Article

How to Develop a Management Incentive Program for Your Restaurant

Ask any restaurateur for the key ingredients of a successful restaurant and you'll probably get a litany of responses; however, one of the most agreed-upon responses will be this: to have a successful restaurant you need to have good management.

In an industry known for its "churn and burn" approach to employing managers, many restaurant organizations large and small are designing incentive compensation programs that treat restaurant managers more as entrepreneurs with a stake in how well the restaurant performs.

The reasons independents are employing incentive programs are much the same as those given by the chains. In a survey we conducted of our Web site RestaurantOwner.com members, several operators stated the following reasons for having an incentive program:

• "Our primary goal with this incentive program is to pull the management of the restaurant all together. We want them working closely together, making them [interdependent] on each other as to achieve company goals and standards."
• "I wanted my managers to think more like I do; like an owner."
• "We've found that our incentive plan appeals to the type of person who makes for a good manager. So it's been a very effective management recruiting tool."
• "With our incentive program, my managers see our numbers; all of them. They know what's going on and they feel more involved in making the restaurant work. I believe that's why we've had almost no management turnover since our incentive program started three years ago."
• "Our goal was to create a win-win. More motivation for managers to produce better financial results and a more profitable restaurant for me and my partners."
• "It (incentive program) puts the opportunity to make more money within their (the managers') control."
• "It (incentive program) fosters teamwork since everyone has to be on the same page to provide great customer service, great quality and watch costs."

So how does one go about deciding on the best program for their unique situation? First, remember that a good management incentive program should be a two-way street, accomplishing both the owner's objectives and keeping managers motivated (rewarded).

Operations guru and consultant David Scott Peters of Smile Button Enterprises strongly advises operators to include their managers when drafting an incentive program. "If they feel like they have no input, then the bonus structure can be a de-motivator," Peters says. "Managers need to 'buy in' to the program and understand that the goals set are achievable."

Performance Criteria

One of the most common questions operators have when contemplating a bonus plan is to ask on what performance standards they should base their plan. Peters suggests that operators first decide what is most important to them in terms of management performance. "Understanding how important an issue is to you will help you determine how much weight to give it within your bonus structure," Peters says. "If you're looking to reduce costs, then give extra weight to controlling cost. But if improving customer service is more urgent, then you might want to factor customer comments or secret shopper results into your incentive formula."

The most successful bonus plans incorporate more than one incentive criterion into the overall scoring formula. However, keep in mind that you want to keep your plan simple and achievable.

Generally speaking, most incentive criteria can be based on four distinct areas:

1. Sales
2. Cost control
3. Profit
4. Performance scores

Sales

Sales incentives are paid by attaining certain sales levels. Operators we talked to offered a variety of ways to reward sales increases. For instance, you may want to reward your general manager on the basis of achieving or reaching an overall sales goal. At the same time, you may also want to include a portion of the bonus for your bar manager for increased bar sales, or the kitchen manager or chef for increased food sales.

This same "top-line bonus" principle can be applied to other revenue centers such as catering, banquet or delivery. This could be on a weekly, monthly, quarterly or annual basis.

By including sales as part of the bonus calculation, you can avoid the pitfalls associated with incentives based solely on cost control, where there is risk that managers can become too short-term-focused on costs at the expense of customer satisfaction.

Cost Control

Since controlling costs is such a big issue for restaurateurs, it's only natural that most incentive plans are devised to pay bonuses based on how well managers keep costs in line. However, there is a huge difference between "cost control" and "cutting costs." As we mentioned earlier, if the incentive is based on getting the lowest cost possible, then the customer could suffer the consequences of the cost-cutting effort.

"I've seen managers that cut portion sizes, substitute with inferior product, and cut back on the schedule just so they could make budget and get their bonus. This is not the intended result of a good incentive plan," Peters says. "The plan should penalize the manager when actual costs fall below the ideal cost as well as when they exceed it." Peters says that's why it is so important that management "buy in" to the incentive program. They need to realize the relationship of cost control and guest satisfaction.

For this reason, operators should consider devising their plan around an "ideal cost" budget versus a fixed percentage or dollar amount. To get the ideal cost percentage for cost of sales, you should first determine the cost of each menu item based on current pricing. Next, multiply the cost of each menu item by the number sold during a given period (from your POS sales mix report). Finally, add the total cost of all menu items sold to get your ideal cost. (For a complete explanation of ideal costing, see "A Cornerstone of Good Restaurant Management: Recipe Costing Basics for Startup Restaurateurs")

The ideal labor cost for a restaurant can be defined as the least amount of labor it takes to get the highest level of guest satisfaction. If you're understaffed, guest satisfaction declines, and if you are overstaffed, labor expense rises. Most POS systems can track sales per labor hour or customers per labor hour, as well as hourly sale reports. Careful review and analysis of these reports can help you determine optimum labor goals. (For more information, see "Right on Schedule: Labor Scheduling Basics Right From the Start,"

Some of the more common cost control criteria include:

• Actual food, liquor, beer or wine cost as a percent of sales. Well-established restaurant concepts oftentimes have predictable sales and cost levels. In cases in which sales mix is fairly consistent, and product cost is steady, then setting a targeted cost-of-sales budget may be effective. However, if cost of sales for your particular concept is greatly affected by fluctuating product cost or sales mix, then a comparison of actual to ideal cost might be a more reliable measure of performance.
• Difference between "actual" and "ideal" cost of sales. Incentive paid if the difference between "actual" and "ideal" costs is kept below a target, often 1 percent to 2 percent of sales.
• Hourly labor costs. Incentives based on keeping labor costs at or below certain levels relative to sales volume. Chefs and kitchen managers often have incentives tied to the control of hourly kitchen labor.
• Prime cost percent. Incentive based on the combined percent of costs of sales and labor cost, the two most significant expenses of a restaurant.

Profitability

Ultimately, every incentive plan should be linked to profit. Some operators set a fixed percentage of profits to be available for bonuses. The distribution formula might be tied to how close management was to achieving certain sales goals or hitting a budget objective.

• Controllable profit. Incentive based on sales less cost of sales, less payroll, less controllable operating expenses. "Controllable" is significant because it represents a number that management has a direct influence on. Controllable profit is the amount of profit available before occupancy costs and debt service have been applied. Management has no control over occupancy costs and debt service; consequently, if these expenses are too great then they oftentimes eat up the controllable profit.
• Net income. Incentive based on overall profitability of restaurant. David Scott Peters suggests that there should be no bonus if there is no profit.
• Cash flow. Incentive based on the available cash flow (excluding depreciation and amortization expenses). Cash flow is a good indicator for tracking the ROI (return on investment). See "Case Study" below.

Performance scores

Some incentive plans factor in performance scores when calculating bonuses. There are a variety of performance-oriented measurements that can be used to evaluate how well management is running the restaurant. These include:

1. Secret shopper scores. Some operators make the payment of any incentive contingent on acceptable mystery shopper scores. (For more information, see "Take the Mystery Out of Mystery Shopping,"
2. Customer comments. Customer comment cards provide a good way to evaluate guest perception.
3. Health inspection scores. Most local, county or state health departments routinely inspect foodservice establishments for health and sanitation compliance. The inspectors then complete an evaluation and issue a report to the restaurant that some ordinances require to be posted in view of the public.
4. Unit inspection scores. This could include detailed inspections, performed by upper management or the owner, covering cleanliness, food handling, general employee and guest safety and maintenance and condition of equipment, building and grounds.

Crunch the Numbers

OK; now that you've identified various areas on which you could base your incentives, and you have a pretty good idea of what it's going to take to make the plan successful, how do you decide what's the best formula for your restaurant? As David Scott Peters suggested, determine what is most important to you first. Whether or not performance scores are important enough to be part of your plan, the bottom line is that every incentive plan is tied to the numbers.

Peters recommends that all bonus plans be tied to net profit. For instance, let's assume that an owner decides to set aside 10 percent of the net profits for a bonus program. The owner and managers jointly agree on what their targeted food and labor cost should be. They also agree that guest satisfaction and cleanliness of the restaurant is equally important as hitting their targeted costs.

In this type of scenario, Peters suggests that a weighted point system be used to calculate the bonus. Keeping it simple, the operator and managers agree that 25 percent of the overall bonus will be awarded for maintaining the budgeted food cost, 25 percent for keeping labor in line, another 25 percent for positive comment card responses, and the last 25 percent for getting a health inspection score of 90 or above. They further agree that management needs to hit their goals on at least two of the four areas or else forfeit all bonus money.

Look at the actual and budgeted profit and loss statement on this page ("Here's How it Works: Budgeting for a Bonus".) Let's say that $4,633 is available for the bonus program (10 percent of the net profit). Each (25 percent) section of the incentive plan would then be worth about $1,158. Based on the results, the managers would automatically earn at least half of their bonus simply because they met their agreed-upon budget objectives for food and labor cost. However, let's assume that the guest comment card results also qualified for bonus; however, one of the monthly health scores was below a 90, therefore they lose the 25 percent portion of the overall bonus. The resulting bonus for this quarter would then be $3,474 (75 percent of $4,633).

Now we're not suggesting that this is the perfect bonus plan, or that it will even work for your situation. Our intent is to illustrate one approach you could use when creating your plan. You may prefer to give a weighted value for increasing sales, or for maintaining a certain net controllable profit.

Get Started

There is no one incentive plan that works for everyone. There are, however, key characteristics of good incentive plans, as those that were pointed out by the survey respondents. Likewise, most incentive plans are based on similar performance results.

Peters offers these points of wisdom to consider before getting started:

• Make sure that your plan keeps efficiency at 100 percent. You can only squeeze so much in order to increase profitability; eventually you need to increase sales.
• Beware of creating a program that allows management to cheat on the numbers, such as overstating inventory, or throwing away an invoice. This is a good reason for considering a quarterly bonus system because it's harder to hide inventory padding.
• Bonuses should be tied to hitting agreed-upon management objectives. Managers must "buy in" to the program.
• Measure and report in a timely and accurate fashion so that management understands the numbers and trusts them.

If you put in place your bonus program so that it is a win-win situation, benefiting management and ownership alike, the results are sure to be a bonus for your customers as well.

Case Study: Description of Small Multi-Unit Incentive Plan

Here's an interesting approach to an incentive program, particularly if you own more than one restaurant or if you want to be more of an absentee owner. This operator owns five profitable family dining restaurants in and around a major metropolitan area. He has been semi-retired for some time and has considered selling out but his incentive program has allowed him to spend very little time being involved with the restaurants while continuing to provide him with a good salary and return on his investment.

Here's how his program works. Like many of the large chains, the incentive plan is structured to give the general manager (GM) a major stake in the success of the restaurant:

The owner pays his managers a base salary equal to about what they could make at a comparable chain restaurant in their area. Each GM's incentive is based on a 50/50 profit-sharing arrangement after the net income of their restaurant reaches a certain level. Here's how it's calculated.

First, every few years the owner has a formal appraisal conducted on each restaurant. He figures that if he can earn a superior rate of return by continuing to own the restaurants, he'll keep it. If not, he'll sell it. For example:

Let's say the appraised value of Restaurant 1 is $300,000. The owner says that if he can continue to earn at least a 20 percent return on the restaurant he'll continue to own it. If not, he'll sell it. A 20 percent return on $300,000 is $60,000. In this case, his baseline net income is $60,000 for him to earn his 20 percent return. After this restaurant earns more than $60,000 on an annual basis, he splits the excess with the GM 50/50.

The owner actually pays this incentive quarterly so here's how it would work:

It is up to the GM to decide what to do with the incentive. The GM can keep it all or can elect to share some portion of the incentive with the two other managers. He tells me some GMs keep it all; some distribute up to half of it with his or her managers.

The owner claims he spends very little time managing his restaurants. He meets with each GM at least once a month to discuss their financials and other issues and often that's it. He's had almost no GM turnover and says he constantly commends them on doing an outstanding job. He believes their motivation to perform well comes from the additional money they can make if the restaurant performs well and also from knowing the restaurant may be sold if it does not earn at least his minimum ROI goal.

Offering Your Managers an Interest in the Business

One strategy to reward top managers and keep them on board is to give or offer for purchase an interest in your business. You want to carefully consider this step, however, since this changes their status from employees to partners or co-owners. If you choose this route, make sure you confer with an attorney and CPA to help you structure the transfer. There are a number of tax and legal issues that need to be addressed, and you have to contemplate consequences that you might not have considered in the short term (e.g., what if the manager dies or becomes divorced, and his interests become entangled in probate or equitable distribution). We'll try to address this subject in detail in a future issue.

Eight Key Characteristics of a Successful Incentive Plan

In a recent survey of RestaurantOwner.com members, operators who praised their incentive plans as being successful shared some common elements. Although the details of each plan varied significantly, the following characteristics were essential to the success of their incentive program:

1. Simple and easily understood. The most successful plans were based on results of three to four key performance objectives for which the managers had some degree of control. The plan objectives must be easy to understand and the payment formula must be simple. Operators with incentive plans that had poor or mediocre results admit that they probably "overcomplicated" the program with too many details and payment provisions.
2. Mutually agreed-upon, achievable goals. Many operators with successful plans stated that performance goals in sales and profit are discussed with management and mutually agreed upon. The objective is to make the goals challenging, but at the same time, achievable and realistic. Make the goals too easy to achieve and managers can get complacent. Make them impossible to achieve and managers can get discouraged and quit trying. Particularly in setting sales goals, it's important to be realistic and come to a mutual conclusion on achievable objectives. Owners need to understand that sales planning is not an exact science and while sales objectives need to be attained, they are not "set in stone" since circumstances beyond management's control can influence the plan (Examples: 9/11 and Hurricane Katrina). Aaron Allen of Quantified Marketing Group puts it this way: "You can have the best bonus program in the world, but if you don't have people that can get excited and rally behind the objectives, it's likely to fail."
3. Cost goals based on "ideal" costs. In those plans where some part of the incentive formula is based on controlling costs, it appeared as though the most effective and fairest way to calculate the cost goals were based on an objectively determined "ideal" cost. While calculating "ideal" costs can take some time to set up, several independent operators proved it's possible. Once it's set up and understood by staff, it provides an accurate, reliable and fair way to evaluate management's effectiveness at controlling these costs. (Calculating ideal food cost entails calculating the ingredient costs in each menu item using current cost of ingredients and standard recipe portions and also the sales mix in each reporting period -- the "ideal" food cost is then compared with the period's "actual" food cost. Many restaurants establish a "goal" of keeping "actual" costs within 1 percent to 2 percent of "ideal" cost.)
4. Incentives tied to "top line" improvements as well as costs and bottom-line profit. Operators with highly successful plans indicated that some portion of their incentive payment is based on improving or maintaining high levels of sales activity. One operator's plan calls for funding the "bonus pool" with a specified amount of dollars each week based on the week's gross sales. The higher the weekly sales, the more dollars are set aside for potential bonus payout. As sales decline the potential bonus payout is reduced.
5. Monthly or quarterly incentive periods. Operators with annual programs with an annual payment cycle only appeared to have less success than those whose programs that were broken down to a four-week, monthly or quarterly cycle.
6. Accurate, timely reporting. Having a reliable, speedy accounting process in place before putting in place an incentive program appears to be very important. Several operators noted that interest and motivation from their incentive programs suffered because managers had to wait so long to get their numbers or that they lost confidence in the accuracy of the reports/P&Ls produced by their bookkeeper/accountants.
7. The incentive program is reviewed on a regular basis. Many operators with successful programs reported that they revisit the terms and goals of their incentive program at least annually to keep it relevant with current operating conditions.
8. Weekly progress meetings. Nearly all operators with highly successful incentive programs indicated that they had some type of weekly management meeting to evaluate their key numbers from the previous week. The previous week's numbers were evaluated in light of whether they were hitting their goals as established by their incentive program.

Here's How it Works: Budgeting for a Bonus

You might want to base your bonuses on several factors to optimize management performance. In this case, the operator allocated $4,633 for the bonus program (10 percent of the net profit), but divided that amount into equal four portions of $1,158. Let's say the operator agreed that the managers could automatically earn at least half of their bonuses simply by meeting established budget objectives for food and labor cost, which, in this case, they did. Let's also say that the remaining 25 percent portions of the total bonus were awarded based equally upon 1) guest comment card results hitting a targeted score and 2) all monthly health scores being above 90 percent. For the previous quarter, let's say guest comments were adequate, earning them another 25 percent portion, but one of the monthly health scores was below 90 percent. As illustrated above, the resulting bonus for this quarter would be $3,474 (i.e., 75 percent of $4,633).