Custom Home Building: Getting What You Pay For And More

Incentive compensation plans can reward performance but be careful about what you’re paying for. 

November 12, 2014

Marnie Oursler has two full-time employees and an incentive compensation plan structured so that meeting the schedule is the primary driver.

Her buyers want a lot of things for their million-dollar beach home, but a top priority is that the house is ready to move into by Memorial Day weekend so the clients can spend a good part of their summer on the Delaware shore. Consequently, the president of Marnie Custom Homes, Bethany Beach, Del., rewards her field superintendents by meeting benchmarks for delivering houses on time.

A basic incentive compensation plan can work well for a builder of Oursler’s size. Her company will close seven houses this year. Plus, the market for beach houses is a different animal from other new construction markets as the lifestyle of buyers in her market is one where she can make meeting the deadline the main criteria for rewarding her field team.

Many builders dropped their incentive compensation plans, if they had one at all, during the recession, but as the housing market meanders its way through a jagged recovery, now might be the appropiate time to revisit how performance is rewarded in an effort to attract new hires, keep the people you have, or light a motivational fire for your crew. 

Home builders, whether they are production, semi-custom, or custom home builders, typically have bonus programs just for their supers. Such plans are expected in the industry. Supers earn extra pay by attaining goals for on time delivery, customer satisfaction ratings, and any other number of ways a builder wants to reward the producers in their company. Home building is cyclical and combining salary with performance incentives is a way builders can turn fixed cost for personnel into a variable cost. Bonus and profit sharing plans enable a builder to offer a base salary at the low end and boost their employees’ paycheck with extras for meeting performance targets.

“That piece of the salary is variable so if the market craters, I can keep my staff and not fire people because I’ve got a piece of compensation that’s going to vary with the velocity of sales that I have, says Chuck Shinn, founder of Builder Partnerships and Shinn Consulting, Littleton, Colo. “The idea is to be able to keep the organization and management team together as the housing industry cycles through seasonality and economic cycles.”

Typical for the industry, however, is that the employees handling accounting, estimating, warranty inspections, and other back office processes are not included in an incentive compensation scheme. They are not perceived as employees directly responsible for creating income. However, a properly-designed incentive pay plan can play a critical part in creating a culture where all employees feel and believe that they are all in this together.

“I think (incentive compensation) is even more important for custom builders,” says Fletcher Groves, vice president of SAI Consulting Inc., Ponte Vedra Beach, Fla. “Custom builders probably can make a traditional performance compensation plan work better. You look at most custom builders; they have flexibility, agility, and people who have to do jobs other than what their job description says because there are not many of them. If they get into a crunch, they’re all going to have to fight together and when you have a performance compensation plan where someone can’t say, ‘that’s not my job,’ then you’ve precluded them from saying that.”

What Not To Do 

The Christmas or year-end bonus is the least effective way to pay for performance because it is compensation that is most removed from your company’s results. It’s more like a gift. If you pay this bonus regularly, your employees will always expect it although they do not know exactly why they receive it. Consequently, if your company’s sales volume doubles the following year, your staff will expect the next bonus to at least grow in kind regardless of how they performed individually. When they don’t get the increase, the bonus could spark resentment rather than appreciation from your workers.

Another incentive compensation pitfall is having a plan that measures and pays bonuses for goals that result in employees being rewarded for the wrong outcome. Shinn cringes when he sees bonuses tied to the homeowner walk-through conducted by the superintendent. Let’s say, the super’s bonus is tied to the homeowner pointing out no more than 10 defects during the walk-through.

“I guarantee you that there will not be more than 10 items on that list,” Shinn says. (The super) might talk the customer out of putting items on that list. Now I’ve got an irate customer, but I bonused the super because my measurement was wrong.”

One remedy is to have someone else conduct the walk-through. Even better, inspect the house before the customer sees it. The builder should not accept the house from the super until it can be delivered with zero defects. 

Per house bonuses also can produce the wrong behavior. When a super thinks he lost his bonus in one house, he’ll devote his efforts to other houses that still are on track to deliver his extra pay. The lost house becomes the “red-headed stepchild,” says Shinn. “I want every house he is responsible for to be a priority.” One alternative is to benchmark delivery on a quarterly basis so all houses—those that are late and on time—are in the same pool for determining bonuses.

Every builder wants great customer satisfaction scores, but overweighing for that element in an incentive scheme can create unwanted results. Shinn’s consulting team scrutinized compensation plans for companies where supers were paid a bonus for attaining high customer satisfaction grades, yet the company struggled to reach goals for its bottom line. Shinn found that cost variances per house were high because the supers said yes to almost every extra the homebuyer requested in order to get a good satisfaction ranking. Effective incentive compensation plans for field employees at minimum should set targets for timeliness, cost, quality, and customer satisfaction. Leave out one element and you’ll be rewarding undesired behavior rather than results that matter.

Also, incentive plans should not be complicated. If an employee cannot figure out how and whether they will earn more money, the scheme ends up being a disincentive. Superintendents have to believe that they control the destiny of their project. If a house is late because the builder got into a dispute with the cabinet supplier, dropped them, and did not find another supplier for three weeks, that fallout affects the schedule, which impacts the super’s bonus and could create a rebellion.

Doing It Right

Incentive compensation plans can be structured in many ways that are more robust than merely paying bonuses to the superintendent. Depending on the size of the company and the priorities of the builder, a plan can be profit sharing available to everyone equally, or profit sharing paid out based on criteria such as rank and seniority, or a mix of bonuses for individuals with profit sharing for all. 

Groves of SAI is partial to having everyone in the same boat.

“You don’t want winners and losers,” he says. “ You want winners or losers as in we all win together, or we all lose together. I think that’s a much better culture than having people go, ‘well you know what, that’s not my job.’ You want a superintendent saying to the builder, ‘I’ll stay on the model home for a couple more hours a day because the more houses we sell, the more money we all make.’ That makes everyone more flexible, more cooperative, more like a team.”

He recommends that incentive compensation for all in the company is tied to a baseline for gross income (net income also can be used as a benchmark) and to targets for growth above the baseline that trigger payments. He’s helped builders set up plans where every dollar above the baseline is divided with one-third going to retained earnings, one-third to the owners, and a third to the employees.

“The goal of the company is to make money,” he says. “You have to reward performance on that basis, not on activity, not on non-financial stuff, not on things like defects and stuff like that. Those are drivers of business performance. Everybody has to understand that the company is in business to make money. That’s how they assure their livelihoods and that is how they get compensated.”

This approach demands builders teach their employees about the business—real classroom stuff—and show how they have a stake in the outcome. Groves is a proponent of open book management—sharing the balance sheet with all employees—so they can see where the company is financially. They also have to be taught how what they do on the job affects important metrics like income and return on assets. 

“If you don’t teach your employees what it means to be a business person and give them a stake in the outcome and the responsibility and accountability to act, that’s a big mistake,” Groves says. 

Picking goals like on-time delivery and cost variances as performance measures for the super and field employees is more obvious than coming up with benchmarks for the office and support staff. If you choose to have bonuses for individuals and want to include support and office employees, Shinn recommends looking at each job to determine what it is that they are supposed to be doing that contributes to the bottom line. The reward, whether it is financial or non-financial, should be based on results achieved, not for performing a list of duties. For example, a bonus for an estimator can be tied to job cost variance. How accurate are the estimates compared with the actual cost of the job? Are the purchasing manager’s purchase orders complete and accurate so that the start package goes into production without delays? Does the accounting department have job cost reports turned in by deadline, and are the bank draws ready so you can pay vendors and get their discounts for being an early bird? Whatever targets are tied to incentive compensation, they should be posted in the office or communicated regularly so everyone knows how they are faring with their benchmarks.

“If you do it right, every employee can measure their own performance,” Shinn says. “If you give them targets, it’s amazing that they know how they’re doing before you do as a manager because you have to wait for a report. They almost know every day how they are doing.”

So how should a builder pay out incentive compensation? Bonuses paid in equal shares signal that to some degree every teammate has equal value, Grove says. Paying bonuses as a percentage of wages reflect the value expected to be contributed by individuals. However, if the overall pay plan is perceived as fair, then the distribution of payouts under the plan will also be perceived as fair.

“If the goal is to build a cohesive team—a savvy, mutually-accountable, and motivated team—working toward a common set of business goals, it is more difficult for these goals to be accomplished with different groups of teammates compensated under different arrangements and motivated under different incentive plans,” Groves says. “It is not impossible; it is just more complicated and more difficult.”

Whether you go with profit sharing, performance bonuses, or a mix of both, use a progressive set of milestones, the more the better. SAI set up plans for builders where progressive bonuses are parceled out in “buckets” and the early buckets of bonuses are smaller payouts of the bonus pool compared with the later buckets.

“If (a builder) can do more milestones in a year, arguably everybody gets a bonus every 45 days,” Groves says. “That’s really motivating. You can see people looking at it and going how close are we to filling this next bucket. Let’s get it done. Because (the compensation plan) is progressive, each bucket becomes more valuable.” CB

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