Reader Comments (1)

Rating (1):

Today’s changing compensation landscape provides opportunities to improve pay designs, specifically in sales management compensation. The good news for sales executives and managers is that, unlike CEOs, their pay designs inherently have the potential for more flexibility, creating a “win-win” for both plan participants and shareholders. Here’s why: Sales management has a more direct line of sight to sales and profits than top management. This allows for commission pay designs with more volatility than discretionary, nonsales management cash bonuses.

Using a hybrid incentive plan incorporates the motivating advantages of sales/profits metrics and the flexibility of discretionary bonuses. A hybrid plan can work for large or smaller organizations, and therefore a variety of companies can reap significant rewards, such as driving higher sales results by tying sales management pay more directly to results and having more flexibility over significant fixed and variable pay expenses.

Singular Design Models: Pros and Cons

Historically, companies often faced conflicting pressures within their incentive plan designs for sales management. On one hand, pressures for transparency and financial return favored plan designs tied to sales and profitability, putting managers on the playing field and making them accountable for short-term results. This called for commission- and/or metrics-based bonus plans. On the other hand, many sales manager jobs were also responsible for nonquantifiable deliverables, such as people development, long-term planning, working cross-functionally, etc. Capturing these and other “softer” deliverables called for discretionary annual management bonus plans such as those used in nonsales areas.

Fortunately, hybrid plan designs incorporate incentives for sales/profits metrics and enough discretionary incentives to reward the “whole job.” Figure 1 outlines the advantages of using both components, as well as complexities to consider when using a hybrid design.

Particularly in today’s weak economy, opportunities for payout flexibility and expense reductions are appealing advantages of the hybrid model. But how should the weights compare for the metrics component vs. the discretionary component?

Generally, metrics components will have a heavier weighting than discretionary incentives if the job’s primary responsibility is to manage annual sales/profit goals. Figure 2 shows that as strategic/discretionary elements of a job become more significant for the highest-level sales managers, their discretionary incentive weighting increases. The weightings are intended to be guideposts rather than definitive formulas, and should be customized based on an organization’s unique job hierarchy.

Note that at opposite ends of this spectrum, it is not appropriate to use the hybrid model. The most junior sales lead job is too focused on day-to-day sales results to incorporate discretionary elements, whereas the highest-level sales executive’s strategic and long-term objectives require too much focus on discretionary goals.

Expense Savings
Economic downturns are the perfect time to maximize expense savings through the hybrid model. These opportunities occur in either direct cost savings through lower bonus payouts or in decreased salary expenses that can shift to variable performance-based expenses.

Bonus Payout Savings: During business downturns sales and profits are moderately to significantly lower. Sales-/profit-based plans will then generate much greater savings than discretionary plans, since commission designs have more severe payout downside for lower performance than discretionary plans.

As a broad generalization, for moderate to significant underperformance, payouts for sales incentive plans may pay closer to about 50% of their bonus target, while discretionary plan payouts may pay closer to about 75% of their bonus target. Suppose your sales executive’s average bonus target is $200,000. So, in an underperforming year, using a hybrid plan, if the bonus target equals $200,000 x 50 percent of target equals $100,000; whereas using a discretionary plan, $200,000 x 75 percent of target equals $150,000. The differential in savings between the plans is $50,000 per manager, resulting in total savings of $1million if your organization has 20 affected managers.

Fixed-Cost Savings: Sometimes, it’s a good idea when moving from discretionary bonuses to hybrid bonuses to increase bonus targets in order to create more performance motivation and buy-in for plan participants. That increased bonus expense can be funded through lower fixed salary expense even without reducing salaries by withholding salary increases for a few years, and using those savings to fund two or even three times as much incremental bonus opportunity.

The basic idea behind this modeling is that bonuses do not impact future costs, since one year’s bonus has no cumulative effect on the next year’s bonus.  However, each salary increase will always “carry into” each upcoming year, since the current year’s salary increase is also an expense that is paid in each upcoming year.

Also note that even if bonus payouts for exceeding goals are increased due to higher upside in hybrid plans compared to discretionary bonuses, potential expense is funded through higher incremental sales/profits achievements. As these plans are meant to motivate increasingly higher levels of performance, accomplishing that will justify additional upside incentive expense.

Ultimately, cost savings benefits and potential for higher sales results in hybrid sales plans have to be weighed against their increased complexity in pay administration. However, sales compensation professionals have a real opportunity to bring value to their organizations by raising discussions with senior HR and top sales management regarding the trade-offs and most appropriate incentive plan designs for sales managers.

When cost savings and increased sales are more critical than ever, the timing is right to consider more creative plan designs. Hybrid models tie sales management pay more directly to results, and give companies more flexibility over significant fixed and variable pay expenses; no longer a luxury when companies struggle to survive.

Ira Feder is assistant vice president of sales compensation for MetLife. He has been a WorldatWork member since 1995 and can be reached at ifeder@metlife.com or 917-496-3562.

Contents © 2009 WorldatWork. No part of this article may be reproduced, excerpted or redistributed in any form without express written permission from WorldatWork.