Beth Carroll | Prosperio Group
For those of you following along, we have recently concluded a four-part series on “The Economics of Commissions.” There is also a fifth article that belongs with this series from September 2019 called “How to Have Your Reps Really Make Bank.” It may be a good idea to go back and review these articles before starting this next series because I am about to open up an entirely different world of compensation design options. Depending on your experience, this world may be familiar to you, or it may feel like I’ve taken you on a trip to outer space. The previous series will help you cross the bridge into the brave new world of “goal-based incentives.”
In the world of compensation design, and in many state legislatures that set rules around incentive compensation, the words commission and bonus mean very different things.
A commission is pay that is calculated as a percentage of revenue or margin, and is volume driven—the more you sell or produce, the more you make. A bonus is incentive pay that is tied to goal attainment rather than volume. To further complicate matters, the Fair Labor Standards Act (FLSA) recognizes two types of bonuses: discretionary and non-discretionary. A discretionary bonus is exactly what it sounds like—paid at the whim of management, usually one time a year, and usually based on company profits. A non-discretionary bonus is based on a formula, which can be every bit as precise, objective, and LUCRATIVE as a commission plan.
Yes, that’s what I said: a bonus plan can be just as lucrative as a commission plan (and an uncapped bonus is often MORE lucrative), so be careful not to assume you understand goal-based incentives (bonuses) based on past bonus experiences that may have been limited to the less motivational “discretionary” kind. The connotations around the word bonus cause me to avoid the word as much as possible, and instead use “goal-based incentive” as an alternative to a commission.
A non-discretionary bonus is based on a formula, which can be every bit as precise, objective, and LUCRATIVE as a commission plan.
There are several kinds of goal-based incentives, including: linear incentives, tiered incentives, MBOs/SSOs, KPIs/IPMs, bounties and other forms of piece-rate plans. This article will focus on the most prevalent and arguably the most complex of the group—the linear incentive. While the math below may get a little intense, all you are doing with a goal-based linear incentive is defining a goal and then establishing the percentage of the target incentive earned for a given percentage of goal attained.
Under a typical linear incentive plan, an incumbent is given two numbers; first, they are given a goal (or quota) which could be revenue, gross margin, load count, or anything meaningful that you could count to at least 100.1 Second, they are given a target incentive amount—which represents the amount of money to be earned at 100% of goal. The actual results attained are then divided by the goal to get a percentage of goal attained. So, if the goal is 100 loads and the result is 90 loads, then 90% of goal has been attained. If the goal is $5M and the actual result is $5.5M, then 110% of the goal has been attained.
One of the most common mistakes made is to then pay the same percentage of the target incentive as the goal attainment; 80% of a goal leads to 80% of the target incentive, and 110% of goal leads to 110% of the target incentive, etc. This approach, while easy to calculate and communicate, overlooks the psychological value of incentive compensation design and does not address the economic realities of business performance distributions, as seen in Figure 1.
In Figure 1, the dark blue bell curve represents an optimal performance distribution of sales people, relative to a goal, as shown on left vertical axis. About 10% of reps are not achieving threshold (minimum acceptable performance) and 10% of reps are exceeding excellence. About 50% of reps are above target (100% of goal) and 50% are below. Ideally you would like this to skew more to the right, so that about 60% of reps are above goal. This means those who are above goal offset those who are below, and in aggregate you end up reaching the overall corporate objective. The series of purple lines represents the compensation plan and shows that at 50% of goal (threshold) incentive pay begins (shown in the right vertical axis). In this representation, the pay at 50% is 1% of the target incentive, but I commonly recommend providing at least 25% of the target incentive at threshold. At 100% of goal, pay is 100% of the target incentive; at 150% of goal, pay is 300% of the target incentive. What this means is that the incentive pay earned for an additional percent of goal attained, is GREATER above goal than below goal.
Some high school algebra will prove this point for you. Just remember “rise over run” or “change in Y divided by change in X,” or “Y = MX + B” whichever one is easiest for you.
Goal attainment is the X-axis and pay attained as a percentage of target is the Y-axis. In Figure 1, the slope below 100% is 2. The payout value changes from 0% to 100% (100—0) while the goal attainment goes from 50% to 100% (100—50). The change in Y is 100, the change in X is 50, so the slope is 100/50 or 2. You can therefore easily tell anyone what they are paid at any percent of quota attained, by simply adding 2 to 1 for every % between 50% and 100% of goal. At 75% of goal they are paid 50% of their target incentive (75—50 = 25 x 2 = 50). At 80% of goal they are paid 60% (80—50 = 30 x 2 = 60). At 90% of goal they are paid 80% of their target incentive (90—50 = 40 x 2 = 80).
Now let’s look at what happens above goal. The incentive growth looks steeper, but you should always be cautious about making assumptions based on visual representations. Check the scales to ensure they are consistent and double check the math with a calculator. In this case, the visual is accurate. The slope of the line above 100% is 4, so it’s twice as steep as below. I figured this by taking the change in payout (Y) (300—100) divided by the change in goal attainment (X) (150—100), so 200/50 = 4. The rate of change is 4 to 1. At 110% of quota, the payout will be 140% of the TIC (110—100 = 10 x 4 = 40 + 100 = 140) . At 130% of quota the payout will be 220% (130—100 = 30 x 4 = 120 + 100 = 220). This increase in slope is important both psychologically and economically.
If your goals have been set appropriately, it is beneficial to the organization for your reps to achieve goal. The sum of the reps’ individual goals should be aligned with your economic “sweet spot” where your operational and fixed costs are covered, and additional revenue or margin represents nearly pure profit. You can afford to share more of the profit with your reps when they get to this level. You want them there, and you need them to want to be there. If you are paying four times the incentive for every 1% above goal, they will WANT to be there four times as much as if you paid one time (1x) the incentive above goal (and 1x is what a straight commission plan does, by definition).
The sum of the reps individual goals should be aligned with your economic “sweet spot” where your operational and fixed costs are covered, and additional revenue or margin represents nearly pure profit.
Above excellence (the point which represents your top 10 performer) it is common to reduce or regress the slope. This allows for an uncapped plan, while still providing some windfall protection. In the drawing above, the slope above excellence is now 1. 200% of quota pays 350% of the incentive. Change in Y (350 —300) over change in X (200—150) is
50 /50 or 1. 151% of quota would pay 301% of the target incentive. You just add 1% of incentive onto 300% for every 1% of quota above 150%. You could, of course, also cap the payout, but I recommend using caution when capping sellers as you are effectively telling them to stop selling when you do this.
Your payout curve is the description of the series of lines that deliver pay to the rep (in this case, I would call this a 50-150 curve, with 0%-300% payout and a 75% slope regression above excellence). There are nearly an infinite variety of options, but some of the most common are 75-125 with 25% to 200% payout (the line slope is 3 below 100% and 4 above 100%), or 80%-120% with 50% to 200% payout (the line slope is 2.5 below goal and 5 above goal). You should design your payout curve to reflect the historical distribution of performance relative to goal. Keep in mind you want about 80% of the outcomes to be “on the table.” Aggregated goals for team leaders, managers, and other leaders should have narrower payout curves as at each level of aggregation, the high and low attainers will balance each other out and the outcome will come closer to the center. Thus, corporate level payout curves are typically 95% -105%. At this highest level of aggregation there shouldn’t be too much variance off the goal.
In the next article, we will look at the tiered incentive method, which you can use to measure something that is more uneven or uncertain in economic value, or which can’t be counted to 100, or which isn’t in fact counted at all, such as margin percentage.
Beth Carroll is the founding partner of Prosperio Group, a business consulting firm that focuses on the strategic management of compensation for global transportation and logistics companies. Beth is based in Chicago, Illinois, and has more than 20 years’ experience developing incentive compensation plans for companies across the globe in a variety of industries. Prosperio consultants have completed projects with more than 180 transportation and logistics companies. Beth can be reached at 815-302-1030 or via email at firstname.lastname@example.org.
1 Goals for things that are less than 100, or for things that are not counted (e.g., margin percentage), are more likely going to be measuring using a tiered incentive—which will be covered in the second article in this series. The reason why 100 is needed, is the calculation is based on whole percentage of goal attainment. If the goal is “20” then it is not possible to be at 83% of goal. The only possible outcomes when the goal is “20” are 5%, 10%, 15%, etc. of goal. It would not make sense to use a linear incentive when ALL whole percentage options (e.g., 83%, 84%, 85%, 86%) are not possible.
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