Four Pitfalls to Incentive Compensation

Why are so many employee incentive plans ineffective and counterproductive? The plans often make one of the four following mistakes.

1. Solely Focused on Top Line Revenue or Volume

The first mistake is the plan is solely focused on top line revenue or volume. An organization had the sales force on a bonus structure that was based only on revenue. This was great for driving top line revenue growth, but the sales force would often default to the most price competitive stock keeping units (SKU) to sell. In this business there were loss leaders, or low profit SKUs, in the portfolio that were meant to draw customers and provide a gateway to selling more profitable SKUs. The sales team quickly figured out that focusing on the loss leaders would help them make up gaps in their quarterly sales quota. This plan ended up being counterproductive causing gross margin erosion while sales were increasing.

2. Only Focused on Profit

The second mistake is a plan only focused on profit. Another organization sold hardware and accompanying long-term service contracts. The sales organization bonus plan was based only on the hardware gross profit.

 

This plan created two issues over the long term. The first issue is the sales team would pack all the margin into the hardware sale and then lower the price on the service, which was the recurring revenue stream. This required constant monitoring by management to ensure guidelines were being followed on service contract pricing. The second problem was packing too much profit into the hardware sale. Most of these hardware sales were financed and by packing too much hardware profit resulted in a higher monthly payment for the customer as they paid off the hardware over time. This higher payment created a perfect future opportunity for a competitor to provide more reasonable pricing on the replacement hardware increasing the probability of losing the customer over the long term.

 

3. All Carrot and No Stick

The third mistake is a plan that is all carrot and no stick. A division had acquired a competitor’s brand as well as the sales force that had been selling that brand. The organization had plans to wean customers off the competitor brand over time and move them onto the legacy brand. The team had set up incentives for the new sales force to earn additional payouts if they converted customers to the legacy brand. The new sales force continued to sell the competitor brand due to their familiarity with the competitive product and avoiding the hard conversation with the customer. The bonus plan was modified to exclude the sales of the competitive brand from the sales team’s quota. This change literally turned off the spigot to the sales of the competitor’s brand.

4. Too Many Components and is Overly Complicated

The last mistake is a plan that has too many components and is overly complicated. A service division had an incentive plan with so many bonus drivers that it took a significant effort to calculate and determine the bonus payout. Most service technicians had no idea why their bonus went up or down and didn’t really understand how to affect change in their pay based on their efforts. When everything is important, then nothing is important.

Overall a good incentive program should have two or three measures and should be balanced between top line revenue and profitability. Having the right program for your organization will cause all team members to begin rowing in the same direction.

Mark Snyder is a Fractional CFO with FocusCFO and is based in Cleveland, OH.