Managing Incentives

Incentives come in many different types, but all are drafted with the belief that offering an incentive will motivate behavior in a way that will provide a reasonable return.

For example, offer one salesperson a five dollar bonus for every blue widget they sell and a different salesperson the same amount for every red widget they sell, chances are very strong that the former will sell only blue widgets and the latter only red widgets. Everyone agrees that incentives work. However, there is no universal agreement as to what specific incentives work or how often to pay them. Most executives would like to pay incentives as frequently as would be effective. Some might also agree that with proper incentives, you can do better than issuing improper incentives. Then the question becomes how to measure the value of proper incentivization? If you accept that some compensation and incentive plans are better than others, how can you determine how much better? The Key Groups in Sales Performance Management The answer to the above question depends entirely upon which decision-maker you ask. In Sales Performance Management SPM-, there are three groups with a strong interest in this question: sales and financial directors and incentive recipients. These groups are often in tension when it comes to the management of incentives. Sales executives want the ability to reward performance with some measure of flexibility to overrule logic and reward perceived effort. They want maximum flexibility to react to market trends and unanticipated changes in the business climate. In addition, they will break the rules if doing so will enhance profitable revenue. Financial directors are less concerned with flexibility. They want cost control, accuracy, reliability and predictability in payments. Where adjustments are necessary, they should be captured quickly. Payments should be regular and follow patterns that make it easy to audit. Expectations of timeliness must be upheld. This group also works with the data that proves incentive payment figures affect overall financial performance. Recipients want the ability to calculate their commissions, influence their results and get paid in a timely manner. Incentives are easier for a salesperson to attain when they feel confident that they can meet or exceed an objective. They look at plans with an eye toward how they will focus their energy for success. If there are ways to cheat the system for extra earnings, some salespeople will exploit the ability to manipulate results. If plans are simply unattainable, they will have little or no motivation. In short, clearly set expectations plus incentives drive behavior. Finance and sales directors especially have multiple points of tension where their goals will diverge and it is critical for these groups to agree upon incentive management tactics and strategies. The common framework of the modern corporation is to apply Return on Investment ROI- calculations. Applying ROI calculations around incentive and compensation management can simultaneously direct performance behaviors and drive company revenues in positive directions. The ROI Calculation of Incentives ROI is a mandatory and overused term. Most every initiative requires an ROI calculation but often the calculation is very difficult to gauge especially with incentive and compensation management. Why? Because different groups of sales and finance leaders in the equation have different, sometimes conflicting, points of view about what is valuable and how that value can be achieved. In order to approach ROI in a logical manner for incentive and compensation management, we have to subdivide incentive compensation into manageable areas that can be analyzed based on how value is created and enhanced. Then it is easier to define ROI around the solution. An incentive compensation transaction has four basic components that deal with who, what, when and how incentives get paid. These include credits, measurements, deposits and of course, incentives. Credits determine who receives compensation. Measurements refer to what gets incentivized and deposits refer to when incentives are paid out or accrued. Burdened by objective and subjective variables, measurements and deposits take the most time to agree upon internally. Incentives define how compensations ultimately will be paid. There are SPIF s, bonuses, commissions and many methods of defining how compensation will be distributed. Incentives are the critical vehicle for enabling full execution of comp plans. Mapped to financial calculations, incentives tie into the business rules that drive them. Company X, Agent Z and Other Scenarios Sales executives introduce an incentive to motivate behavior. A simple example would be a store that is offered a 10% discount by a manufacturer if they sell 100 units within 30 days. The sales director could offer up a 9.99% commission for the sales team if they sell over 100 units of the product within 30 days and still make .01% additional revenue for each unit as opposed to no additional revenue. Following the same simple example, suppose now that a different manufacturer offers a 5% discount for selling 50 units within 90 days. Here, the sales director has 90 days to move a smaller number of units but has a lesser percentage to offer as incentive. Of course, if the base value of the second example is much higher than with the first example, this will impact the sales director s plans. With even two simple examples, it is easy to see that the sales director needs decision-making support to determine the proper route to take with the sales team. If compensation plans are only formulated annually, there is minimal flexibility to leverage opportunities derived from manufacturing incentives. Of course, there are other examples that illustrate the dilemma of the modern enterprise. Suppose that Company X is a retailer in California and buys widgets from China on a monthly basis. If the currency exchange rate fluctuates, it can affect the profitability for goods. A sales director has the power to incentivize in reaction to this type of fluctuation. A modification could result in increasing revenue by taking advantage of the fluctuation. In a different context, an insurance company manages a network of agents. There are set residuals and commissions for set packages. The agency relationship is normally contractual and includes various provisions for hitting additional incentives, or receiving reductions due to cancellations. Agent Z normally receives a commission of five dollars on the last day of each calendar quarter for having sold a specific life insurance policy. The insured cancels the policy. The insurance company has a loss of four dollars for the quarter. The following quarter the deduction is counted. The insurance company has a profit of 100 dollars for that quarter. One transaction would have been quite useful for profitability in the previous quarter. This is a case where timing of the deduction has an impact. One further example is a financial services institution that acquires a new subsidiary. The subsidiary had operated in several territories that had not been covered by the acquiring company. With no additional overhead, the sales director has an opportunity to generate revenue if he offers modified compensation plans for his entire existing and new teams to take into account opportunity in the new territory for existing products and in the old territory for new products. However, the sales teams have no practical training in their mutual product sets. That means that some products will have limited success if incentivized too soon, depending upon the marketplace. The acquiring company does an analysis and determines that they are generating ten dollars per salesperson out of the acquired company. Of those ten, nine are from the pre-existing offerings of the acquired company. The sales director determines which offerings are generating the single dollar from the parent company and provides specialized training related to it, resulting in two dollars of output instead of one. In this case, 11 dollars per salesperson is balanced against the internal cost of the additional training. Investing in Incentive Management Technology For a small or large company with very simple requirements, the ROI is often sufficient to justify working out incentive scenarios on a manual system. However, for a mid to large-sized company in a competitive industry like financial services, insurance, telecommunications, technology or pharmaceuticals, the manual system has an extremely poor ROI. One level of corporate investment in incentive compensation processes is partial automation and the use of non-integrated software to store and translate information. At this level, spreadsheets or simple databases come into prevalent use, along with data warehousing, ERP and CRM systems. Using a valuation calculus, there is better ROI for this type of solution than completely manual, but there are still the same list of limitations and inefficiencies that limit the ROI for this type of environment. As an example, the error rate on incentive compensation for partially automated systems is roughly 3-10%. Environments differ on level based on multiple factors so there is no ability to assess an actual number without careful analysis. Total integration and automation is the final step in the evolution of the incentive compensation process. At this stage, an integrated process can carry an incentive and compensation plan from definition through to actual payment. An authorized person could query the system, determine the state of any participant on any plan, alter schedules, modify plans and count on controls to ensure no rule violations, data-entry errors or other basic inefficiencies are introduced into the system. Error rates on a fully integrated, automated system approach .1%. They also feature much more efficient response times to eliminate errors. Thus, an organization with appropriate requirements can realize between 2.9-9.9% ROI, on average, over their original system. Of course, these percentage points must be offset by any additional software, hardware and training expenses. In a majority of instances, there is still an ample business case for making a change. Incentive Management Drives Revenue Additional profitable revenue is a pernicious area to measure because by definition there will be added incentive compensation expenses. One of the key metrics is tying revenue directly to the associated incentive plan. Very few organizations have advanced to this stage of analysis because of either a lack of empirical data available, integrated processes, or of a belief in the ability to influence revenue proactively through incentive compensation analysis. In cases where the effort is made, it can influence revenue by several percentage points of the overall revenue derived from incentivized activity. For example, a company paying out ten dollars in incentive pay as a 10% bonus of revenue generation would have 100 dollars in play due to incentivized activity. Optimized incentivization could drive revenue to much higher levels, but a conservative figure would be 1% of total corporate revenue. A company analyzing incentive compensation properly, then, could raise its overall revenue from 100 dollars to 101 dollars. At the billion-dollar level, this represents a minimum of ten million in added revenue. Of course, analysis may yield much better results. The only thing it will not do, if applied correctly, is hamper results. The modern global enterprise handles so many diverse environments and changing conditions that analysis, even rudimentary, is highly valuable if accurate. Unfortunately, most enterprises have a lot of inaccurate data due to changes that are not replicated throughout every data repository. This is especially true of sales, where figures may involve multiple channels. Hence payment can become very complex and difficult, especially on short timescales. Measuring the Incentive Management Delta with Statistical Analysis Since many vendors and salespeople derive their primary income from incentives, there will be revenue generation even with a very flawed plan. The key to creating value is determining the ability of a properly set, communicated, and paid upon plan to influence corporate profitable revenue. There is a delta between a randomly generated plan and one that helps the recipient reach their maximum potential. How can we measure that delta? Statistical analysis is our best tool. Applying analytics can assist in identifying the trends, correlations and predictors that affect this measurement. For example, different statistical algorithms may demonstrate a positive correlation between different product sets and a specific market. Marketing and sales tend to use these types of analyses to drive pricing and offerings already, but this is a different, specific application. The maximum potential of all incentive and compensation recipients is a combination of training, experience, comfort, market conditions and competitive environment. Incentive compensation plans are often reactive, being set after work has been done that will be assessed. These types of plans have almost no value in terms of reaching maximum potential. They also do not fight attrition. Recipients often compare offerings from different firms to determine what plan to pursue, whether under an employment contract or as a vendor. Simplicity is one facet of this calculation. Only recently have advances in SPM technologies enabled the realization that incentive management not only drives performance, but ultimately revenues. Certainly enterprises are addressing incentive compensation issues annually, at a minimum. It is the quantification and qualification of ROI that is advancing rapidly and giving the relevant leaders the necessary justification to proceed with modernization and innovation in this field. Leaders in telecommunications, technology, insurance, retail, pharmaceuticals and financial services are all seeking greater competitive efficiency. Incentive compensation is an area that has an immediate and lasting impact on revenue. It is worth quantifying the ROI and taking steps to optimizing your current capabilities, if you want to stay solid in increasingly complex, global environments. Source: