10 Apr What Makes Incentive Compensation Work?
There are many different ways to compensate and reward employees: commissions, goal-based incentives, bounties, MBOs, time-off, pizza parties, etc. In some organizations a pure commission model works the best, whereas in others, a goal-based incentive model works best. What makes the difference? How can one be “right” for one organization and another right for different organization?
Before answering this question, let’s review some basic compensation methods: Commission vs Goal-based incentive (sometime called a “bonus”). Both are valid and lucrative ways to provide variable compensation to employees that reward and motivate additional effort and results. A commission, in the true sense of the word, calculates incentive pay as percent of profit or revenue. A goal-based incentive calculates incentive pay based on a formula that connects percent of goal attained to percent of target incentive. Under a commission model, the mathematical relationship between performance and pay is fixed, e.g., 15%. Under a goal-based incentive, there is no fixed mathematical relationship between performance and pay, ensuring management can pay enough to attract the right talent, but not more than is necessary or economically sound. Another key benefit to a goal-based incentive is it allows for the blending of different types of accounts into one portfolio goal. Many brokers who use a commission model find themselves creating different deals for house accounts, inherited accounts, or sole sourced accounts. Under a goal-based method all of these can be thrown in to one bucket as you are not paying a rate on volume, but an incentive for attaining specific, defined, growth objectives.
Either approach, commission or goal-based incentive, can be used successfully in an organization but there is one ingredient that must be present to really achieve the full bang for the buck: GOALS. You can use a commission model that changes the percentage rate paid after different performance tiers are reached, or you can use an individually customized goal-based incentive. In either case, you must be very clear about three things:
- What performance level constitutes the minimum to justify incentive pay on top of salary
- What performance level constitutes “doing the job to the level of management expectation”
- What performance level constitutes “excellence”
Once you define these three most important break points, you can sub-divide if you like to five or seven or more tiers, but the number of the tiers isn’t what matters. There are only three things that matter to make any incentive plan more effective than it currently is, once you have defined the goals.
1) Communicate the goals to your staff
2) Ensure something positive happens when a goal is reached
3) Reinforce the plans through dashboards, meetings, feedback and general management oversight
Let’s look at each one at a time.
First, communicate the goals to your staff. This is a common failing among pure straight-line commission organizations. The plan is “set” so management has never indicated to the staff what “good” looks like. Instead, each person decides for him or herself how much money they want to make and they produce that amount. This may or may not align with management needs or expectations. Upper level management may be wondering why overall corporate goals are not reached, but it’s not too hard to see why if the goals have not been cascaded and communicated to the team.
Second, once you communicate the goals, you must ensure their attainment matters. Something must happen or be different when goals are reached or not reached or your staff will take your communication of them as just more corporate white noise they can ignore. Pay should increase at a higher rate above goal, and decrease at a faster rate below goal. You can do this with a commission plan by simply paying a lower rate below goal and a higher rate above goal. The rates must, of course, make economic sense, but the thing that matters the most here is THE GOAL. Also, you need to be willing and able to adjust the goal over time to reflect changing business conditions and expectations. It also gives you a way to manage house accounts and gifted accounts…RAISE THE GOAL.
Third, the plans require continual reinforcement. ALL..THE…TIME. Staff members are pulled in thousands of directions every day and they pay attention to that which is in their face. A customer problem to be solved, or their own personal issues, will occupy significant brain space. Their compensation plan needs to be something they think about more than just on pay day. You want them trying to game the system (if you’ve build the plan right) as then they are investing BRAIN SPACE into making the incentive plan work for them. They are thinking “If I do more of X, then I will get more of Y and that will lead to more money in my check.” You want this type of thinking and you need to reinforce it, encourage it, reward it, and guide it. Teach them. Help them understand how to make the plan work for them.
For those of you who have read my book (or previous articles) you know that I’ve used incentive plans on my kids for their school work. I’m 2/2 now on kids getting into their top choice of university with hefty scholarships and honors college or special program admittance. After the acceptances and scholarships came in for kid #2, a number of my friends asked for “my plan.” They wanted to put it in place for their kids. This made me consider…did I have a “magic plan?” Were the numbers on the page the thing that made the difference? No. Not at all. What made the difference is I set up a mechanism that required me to talk to my kids REGULARLY about their school work (for this last one I calculate her pay every week), and enabled me to provide guidance on how to do better. They may not have cared especially if doing that extra credit moved them from an B+ to an A-, but when I showed how that shift would impact their PAY, then all of a sudden the extra credit mattered to them A LOT. What made the difference as not the formulas I used, or the amount I paid, it was that I RELIGIOUSLY checked their grades every week and talked to them about any problems. I made sure they got on teachers who had forgotten to enter a grade or missed marking an assignment that had been turned in (happens a lot, unfortunately). I knew the minute something started to go bad and I pushed them to self-advocate.
Managers need to have this same mechanism as an excuse to guide, monitor, adjust and above all TEACH how to do the job better. What matters the most? Is it driving a hard bargain on one particular load, or providing exceptional customer service when a customer is in a tight spot (extra credit). Employees need you to tell them what they need to do, and you need to make it directly matter to them when they do it well. It doesn’t have to always be a monetary reward. Public recognition can be very powerful for some people (but embarrassing for others, so know your staff). Promotions and salary increases can also be good rewards, but they happen less frequently than incentive pay typically does. The key is, as with so many other things in life, frequency and consistency. Stay on it. Don’t let up. Make it matter.