Tag Archives: Thresholds

How should we build a payout table for very small goals, or goals that could go negative?

This one is tricky since the usual percent of goal type payout table just doesn’t work in these situations. For example, if a small business had a business plan that included an operating loss of $200,000 for the year, putting together a payout table to reward for this “success” would not work if the mechanics were communicated as a percent of the goal, which might be restated as

Goal: Operating Income = -$200,000

To build the payout table, we’ll need threshold and excellence performance levels, a target payout, and a leverage factor.

Threshold = -$400,000

The Threshold is the level of performance below which no payout is earned. Usually the goal is aligned with the annual operating plan. No payout at all below goal means goal setting precision must be very high. A modest payout as goal is approached is often a better design.

Excellence = $0 (breakeven)

In this case where a loss is expected, it may be the case that breakeven would be a fabulous result for the coming year. If so, a handsome reward could be delivered at that point.

Target Incentive = $10,000

Someone reading this is thinking that it’s hard to pay an incentive to reward someone to deliver a loss. And clearly this is not a sustainable business model for the long run. But in come-back situations, or years of investment, it may be a great idea to have those who influence the outcome with compensation at risk, along with upside, for delivering against the annual operating plan.

Remember that we’re talking about sales compensation here, so the assumption is that the incentive pay is true at-risk pay, not over-and-above pay. The person with this incentive opportunity has put some portion of their market value at risk with the expectation that they do influence the outcome materially, and that when they do a great job they could earn back all that they have put at risk, and then some.

So what does the payout table look like? Here’s a sample:

Annual Operating Income Payout
Better than break-even (positive OI) $20,000
$100,00 loss to break-even $15,000
$200,000 loss to $99,999 loss $10,000
$300,000 loss to $199,999 loss $5,000
$400,000 loss or worse $0

 

 

 

 

 

When is the use of a threshold a good idea vs. paying on every sale?

A threshold is a level of performance below which no variable pay is earned. If a plan has no threshold, then earnings start with the first sale (sometimes referred to as “first dollar plans”). If there is a threshold, then some level of performance must be attained before any variable pay is earned.

The question of whether or not to have a threshold is largely philosophical, though one could make a case that there is some relation to pay mix, in that a higher base salary would pair with a (relatively) high threshold  and a lower base salary would pair with a lower (or no) threshold.  For plans without a threshold, it is likely that  a substantial portion of the incentive that is paid from the first dollar is actually a “phantom base salary,” acting much like fixed compensation, and therefore not truly variable (or motivational).

It makes good sense to consider no-threshold plans for…

  • Roles with low base pay as a percent of total compensation at target
  • New business roles without any existing book of business to manage
  • Roles in which compensation is calculated by transaction or deal (not aggregate results)
  • Roles in which it is important for the sales person to have a clear understanding of the comp value of any proposed deal.

Is makes good sense to consider a plan with a threshold for…

  • Account manager / territory manager roles with an existing book to manage
  • Established/mature markets where growth is a priority
  • Roles with good historical performance data enabling management to confidently set the threshold so that 90% of sales people are likely to exceed it
  • Roles measured on aggregate performance measures (e.g., total sales, or total margin value) vs. deal/transaction-level measures.

Tips for picking the right threshold if you’re going to use one

If a plan does include a threshold, we generally recommend that the threshold be set so that no more than 10% of reps are performing below threshold.  Some organizations tie the level of the threshold to a base salary, or the fully loaded cost of an employee to the organization (which is often a multiple of the salary in the range of 2-2.5x times to account for benefits, overhead, etc.), expecting the sales person to “fully recover” their cost before additional (incentive/variable) compensation is earned.  However, this approach leaves little flexibility for times when the company needs to deploy a resource to sell a new product or service, or to build a new customer market.

While calculating the marginal cost of the next sale, or the next sales person, can yield good insights, it’s better to think about the overall cost of compensation as a system (total employee cost divided by total productivity) than at the person by person level.  This will enable you to set a threshold (or not) based on the minimum productivity that is acceptable given the different key accountabilities, and goal-setting confidence, for the different selling roles.

Why should I pay incentives to my employees when the company has not hit its overall goal?

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.