Best Buy Offers Choice in its Long-term Incentive Program to Keep the Best and Brightest

Linda Herman joined Best Buy as senior manager, executive compensation, knowing that the pace was going to be faster than she was accustomed to at her old job in financial services.

   “In retail, you need to be able to turn on a dime,” she says.

   That’s why she shouldn’t have been surprised when she came back to work after a long weekend last July to a request, by CEO Brad Anderson, to be more creative with the 2006 long-term incentive program. Specifically, Anderson asked Herman and her staff why the company couldn’t offer employees a plan that provided an array of options.

   “He asked why we couldn’t have an innovative incentive program to foster our innovative culture,” she says.

   To get a plan together for 2006 would require soliciting feedback from the 2,600 managers and executives who participated in the long-term incentive program, designing choices, getting board approval and communicating it effectively to employees–all by the end of September, a scant three months from Anderson’s challenge.

   That was the genesis of Best Buy’s choice-based incentive program.

   Companies have largely stayed away from offering flexible compensation programs because of the communications and administrative burdens associated with offering employees choice, says Jack Dolmat-Connell, CEO of DolmatConnell & Partners, an executive compensation consulting firm in Waltham, Massachusetts.

   A number of firms learned this lesson a few years ago when they rushed to offer this cafeteria approach with their benefits plans and couldn’t handle the administrative and communications headaches, he says.

   Another reason employers are hesitant to offer choice in their incentive programs is out of fear that if two employees receive different levels of rewards from their choices, the ones who received less could come back and sue the company, Dolmat-Connell says. “They are concerned about having a sense of equity,” he says.

   But providing choice is a great way to recruit and retain employees if it’s done right, Dolmat-Connell says.

   “Offering flexible compensation programs is important for workforce management because it recognizes that employees are in different places in their lives and have different needs,” he says.

Designing a plan
   Up until 2003, Best Buy relied primarily on stock options to retain and reward those 2,600 managers and executives. But the Minneapolis-based electronics retailer, like many employers, realized that stock options aren’t always the best retention tool, particularly during times of market volatility, Herman says. And the company knew that accounting rule changes were looming. The rules have since come to pass, and they require companies to expense options.

   With all that in mind, the firm wanted to try alternatives. So in 2003, the retailer replaced its stock option plan with a mix of performance shares, which employees would get if they reach specific performance criteria, and restricted stock, which are grants of shares that vest at the end of a given period if an employee remains on staff.

“Offering flexible compensation programs is important for workforce management because it recognizes that employees are in different places in their lives and have different needs.” –Jack Dolmat-Connell, DolmatConnell & Partners

   In coming up with a tailored replacement to this long-term incentive plan, Herman and her team had concerns about offering too much choice. They also wanted to know how best to explain the options to employees, so they teamed up with Ayco, a Saratoga Springs, New York-based communications specialist.

   The company also spent months surveying its managers and executives to make sure that the options it offered were the right ones, Herman says.

   “As we designed the plan, we were also working to get the communications plan together so that when the plan was approved by the board, we could start talking to employees right away,” Herman says.

   The final plan, introduced on September 30, 2005, offers participants four choices.

   Choice 1 is 100 percent stock options with a four-year vesting schedule and a 10-year life. Choice 2 is 50 percent stock options and 50 percent performance shares, which are based on the company’s total shareholder return compared with the S&P 500 over a three-year period.

   “The first two choices are catering to people who are willing to roll the dice,” Herman says, adding that the payouts are vulnerable to market conditions.

   The third and fourth choices are quite different. They are based on “economic value added,” a metric devised by Best Buy that uses an internal formula that changes from year to year. They involve the meeting of one-year performance targets, but employees can’t access the rewards for three years.

   Choice 3 offers 50 percent stock options and 50 percent restricted stock, which is awarded at the end of three years for performance measured against the company’s economic-value-added goal at the end of 2007. Choice 4 offers 50 percent restricted stock and 50 percent performance units, both earned at the end of three years, based on company performance against the economic-value-added goal at the end of 2007.

   It might sound like a lot of delayed gratification, but at the end of 2007, employees can clearly see what they will get three years later, Herman says.

Communicating choices
   Communicating these choices posed a huge challenge, particularly since employees only had from October 10 to 28 of last year to make a decision. Also, since Choices 3 and 4 are based on an internal metric, it was hard to explain to employees what that meant without giving away competitive information, Herman says.

   Ayco sent out e-mails and worksheets and offered a webinar and one-on-one phone counseling to employees to help them with the decision.

   Although only 25 percent of the employees eligible for the plan took advantage of the one-on-one counseling, a majority attended the webinar. By the October 28 deadline, 73 percent had made an election. The rest were defaulted into Choice 2: 50 percent stock options and 50 percent performance shares.

   A majority of eligible employees opted for Choice 1 or 2, while only 11 percent took Choice 3 and 2 percent chose Choice 4. Herman attributes this imbalance to the difficulty of explaining economic value added to its employees.

   “It’s hard to get people comfortable with a metric without giving too much information,” she says. To address this, the company is sending out quarterly communications about the metric to better explain it and will update employees how the company is faring.

   Time will tell whether the new incentive program will help retain the company’s best employees, Herman says. One pitfall the company may come across is that offering choice could actually create discord among employees, says Jude Rich, chairman of Rich Associates, a compensation consultancy in Princeton, New Jersey.

   “What happens when you have two employees who opted for different choices sitting next to each other and one has done much better than the other?” he says. “For recruiting, offering choice can be great. But for retention it could really backfire.”

   But according to a recent survey Best Buy conducted, so far employees seem to feel good about the offer, Herman says.

   Eighty-seven percent of respondents say they feel that Best Buy’s reward program is better than it used to be, and 99 percent say they understand the program better now than before.

   “Eighty-three percent say that offering choice positively impacted their decision to stay with Best Buy,” Herman says. “That’s a good sign.”

Workforce Management, April 24, 2006, pp. 42-43 — Subscribe Now!