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How to Link Compensation to Intellectual Capital (IC)

By Tom McGuire and Andrew Lobo, Talent Growth Advisors
IC accounts for more than $4 trillion of the market capitalization of the Dow Jones Industrial Average. What should this mean for compensation?

Most of the time, the majority of companies focus their compensation philosophy on fairness as a typical practice. The process, familiar to most, goes something like this: The company hires a compensation consultant to help identify job categories and benchmark pay for those jobs against companies similar to the client company. The company then determines a target percentile and starts adjusting its existing compensation to match the target. There are, of course, many complexities involved including the split between base salary, short-term incentives, long-term incentives, etc. But overall, the process is similar and focused on achieving fairness. This process has worked for a long time. However, recent research suggests a fundamental shift in approach is necessary.

Today, more than $4 trillion of the market capitalization of the Dow Jones Industrial Average is now driven by intellectual capital, according to the Intellectual Capital Index. This represents 86% of the market cap – a huge amount. It is the market value manifestation of the larger transition from an industrial economy to a knowledge economy.

So given this information, what are the implications for compensation? The answer lies in 2 areas:

  1. The nature of how intellectual capital is created and grown
  2. The definition of “fairness.”

Intellectual capital is often created and increased by relatively few critical roles within a company. Examples include: researchers at pharmaceutical companies; developers at technology companies; and brand managers at consumer products companies (CPC). In order to maximize intellectual capital creation and growth, or market capitalization, companies are wise to focus investments on those critical roles.

The definition of fairness has historically been paying all areas of the company equally, relative to their peers and seniority. For example, a manager in finance would be paid similarly to a manager in marketing; or a director in R&D would be paid similarly to a director in legal. And this pay would fall near to the selected overall compensation percentile target for a given job grade. Combining the 2 points above, the implications of intellectual capital on compensation philosophy are: fairness is now defined in a way that pays roles unequally with roles that create and grow intellectual capital paid far more than all other roles, regardless of seniority. So in the new paradigm, a manager in brand development at a consumer goods company might be paid more than a VP in procurement.

This is fair because the brand development role contributes far more to intellectual capital, and therefore market cap, than does the procurement role. While this is absolutely disruptive (in a real rather than cosmetic way), this idea is not unique. Professional sports franchises have been doing this for a long time. Their players are paid at or above market with the most important roles (say quarterback) being paid far more than less important roles (right guard or VP of human resources). Similarly, many companies will pay certain performers far more than other people in the same job – based on their contribution to the company. For example, at most investment banks and many other companies, the best bankers and salespeople can earn 10 times what others in the same jobs earn. Similarly, Google claims to pay people in the same roles hugely disparate bonuses based on their contribution.

As the recent head of people operations at Google, Laszlo Bock wrote in his book Work Rules, “At Google, we ... have situations where two people doing the same work can have a hundred times difference in their impact, and in their rewards. For example, there have been situations where one person received a stock award of $10,000, and another working in the same area received $1 million.”

Here’s the difference between the approaches taken by Google and many investment banks and sales companies and our suggested approach: Those groups focus on disparate compensation based on value contribution among individual associates working in the same jobs while we think there first must be disparate compensation based on the value contribution of roles. The logic is identical – pay more for more value contribution. But in an age where intellectual capital provides more than 86% of a company’s value, companies should seriously consider paying critical roles more than other roles that do not drive as much value.

FIGURE 1 Compensating for Critical Roles

One question, of course, is, “Who is the judge of critical versus noncritical roles?” Fortunately, identifying critical roles can be a very objective exercise. By understanding the components of a company’s core intellectual capital, which most companies already highlight in their investor communications, expert analysis of the work that produces these intangible assets is the best path to identification. 
To summarize, the rapid rise of intellectual capital as the primary driver of market capitalization suggests strongly that companies should maintain 2 distinct pay tiers: critical roles that drive and grow market cap directly should be targeted at the 100th, 200th, 400th percentile while all other roles should be targeted at a more traditional (assume far less than 100th) percentile.

Ultimately, fairness is achieved by building an organization that is sustainable. By recognizing and acting on the new economic reality, all employees benefit from a more viable business model that can more effectively compete and thrive in the knowledge economy.

 

About the Author

Tom McGuire is co-founder and managing partner of Talent Growth Advisors, a national management consultancy that helps companies connect talent investments with business value.

Andrew Lobo is vice president of talent strategy at Talent Growth Advisors.


Read the December edition of Compensation Focus.

Contents © 2016 WorldatWork. No part of this article may be reproduced, excerpted or redistributed in any form without express written permission from WorldatWork.

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