Thoughts on Compensation & Incentive Based Pay

This is a blog post that I’ve been working on for a while and I finally got the impetus to complete it after reading a post by Clint Greenleaf, Founder of the Greenleaf Book Group.  To view a complete version of his blog entry for Inc Magazine click on this link.  

I started working on this blog entry when I heard about the new TARP restriction about caps on incentive based pay for Executives at Banks that had accepted federal bail-out money.  Turns out they are restricted from receiving any more than 30% of their base salary in bonuses.  The whole idea of the Government trying to put caps on anything really started to frustrate me simply because they have absolutely no place legislating incentive based pay at all.  

Before you stop reading now thinking that this is going to be a political rant give me one more moment to justify why I believe the government shouldn’t be involved in compensation conversations at all: last year, the Postmaster General received over $800,000.  For those of you keeping track, that’s well within the top 1% of all wage earners in the entire United States and about 40x above the Poverty Level.  Honestly, I wouldn’t be upset at all if the pay was justified but when you look at the real numbers, he earned nearly $1m (and 4 other execs earned $250k+) while the US Postal Service: (1) has a government guaranteed monopoly on First Class mail (2) has discussed reducing the delivery of mail by a day to reduce costs and (3) lost more than $3 Billion last year.  

Going back to the original premise of being more than a little irritated by the Government’s desire to cap incentive based pay for Bank Execs: aren’t they looking at the wrong data point?  Instead of worrying about people making more or the same amount as the Vice President or President Obama, why not reduce base pay by 80% and place absolutely no cap on performance based bonuses that are driven through the execution of behaviors that will drive great results.  To let a bank choose to pay a top Executive (who in the case of a company like AIG or Citibank are essentially government employees) $500,000 in base pay is what’s so wrong, in my opinion. 

I mentioned Clint Greenleaf’s post at the outset and want to bring that back into the forefront.  Clint points out nicely that there are certain roles inside of an organization that make it very easy to incentivize employees.  The easiest example is Sales.  But even with Salespeople, companies rarely get it right.  Here’s a real life example: 

Acme Widget Company: Sales Rep – John Doe

• Base Pay: $80,00
• Average Sales Price: $100,000
• Quota: $400,000 per year
• Gross Margin: 50%
• Net Margin: 30%

John receives his commission from Acme based on Gross Revenue.  He’ll receive a 5% commission on his sales for 2009 regardless of if he hits quota or not.  Let’s assume he hits exactly his quota and they’re at the target numbers as stated above: 

• Base Pay: $80,000
• Commission: $20,000
• John’s Total Compensation: $100,000
• Company Gross Profit: $200,000
• Company Net Profit: $120,000
• Real Company Net Profit: $20,000 (taking out John’s compensation)

It’s rare, however, that salespeople who are incentivized and paid commission on Gross Revenue are ever going to be worried about preserving margins.  If you’d like to determine if this is true I’d encourage you talk to anyone you know who’s been a sales manager in their career.  

Let’s change around John’s production now and assume that he EXCEEDED his quota by 25%.  Instead of selling $400,000, he sold $500,000.  What a banner year!  Most companies would name him to the President’s Club and reward him with a trip!  But instead of selling 5 deals as in the statement above with the target price of $100k, John brought on 7 new clients with an average purchase price of about $71,500.  Let’s look at the impact that his Commission Structure had on his wallet and then the Company’s:

John’s Total Compensation:

• Base Pay: $80,000
• Commission Paid: $25,000 (5% of Gross Sales of $500,000)
• Total Compensation $105,000

Company’s Profit on John’s Sales:

• Gross Revenue: $500,000
• Gross Profit: $150,500 (Gross Profit reduced from 50% to 30% because of price cutting)
• Net Profit: $10,500 (Net Profit reduced from 30% to 2% because of price cutting)
• Real Net Profit (Loss): ($94,500)

By incentivizing the wrong behavior, John’s employer celebrated his victories and got excited about being able to really bring in lots of revenue.  But the real impact on the company is that John is quickly driving them into the ground because of his inability to sell in a competitive environment and maintain pricing. 

I find myself talking to CEO’s every day who are grappling with this, especially in this economic environment.  They look back on the previous performance of their sales team and they give credit where it simply isn’t due to sales reps who are successful simply because they haven’t quit yet (they’ve inherited the clients of former employees, answered the phones when people called in looking to buy, etc).  Even crazier, other prospective employers look at guys like John and see annual awards, a history of beating quota and a guy with lots of industry contacts and start to drool.  

Incentive-based pay is one of the greatest levers you can tweak to really drive the kind of behaviors that you’re seeking but unless you’re thinking about it the right way, they can absolutely cause your demise.  

Do yourself and our Country a favor, if you have any friends in leadership positions with the Government who would benefit from reading this, forward them the link.  It’s not exactly Tea Party-style rebellion but someone needs to say it.  We’re incentivizing our Federal and State employees to not do anything to rock the boat, spend money with reckless abandon to ensure re-election of their bosses, and spend at least 100% if not more of their annual budgets to ensure that they don’t get their pay reduced the next year.  Anyone else see a problem with this?

Here are some additional resources: 

1. Dave Kurlan on How to Get Salespeople to Perform
2. Sandler Sales Institute on Why Salespeople Fail
3. Jack Daly on Understanding the Personality of Salespeople
4. Dave Kurlan’s Free Salesforce Grader

Tags: AIG, barack obama, Baseline Selling, by the book blog, Citibank, Clint Greenleaf, commission, Compensation, Dave Kurlan, david sandler, federal bail-out, federal employees, government employees, gross revenue, hiring, Inc Magazine, Incentive-based pay, incentivizing salespeople, Kurlan, net profit, OMG, Postmaster General, president's club, talent acquisition, TARP, topgrading methodology, understanding the salesforce, US Postal Service