Incentive Compensation Awards in Large Life Sciences Organizations Still Focus Too Heavily on Financial Results

Out of focus: Long- and short-term performance metrics seldom focus on sorely-needed product or process innovation

PHILADELPHIA--(BUSINESS WIRE)--Large life sciences companies—traditionally known as “big pharma,” though some have diversified beyond their pharmaceutical roots—remain caught in a metrics morass that may be preventing them from confronting new market realities. While the changes in this arena have been well documented—from the fallout of the patent cliff to the rising power of payers in the marketplace—this group is moving “way too slowly in changing the way it measures the performance of its top executives,” according to Hay Group Life Sciences Global Managing Director, Ian Wilcox. The result: “Both the organization and its stakeholders are getting a business-as-usual message in the middle of the greatest transition this industry has faced in the last 50 years.”

“While no one is suggesting that large organizations ignore financial measures in their executive reward programs, these kinds of metrics certainly fall into the ‘rear-facing’ or ‘lagging indicator’ category”

Most media coverage of executive performance “metrics” focuses on the gaudy levels of compensation levels that these industry leaders are awarded. In times like these, when short-term profits and long-term growth in many industry stalwarts may seem to be imperilled, the rumblings over supposedly excessive compensation at the top will naturally crescendo. But this may not be the right focus of contention.

“It’s not that these numbers are not a valid topic of discussion,” says Hay Group’s Irv Becker, U.S. National Practice Leader for Executive Compensation. “However, we think the discourse here should start with the actual performance metrics themselves and not with the amounts of cash and stock they may yield.”

Design Flaws

Hay Group has identified three major design flaws that plague many of the large life sciences companies, even as they struggle in the throes of change:

1. Metric overlap. Many incentive metrics often appear in both long- and short-term plans. In a sample of these large organizations, 78% overlapped two or more measures. “In effect this often means 'paying twice' for the same performance,” says Becker.
   
   The most commonly overlapped measure was Sales growth; the most commonly overlapped pairing was Sales and Earnings Per Share.
2. Over dependence on financial measures. In the short-term (annual) incentive plans that we examined for executives in the larger life sciences organizations, financial results accounted for 64% of the payout opportunity. In contrast, midcaps/biotechs focus much less of the short-term incentive on financial results—with this measure accounting for just 41% of incentive opportunity.
3. Lack of operational emphasis. In larger organizations, operational measures—such as the management of the organization’s portfolio of products, its pipeline process, its talent pool, etc—was weighted at just under 15% of total incentive opportunity (with the remaining opportunity of just over 21% assigned to performance on strategic measures).
   
   Again, in contrast, midcaps/biotechs weighted operational measures at 47% of opportunity.
   
   “While no one is suggesting that large organizations ignore financial measures in their executive reward programs, these kinds of metrics certainly fall into the ‘rear-facing’ or ‘lagging indicator’ category,” says Hay Group’s Becker.
   
   Adds Hay Group’s Life Sciences Global Sector Leader Wilcox: “A fundamental rethinking may be wise—especially in an industry that increasingly will need to prove the value of its products to payers and patients.”

Some more progressive than others

Of course, performance measurement practice within the industry is not quite monolithic. Some life sciences organizations in our sample have begun to deemphasize “financials” in their incentive metrics—with several showing a 50-50 split between financial and non-financial measures. In one of these, non-financial categories include improving the innovative core, reputation, people and culture. Over the past years, this organization’s TSR has greatly outpaced most of its pharmaceutical peers.

However, an equal number of these organizations fall on the far end of the incentive spectrum—not only with between 75% and 100% weighting on financial measures, but a narrow focus on the most traditional financial measures: EPS and Sales.

Looking ahead

In and of themselves, pay programs will not produce the novel therapies or products or new organizational structures best suited to confront the changing realities in the life sciences marketplace. But by encouraging executives to place innovation much higher on their list of priorities, these programs can begin to redirect their efforts—not to mention sending an important message to the entire organization and even external stakeholders.

According to our research and experience, early biotech and emerging biopharmas, admittedly with more flexibility and in a somewhat different market position, are showing the way here – not just paying for financial “performance” but paying for new and innovative technologies and products and processes.

As change envelops the life sciences industry—with the largest and most entrenched entities perhaps facing the biggest challenges—it appears that the most forward-thinking leaders are beginning to break the mould of insularity and looking outside their organizations for new approaches. Not just to their smaller bio-tech cousins, but to other industries as well. And certainly not just in the area of performance metrics, but to all areas under their purview. But what an organization measures and rewards certainly is an important factor in creating and maintaining an internal culture of success.

For more information, or to interview one of Hay Group’s Life Sciences experts, contact Mitch Kent at 215 861 2315, [e-mail].

About Hay Group

Hay Group is a global management consulting firm that works with leaders to transform strategy into reality. We develop talent, organize people to be more effective and motivate them to perform at their best. Our focus is on making change happen and helping people and organizations realize their potential. Visit www.haygroup.com.

Follow us on Twitter: @hay_group