This is a common question, especially for smaller companies, whose resources are limited. It’s certainly understandable for a manager to want to develop an incentive plan that only pays out of the company profits (if there are any). The first problem with this approach is it neglects to consider that for employees who are instrumental in generating revenue and margin for the company, individual performance-based incentive compensation should be an essential part of their compensation package (often as much as 50%) and not just a “nice add-on” to payout only when the company can afford it. You would not opt to skip their base salary payments if the company is below its goal, likewise you cannot “skip” their incentive payments. The second reason serves management’s self-interest. When employees believe that it’s possible to earn incentives for their individual performance, they will be motivated (assuming your plan has been well-designed) to work to earn those incentives and then earn even more. If you make it a requirement that the overall company must hit its goal before any individual incentives are earned, then you’ve created a hurdle that may feel unattainable and certainly will feel uncontrollable to the individual employee. When this happens, the employees are more likely to “just give up”, making attainment of the company goal even more difficult, and the short-fall even worse. It’s perfectly appropriate, however, to include a secondary or tertiary plan component based on company goal attainment, but even then the payout should begin at a level of performance that is somewhat below goal as this encourages more growth towards goal.
My employer thinks I made TOO much last year therefore he has a new pay package for me which caps my sales commission! I am paid a percentage of the profits from my sales…..how can I make too much?
Unfortunately, we don’t have a quick easy answer to make all employers rational sales comp designers. We have to just help the clients who want help, one at a time. That said, here are two principles that may be relevant:
- No caps. We rarely recommend a sales comp plan be capped – no need to take your top performers’ motivation out. But we do recommend deceleration at high levels of attainment, per-deal caps, caps on the % of margin on a deal that may be paid to the rep, etc. – these keep pay rational even in case of windfalls and large deals that were sold with “help” from company leadership.
- Over time, sales people generally should earn more money each year – with pay going up as the labor market rates go up (a few percentage points per year). In a well-run company, sales productivity should go up much faster than the labor market rates for the sales people due to the investments the company makes in broadening the product line, building the brand, selling tools and systems, etc. As a result, compensation plans that are communicated as commission (% of revenue or margin sold) generally have to be adjusted so that the payout rates decrease. That’s the only way the math works.
So… you are right that caps aren’t a great idea. But your employer may also be right that there should not be a linear relationship between your compensation and your productivity over the long run.
We generally recommend that rates decrease at a very high level of performance, well above goal. And the decrease should continue to hold the rate above the “base rate” (immediately below goal rate).
While this is not always appropriate, it should be considered when:
- The plans are goal-based and goal setting is “loose” so that some people achieve, for example, 200% of the goal. In this case, the high level of achievement could be due to a bad goal.
- The sales people sell very large deals, which could tend to make performance “lumpy.” Oftentimes these deals are closed with help from senior leadership in the company, and often also at a lower marginal profit. While it may be harder to close a $4M deal than a $2M, it’s probably not twice as hard (and it may not be worth twice as much to the company).
- The company has a history of capped plans. Deceleration is always much preferable to caps.
The other philosophical principle here is that you want to put as much money as you can right above goal so that the reward for getting to and beyond goal is the opportunity to live on a wonderfully accelerated slope. In fact, it’s great to put so much money there that the company would not choose to afford it indefinitely. So when you do decelerate, the rate is still quite attractive. This will serve to pull your OK performers up and over goal without causing an unaffordable high cost of comp.