lawn with me. One day, you're going to take over the business,” as you talked about. The same thing in pest control, getting out there, struggling, stressing together, working together, and seeing what you accomplished. We've talked about family business. I think about Bryan Dodge and that interview comes to mind, that's a great idea to get the communication out there. It has to do with spoken and unspoken expectations of taking over the business and here's what it's going to be.
I've seen, “We're going to let you buy the business for X and at Y point in time.” I don't know if X and Y are ever firm and steadfast. That number, especially as multiples and valuations have increased, it's been harder and harder. We've talked about that ad nauseam here. The problems I hear a lot in which family businesses go sideways have to do with, “We talked about this in a general gray area,” and then it didn't happen like that and there's some resentment either between siblings or father-son, in most cases. Now, there's strife in the family. There's a lot to lose by doing this incorrectly.
Paul Giannamore: Some of it comes down to simply documenting it, having a discussion, and putting a roadmap on paper. If you're doing this correctly, neither party is going to let you get away with, bullet point B, “We'll figure this out at some point in the future.” For the child, “I'm foregoing opportunities in order to do this. Do I have what it takes? If I ultimately stick it out and do this, what's in it for me?”
For the parents, if you want to make it performance-related, it's like, “You're not on the family dole here. You have to perform and here's what you have to do. We're not going to just let you be a 22-year-old kid working from the family business. The average employee there is making $70,000 a year, and you're making $300,000 a year and you're using that all for hookers and blow and driving around in a nice car. That's not how we're going to operate.” That's ultimately what happens in most cases. There are a lot of things that could be done upfront when the conversations are easy.
Patrick Baldwin: This competitor potentially could buy out my business assuming it's something smaller. They don't know about selling it through a process. That might go sideways. There's not a lot of complications there. It's like, “We'll never talk to each other again.” If you take that same approach with it, if it was an employee or if it was a competitor and you apply that into the family because that's what you know and you're having those similar conversations without these guardrails, you're going to blow up your family.
Paul Giannamore: Not to get into the Rollins family business but a high-profile situation in the pest control space is what happened between Glenn Rollins and his father, Gary. There was a dispute over the value of the family trust that comes down more to ownership that took place back in 2010, 2011, 2012, or something like that.
That was a spectacular public blow-up related to a family business affair. It happens all the time. We interviewed Jeremy Kreer on The Buzz if you remember his tales. That was one of our first twenty episodes where we talked about some of the issues that he had with his father and his brother. When you listen to his stories, you talk to his father, and you talk to his brother, they're all right in their own way.
Patrick Baldwin: Someone comes to you and says, “I've had conversations with my son about turning it over to him but I now know that my business, I could sell it for three times that and make generational wealth that way.” What advice can you give to guide that conversation?
Paul Giannamore: It comes down to, first, what expectations were set up in the kid's mind. You're giving me an example of where no planning has been made whatsoever and it's a dinner conversation, “One day, I'm going to retire and you're going to take this over.”
Patrick Baldwin: I assume that's the norm.
Paul Giannamore: One of the things that we run into quite a bit and we have in recent years is parents having had those discussions and having adult children in the business and thinking to themselves, “I never thought I could get $25 million for this business.” They have a lot of concerns about having conversations with the children because the children have these expectations, “My son, Jimmy, thinks he's going to take this business over, but I'm going to $25 million for it. I never thought that would be the case. I can't do this to him.”
Many times, Jimmy is happy to take a lump sum payment and be freed from the requirements and expectations that his father has. Jimmy might not even be interested in the business. The first question I always ask is, “Does your son have any interest in running this business? Does he have any interest in owning it?” “We've talked about it and he's worked here for nine years.” “Do you talk about his aspirations? Does he show up at your house on Sunday for dinner and say how charged up he is to take this thing to the moon?” “We don't talk about that that much. We don't talk about the future.”
A lot of times, the parents will sit down with the kids and say, “We never thought this business could be worth $25 million. Your mom and I want to retire. She and I only need $10 million. How about we solve for $25 million, pay our taxes, and then I give you a lump sum of cash and then we take this other money and invest it?” There's a variety of different things and more times than not, the kids are like, “That's a great idea. Let's do this. I'm so happy. I don't have to be involved in this stupid family business anymore.”
Patrick Baldwin: That's where you recommended getting a family psychologist in there. It sounds like you might have to play that role without one.
Paul Giannamore: It's important if you're going to run a family business. If you want to run a multi-generational family business, if that is your goal, it's important to talk to a psychologist who deals with family systems because it'll enlighten you as to how to deal with different participants in the family. This is important whether you have 1 son or if you've got 6 children and your daughter's in the business and the rest of your kids are in college or in different places. Now, you have a very big complication here.
Let's say you have 6 children and a son runs the business and you've got 5 out, one's a teacher, one's a lawyer, one's a gardener, or whatever. The son's probably looking at it saying, “Wait a second, I'm running this business. so I should control the corporation. I should ultimately become the majority owner because I'm running it.” In reality, ownership and management are distinct. He could own 1/6 of that business as long as he's getting paid market comp for his services.
At the end of the day, he gets 1/6 of the voting shares and the other five should be able to vote their shares. That becomes problematic when you have siblings. I've often seen one sibling running the business and the other siblings are out married, going off, and doing other things. They, of course, look at it and say, “Ownership is ownership, I'm an owner in this business so I have a say.” The kid running the business looks at it and says, “I'm running it so I'm in charge here and I should own more.”
By the way, that's not illogical. It's not factually correct but it's not unreasonable for somebody to think that. If you don't get outside parties involved to help family members understand corporate governance and what this means, what voting shares are, and all of that jazz. If you haven't put together a proper shareholder agreement, which none of them have, the father dies, retires, or something happens, and the next thing you know, the kids own the business and 1 is in and 5 are out and there's no shareholder agreement in place.
They always fight about compensation, “Why should you get paid $600,000 a year and get dividends and I get dividends and distributions? Your $500,000 or $600,000 salary is impairing distributions to the business.” The son says, “You wouldn't get anything if it wasn't for me. You're out there having fun, taking your holidays to the French Alps, and here I am running the business so you don't deserve this.” In reality, the GM or CEO only deserves his share of the economic benefit to the company, which is a market salary. You just get into all of these things.
If parents set this up right from the beginning and say, “All executives at this company, including myself, will get market compensation based upon what they provide to the business. Here's the dividends and distribution policy. Here's how the board is set up. Here's how shareholders can vote. Here are tiebreaker situations and all of this sort of stuff.” If that's set up, then that is already in play. Once the children are involved, that's it, this is the way it's set up, and corporate governance is done. It helps everyone get into a routine when the children are young and they're educated on how corporate governance works.
Patrick Baldwin: It sounds like market comp covers a multitude of sins.
Paul Giannamore: In a lot of ways.
Patrick Baldwin: I don't know who's right. Thinking about it, the conversation in my head is always the father. If there are six siblings, it's the father, and then the son that's in the business. The conversation missing is probably the father with the other five children. It’s like, “Here's the expectation. Here's what's going to happen.” Maybe it's a conversation that says, “If you want to partake in the future equity in this business, I need you to participate. If you choose not to, that's fine, I'll help fund your career, or get you off and running somewhere else, and support you just the same in a certain way.” Is that the wrong thing to do?
Paul Giannamore: I don't know that there's a wrong or right thing when it comes to that. If I were the sibling who was out doing something else, I would view that as unfair. I would say, “Why does he get that and I don't? Don't give it to any of us and put a non-family manager in place. Are you building a business here or are you creating some sort of a welfare program for my brother? What are we doing here?”
Patrick Baldwin: Definitely makes sense. Once the dad passes away, if there's nothing in place, it's going to all six. Depending on the state, going to the widow, but eventually getting to the six.
Paul Giannamore: There was one situation where a father had all daughters. The number three daughter is not involved in the business and one daughter was running it. The valuations continued to climb. Father was ill. The daughter who was running it had been around for decades running that business, she was effectively the president.
When it came time to make some decisions, she looked at it and had the same position as you, “If Dad dies, I should have voting control of this business because I'm the one running it. You guys are off doing whatever it is that you want. You went off and explored your own careers and here I've been picking up the pieces.” They, of course, didn't agree with that.
She came back and said, “Good luck trying to sell this business without me. If I walk out the door, I have all the power. No one's going to buy this thing.” She was right. You have to think about those things in shareholder agreements. You've got a family member at the helm. You've got other family members that aren't active in the business and they're potentially hostage. Sometimes siblings have awesome relationships and sometimes they don't, and now you're in a situation.
As part of the shareholder agreement, the duties of the sibling that's sticking around to run the business need to be laid out. If there's a sale and the siblings are required to go, are they required to go? If they are, what do they get for that? The argument would be, if it were me, I'd be like, “I'm making this a saleable asset when you guys are sitting around on your asses. I need to be compensated for that.”
It's important to figure out what that compensation is far in advance because you give that particular individual a tremendous amount of leverage if something happens unexpectedly like somebody dies or you ultimately wake up one day and valuations are super high and you want to seize an opportunity, now that person is able to extort money at the closing table. Once they attempt to do that, it causes a rift among siblings. The last thing a parent wants is kids fighting over money while they're on their deathbed.
Patrick Baldwin: All the family businesses that have come to you over these years, could you put a number to the ones that there's not some drama involved in those conversations?
Paul Giannamore: There's a level of drama, it's a spectrum. I had the opportunity to work with some that have gotten their act together and done a lot of the things that we're talking about and those are super clean, nice, and easy. For the ones that have not prepared, there's always a certain level of expectations that haven't been voiced and confusion. One of the most painful aspects of my job is working with family businesses.
On the one hand, it creates a tremendous amount of stress because not only are you dealing with acquirers, you're trying to run a process, but you're also dealing with the family dynamics. On the other hand, some of my best memories and most rewarding aspect of my job is working with family businesses because if done right, you can help people in a way that folks that don't pay attention to this can't. I've got a big stack of family systems books and social psychology books because it's an important aspect of our business.
Fat Pat, speaking of social psychology, I realized a tasty little morsel about our Mexican friend. We talked about his Indian food expedition. The Mexican is down here in Puerto Rico. There are a lot of things I like about Puerto Rico but my biggest issue with Puerto Rico is the cuisine here is homogenous, the Caribbean cuisine. I had a YPO meeting and we ate Indian and it was difficult to get Indian food. There's no Indian restaurants down here. We had an Indian make the food for us.
Patrick Baldwin: I was wondering logistically how you pulled that off. Door dash from where?
Paul Giannamore: There's not a lot of variety here. You can't go to a Uzbeki restaurant, for example, or an Ethiopian place. The Mexican has dined on a homogenous set of Caribbean cuisine over the years. I was told an interesting tale that I didn't know, the Mexican was in Europe working on a transaction, and on his way out, he had to stop through Spain to meet with Rentokil’s Spanish crew. The folks that run Rentokil Spain took him out to dinner and they took him to a restaurant that was somewhat like a Korean barbecue. Probably many folks have been to a Korean barbecue. Have you been to one, Patrick?
Patrick Baldwin: I don't think I have.
Paul Giannamore: Do you know what that is?
Patrick Baldwin: Korean barbecue? When I go get wings somewhere other than Chick-fil-A, there's a Korean barbecue sauce. That's my experience with chicken Korean barbecue.
Paul Giannamore: Depending on what part of the world you are. Have you ever been to a restaurant where you've got something to cook at your table? Maybe some folks would call it Mongolian barbecue. There's a variety of different things.
Patrick Baldwin: Mongolian barbecue.
Paul Giannamore: Depending upon where you are, it might have a different term. Mongolian barbecue, you're sitting at the table, there's a cooking set there, and they bring you raw meat, lettuce, and all sorts of garnishments for your cuisine. The food was delivered, raw pork, raw beef, and all that sort of stuff. They had barely turned on the range to cook it and the Mexican dove in. Raw meat, he didn't realize it needed to be cooked, he just scarfed it down.
Patrick Baldwin: How's he doing?
Paul Giannamore: The guy constantly has gastro issues. He was on a DD session in New England. This wasn't just him, the acquirer was there, and the principals were there. He was up there and he told me it was the first time in his life he had significant gastro issues on a plane. He lived in the toilet on the way home. He had to take the next day off of work. As I hear from the sellers, they ended up having bad seafood.
Patrick Baldwin: It wasn't just the Mexican.
Paul Giannamore: No. They all got nailed.
Patrick Baldwin: I heard about that headline. I was wondering if that was the Mexican.
Paul Giannamore: You heard about that, right?
Patrick Baldwin: Diarrhea down the center aisle.
Paul Giannamore: Where the plane was diverted.
Patrick Baldwin: Yeah. That was a trip to Spain or on the way back.
Paul Giannamore: That headline came out the day after he came back. I had to take a double-take just to make sure they weren't referring to him.
Patrick Baldwin: We talked about this family business. That got me thinking about incentives and market salary. In fact, I had a call with someone looking at FRAXN. I'm going to read this text, “I have a guy on the ground helping me. I want to give him a bonus based on what the business grows. What do you think is a good percentage to give him?” Currently, he is paying this manager $70,000 and they're doing roughly $500,000 in revenue. This owner has relocated, moved to a different state, left the manager behind, and he wants to know what's a good way to compensate him, incentivize him, and without creating perverse incentives.
Paul Giannamore: The compensation structures in a business are some of the most important decisions an executive can make. Oftentimes, we'll hear issues where when a business is small, a comp structure is set up in a certain way, and next thing you know, you've got a $35 million business. The guy, fifteen years ago, was making $100,000 a year, and now he needs $1.5 million a year because you set up some funky structure.
Interesting you brought this up. I've been talking about compensation plans and structures here, not only in our own business but also in general. One of my YPO buddies gave me this book that I started reading on the plane called Scaling Up Compensation: 5 Design Principles for Turning Your Largest Expense into a Strategic Advantage. It's a relatively short book, it's 100 pages, and it's written by Verne Harnish and Sebastian Ross. For those who know Verne Harnish, he wrote the book Mastering the Rockefeller Habits as well as Scaling Up.
I have had the opportunity to hear him speak many years ago at a conference. He's a sharp guy. Sebastian does great work in the comp space. We were talking about this at YPO and one of the guys gave me this book. I'm maybe 30 pages into it. It's pretty interesting. It's concise and easy to read. The main question is if you find the ideal manager for your business, what would you have to pay that manager to attract and retain him? That's what we're talking about, market compensation.
In family businesses, notoriously, they don't mind violating the norms of market. You'll have a son who makes $300,000 a year and quite frankly, he shouldn't make more than $50,000. With regard to the text that you got there, there are ways to set up a base salary and then incentives. You want your managers to have long-term incentives that align with you as ownership. Did he base it on the percentage of revenue?
Patrick Baldwin: Right now, he has a $70,000 base built in and he's wondering what to do from there.
Paul Giannamore: In a perfect world, if you want it to be long-term, you're targeting the value of the business or you're targeting some sort of metric of cashflow. Obviously, you don't want to ever tie somebody's incentive to something that they cannot entirely control. You can't control the market. You can't control economics. There are a lot of things that you can't control and that's inherent in any sort of comp structure.
If he doesn't have P&L responsibility, if he can't control costs, let's say he can only control revenue to a certain degree, he can't control how much money the company's going to spend on marketing, and so on and so forth. You tie his bonuses and incentives purely to profit, which is after costs, that's not ideal. You have to tie compensation to that, which the individual can control. It's problematic because I've seen a lot of times over the years when a company is young, folks will give somebody a percentage of revenue. You get 5% of revenue or 2% percent or something like that.
That might work for a company doing $1 million a year in revenue. When you start getting $10 million or $15 million and then if that's individual's important, no acquirer is going to respect that agreement so they're going to ultimately be gone. You got somebody who's making $700,000, no acquirer is going to pay that. Even if you don't sell the business, now you're looking at this saying, “I'm paying a guy $700,000 a year. I can go out and find somebody who's as good as he is, probably better, and maybe pay him $200,000 a year.”
I don't know that I'll be able to work through the details of a comp plan here on this short episode, Patrick. There are resources out there for that. It is a big conversation for everyone. If you're sitting back there saying, “It's pretty easy to pay my technicians but I got sales guys and I've got managers and I've got all sorts of folks here. Everyone always wants more and I want to give them incentives.” Take a step back. I haven't read Scaling Up Compensation yet, I'm 20 or 30 pages in. It appears to me to be a pretty good place to start if you're going to go down that path.
Patrick Baldwin: Could Fat Pat wrap his head around it?
Paul Giannamore: There's a stamp on it that says when you go into the toy store and it says five and below type of thing, there's a Fat Pat stamp on this book.
Patrick Baldwin: I love it.
Paul Giannamore: It should be accessible to everyone out there.
Patrick Baldwin: That brings up a few things that you said. If you're paying a percentage of revenue, I would shy away from that, it's a tax. At the day, you're taxing your business through compensation by taking it off the top line. I don't like that one. We talked about it in episode 144 and I sent it to him, like, “This is a great one for you to think about looking through your P&L up and down.”
What you said, though, was you want to incentivize for what they can impact, nothing more, and nothing less. I'm paraphrasing here. Oftentimes we get into where you see this team environment and you're going to get part of net profit. We're going to do profit sharing for our business. Is that a bad idea? Do you tell people to run away from that? Does that ever work?
Paul Giannamore: A lot of times, profit sharing turns into a corporate welfare program. When you think about compensation, you have to think about how compensation impacts the culture within an organization. There are a lot of different schools of thought on this. If you think about it for a second, you have group versus individual. We always talk about long-term incentives versus short-term incentives.
The closer you are to the customer, in theory, the shorter term the incentive should be. There's an immediate feedback loop. I send my guy out, he sells an account, and he services an account. That feedback loop should be short. If somebody is a general manager of a business, his incentive is going to be long-term. Part of what he or she will receive relies on the customer being made happy today but we want the horizon to be long-term.
We then think about individual versus group and this is where a lot of the culture stuff comes into play. If incentives are paid to the group, not individually, it sometimes can have negative impacts on high performers, but folks are more willing to cooperate. If we're working together, Fat Pat, and I've got a little bit of extra time and I help you out because you're bogged down over there. If I can make your life easier and more efficient, the spoils of our labor are collectively coming to us.
I have an incentive to help you. Of course, you have the freeloader problem. The inverse is also correct. If I'm not feeling so great today and the rest of my team is out, I'm still part of this group incentive so I'll let these guys bust their tail. Group incentives tend to foster cooperation. Individual incentives tend to foster competition. There are companies out there that have found a balance between the two.
Where profit sharing turns into a problem, and a lot of companies do this, is they'll say, “We're going to set up a profit-sharing plan and 8% of corporate profits are going to be distributed on a quarterly annual basis.” If the team or the employees don't even understand how they're impacting that, then you've just created almost like an entitlement program within the organization that they're just getting that.
They're going to go about doing their daily work and they're getting that. When you do those things, you have to be clear about measurement, goals, objectives, how the needle moves, and what impact that has on star performers, because that's now a group incentive as opposed to an individual incentive. There's a lot of thought that has to go into that.
Patrick Baldwin: Based on the frequency of paying out profit share quarterly or annually, that goes against the principle of the frontline employee getting rewarded quickly and often.
Paul Giannamore: That would change the duration of the incentive plan from immediate or short-term to slightly longer term. An example of a long-term incentive plan would be I am a manager in a business and the executive team has set up a plan for me that's based on the value of the business or value creation. Some firms will set it up and attempt to do it based on market value. They'll do annual business valuations.
I tend to not like those because when you set up an incentive plan, there should be clear goals, objectives, and metrics. It gets difficult for people to understand and think through market dynamics and the market value of a business. It becomes the job of the CEO to remove a lot of that ambiguity within the organization and say, “Let's walk through the entire value chain. This is how we create value within this organization.
Here are the financial results of the various different value-creation levers we can pull in this business. Here's how it all works together as a system. Your incentive will be based on these results.” In a pest control business, you could say we've got a variety of different metrics, we've got a revenue metric, we have a customer retention metric, and we've got a profitability metric. You can take 4 or 5 lines off the P&L or 2 or 3 lines, or what have you.
You could take some non-financial metrics that you're measuring, customer satisfaction, and so on and so forth. You could build a matrix out of that and basically show a clear line of sight of how value is created within that organization. Ultimately, what the incentive will look like, what's the payment? When is the payment? Is it annual? Is it something that is almost paid in kind over the years where you're saying, “Upon a change of control, if we sell this business, you keep doing these things, and here's how we're going to keep track of it.”
“Now you've got $100,000 in your value bank, you've got $500,000, or you've got $1 million. When we ultimately sell this business, you're going to get this. Or if we don't sell the business at some point in time, five years from now, there'll be a trigger and you'll be able to take some of this value.” There's a lot of different ways that you can do that. The key here is it makes scant sense to pay somebody for something that they can't control or that they don't otherwise understand because it becomes hard to affect that.
In the early years of door-to-door, compensation was you go out and sell an account and shortly thereafter, you're getting paid a commission on that account, it doesn't matter what happens. The customer sticks around, it doesn't matter, you're getting paid. Over time, the industry has realized that incentivizes hard sales tactics. We need to change the comp structure so that customers need to be retained.
Some companies say they got to be retained for a year, they got to take four services, and others say you got to take two services. In creating incentives, it's important to think about yin and yang. If you're purely in setting for revenue growth for a manager, you got to think about all of the bad things that he could do to create revenue, “Let's add a cost line to that.” Now he can't blow a lot of money to create revenue, he's also responsible for costs.
Now he's selling a lot and he's spending a lot of money on sales but he's grown the top line. He's figured out how to manage the bottom line but now the customers aren't getting great service because he's realized, “If I pile them on, get a lot of route density, it doesn't matter if they defect because here's how I can game the system.” Now, you go in there and you add, “We need a customer satisfaction score. We need a retention metric.”
I've seen, over the years, companies pile on metrics because you tinker with one area of the system and it messes up. You put a Ferrari engine in a Pinto, you get the point here. It's important to think through that and you have to think through non-financial metrics. We talked about autonomy and decision-making in one of the early Buzz episodes where some employees who have children might value vacation time more than financial compensation.
If you think about a profit-sharing plan, for example, let's use the 8% example. Everyone on the team is getting 8% profit sharing. Let's say that I'm a father and my wife has a great job and I get paid well and she gets paid well, I might value more time with my children. Instead of that 8% profit share, I might be better served by being able to take additional time off. Can I be paid my portion of the profit-sharing plan in additional vacation days? I don't need additional money, I need to spend more time with my children.
Remember, value is always subjective. I might value vacation days more and you might value money more. The company is giving me something I value more by providing me with more vacation days than what it would financially cost the company to hand me money. Now we've created value, the value equation is larger. The pie that we're splitting is larger by letting me, the employee, choose. There are ways to do that. I've seen companies do that successfully.
Patrick Baldwin: As you continue to pile on these different metrics, it just gets more and more complicated. I don't know how far is too far. Is there a rule of thumb? You need three metrics or no more than five metrics.
Paul Giannamore: I would say no more than five metrics. Obviously, the more senior the executive and more sophisticated, the more complicated the incentive structures can be. At the end of the day, you want to keep this simple.
Patrick Baldwin: It makes sense. Recurring revenue was number one for me, incentivizing to grow recurring revenue because it's going to drive. That helps you as the shareholder of the business. It's going to help create opportunities for the business and help it to grow. It focuses on customer retention. That's another benefit of that. That was the number one thing I said to him.
Back in episode 144, we talked about a P&L that you can make custom for a manager. If the manager is in charge of this revenue and these expenses, you said, “Make it happen in FRAXN.” It's ready. You could take a manager and say, “He's in charge of these things.” You could split out the recurring revenue categories. You could split out labor chemical materials, put that on as many P&Ls, and you've got a way for a manager to track his performance and how to compensate him off of that.
Paul Giannamore: One of the roles of the CEO is to remove ambiguity from a business. You could use recurring revenue as a metric and it becomes your job though to sit down with your managers and not just say, “We're going to focus on recurring revenue.” Start to unpack what impacts recurring revenue. You've got sales growth rate, right? Bring new accounts on but you also have retention. What impacts retention?
If you start to slice and dice your own business, if you sit back as an executive and do the hard work, pull out your accounts, look at cancellations, start to do customer surveys, and get a sense as to, “On my market, 2% people a year move away, die, or otherwise disappear for no fault of our own. How many of our customers are getting picked off on the doors by their folks? How many of our customers leave because of bad service?”
Over time, as you build data within your organization, you can figure out what the symptoms are of your illness and then start to address those. When you're sitting down with your managers about recurring revenue, you can say, “What impacts recurring revenue? Sales. How are we going to focus on the sales system? The service system. Here are the impacts our service organization has on customer retention. Here’s what our back office is doing. Here's what our CSRs are doing. Here's what our technicians are doing.”
You can use recurring revenue as one metric but it cascades or waterfalls to the standpoint that you have a lot of different things impacting the retention of a customer. If you clearly put together a process so that your team members, all the way from management down to technicians, understand what impacts retention, you can get them focused on a subset of goals or objectives within the retention metric.
I'm not saying this is a good or bad thing to do necessarily. I'm just saying you could set up incentive plans based on an absolute amount of recurring revenue, you could do that but you can't just say that, like, “Recurring revenue, let everyone figure it out.” It's your job as the CEO to say, “This is specifically what impacts recurring revenue. This is how it's measured. This is what impacts growth rates. This is what impacts retention rates.” Under the retention rate, there should be a lot of other things going on within the organization and where it touches different systems so that folks can improve it as opposed to running around, “We just need recurring revenue. Get it. Let's do it.”
Patrick Baldwin: More than just measuring it.
Paul Giannamore: Yes.
Patrick Baldwin: Lead and manage
Paul Giannamore: Lead, manage, do the hard work, do the analytical work of understanding what those various levers are within your organization, and then discuss that and communicate that with your team so that everyone understands that. Not only can you be looking at recurring revenue, you can find some things that you'll measure that impact. You don't have to measure everything, but you can think of 3 or 4 things that are important levers on customer retention that you're measuring.
Patrick Baldwin: I love it. I got another book recommendation. I wasn't coming today for that but thank you.
Paul Giannamore: Fat Pat, I guess that's a wrap here on The Buzz. We've got some guests we're going to be interviewing here and some pretty good ones so I'm looking forward to that.
Patrick Baldwin: All right. Have a great weekend. I'll see you soon, man.
Paul Giannamore: Sounds good, brother. Take care.
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Dylan Seals: Thank you so much as always for supporting us at The Boardroom Buzz. We know your time is valuable and the fact that you spend 45 minutes or an hour with us means the world. All the media that we put out from Potomac is meant to honor and celebrate you, the service industry owner. As Paul would say, “Yee who toil in the pest control vineyards.”
As part of giving back, we have this podcast, but more than that, Paul and I have been working our tails off over at POTOMAC TV. We've spent a tremendous amount of time, energy, and resources to build out that platform to bring you market updates, to bring you visual breakdowns of the merger acquisition process, and to tell stories and present information in ways that, frankly, it's not possible for us to do on The Boardroom Buzz.
Adding the visual element takes it to the next level. I want to invite you to go to YouTube and find us, it's POTOMAC TV. Potomac.tv will get you there. Go there and subscribe. Check out some videos and leave some comments. Let us know what you like and let us know what you don't like. Let us know what you want to see more of and we'll see you over there.
Bryan Dodge – past episode
Jeremy Kreer – past episode
Scaling Up Compensation: 5 Design Principles for Turning Your Largest Expense into a Strategic Advantage
Mastering the Rockefeller Habits
Scaling Up
episode 144
Potomac.tv
