The aggregate cost model projects the cost of the new compensation plans at different levels of business performance, and compares that cost to prior year costs. This simple example also includes some useful ratios of the cost of compensation as a percent of revenue, and per headcount. Depending on the critical business drivers other values may be included in the comparison or scenario creation such as:
- Gross margin
- Unit volume
- Detail by division or product line
- Specific large customer scenarios
Expected cost of variable pay > total variable pay at target
- This is an important concept, and often overlooked. If your plans have accelerated payout rates over goal, then the total compensation earned by two people, one at 90% of goal and the other at 110% of goal would be greater than the total compensation earned by two people both at 100% of goal. If you look carefully at the example above, you’ll see that variable pay for “All at Goal” is 48M while the expected cost if the organization hits 100% of its overall goal is 52M. The reason for this difference is acceleration.
- Another consideration in this modeling is over-allocation of the goals. If the sum of all individual contributor sales goals is 5% greater than the annual operating plan, then average goal attainment of 95% would yield sales at 100% of the organization’s goal. This common practice often offsets the increased compensation from acceleration.
- But whether these two situations offset each other is totally a function of the shape of the payout curve (and amount of acceleration), the dispersion in performance against goal, and the amount of over-allocation. Only careful modeling will accurately predict the outcome over a range of organizational performance scenarios.
While the summary is relatively simple and usually fits on one page, the modeling and analysis behind it can be quite complex, and includes the results of the incumbent model in which the effects of the new plans on each incentive-eligible individual are modeled and assessed. View a sample incumbent model here.