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.
(This was a question from an IT services company, but the ideas apply to other industries as well.)
When you think about it, it’s true in just about any sale that the sales person must be part of a team that has:
- the right offering (services staff, right skills, right organizational capacity, …),
- the right delivery system (tools, processes, methodologies, management structure, …), and
- the right business model (pricing, contracting/terms, contractors vs. employees, …)
to create perceivable value for both the customer and the company. So why do the sales people earn variable pay while the others vital to closing the sale (and delivering the value) not earn variable pay?
The answer may be that some of the others do earn variable pay. But more often the answer is that the sales person’s own individual value creation is reliably measured in terms of sales closed (order value, margin value, hours booked, etc.) than that of others on the team, AND the sales person is interested in placing a meaningful portion of their at-market compensation at risk (20% to 50% is typical) in exchange for the opportunity to double or triple the amount risked if they are able to put together a banner year. That’s the basis for much of “sales compensation” as we see it today.
So, even if “it takes a village” to make the sale, the hunter who finds the opportunities, identifies the decision makers, puts together a strategy to win the business, and coordinates the internal team often has both risk and upside in their compensation plan tied to the results they manage to produce in order to encourage and reward their success.
Many of the other vital technical or industry expert contributors may also see the value they help create and express an interest in sharing in the upside – but they often are not interested in putting a meaningful amount of their compensation at risk.So while you may choose to offer spot awards and/or recognition to those non-sales associates who make a great contribution to closing an important deal, that’s not the same as pay at risk, a structured incentive plan, and exciting upside for the “stars.”
A few key principles may guide you here:
- Be clear on how much and for what measures the managers involved can “move the needle,” with a direct effect on the company’s financial results. Product Managers could be measured on product line gross margin or operating income, with a similar measure for Program Managers, for example. But make sure the measurement and reporting systems will support robust measurement of their results.
- Be sure you have enough incentive to actually motivate and drive behavior towards the results you want. Anything less than about 15% of target cash compensation may not be worth the cost of designing, reporting and administering the plans (in terms of the effect on results). This can be tricky if you are offering incentives for the first time as you probably don’t want to reduce base to fund them. If you can redeploy budgeted money from a broad-based employee incentive plan to help fund it, you can bring the pay mix in line over time through reducing the increases in base and putting them towards the variable portion.
- Be careful with target setting. You need to aim for about 60% of your employees on variable pay plans to be at or above target, or it won’t motivate much.
- Offer enough upside. If you are putting people in an at-risk pay situation, possibly for the first time, you need to be sure a few people really ring the bell and get a handsome payout (1.5-2.0 times the target incentive), and publicize and celebrate these successes — it helps motivate everyone.
- Be sure the people in the role have the risk profile to find this motivating (or that that is the sort of person you want in the role, and are willing to make the needed adjustments). Not all solid employees are “coin operated.”