SalesCompInsights

We subscribe to the notion of the sales compensation plan as a tool for sales management.  Whenever possible, this means that sales management should be part of the design team.  They may not own every decision, but certainly theirs is a voice that should be heard.  And perhaps more importantly, this means that sales management should lead the communications effort.    We observe many companies where sales leadership actively, and enthusiastically, participates in the evaluation and design of the new incentive plan.   They recognize the impact the plan can have and want to maximize the likelihood of success for the business, their team and themselves.  When it comes time to communicate any changes they line up in front of the organization to help people understand why the changes were made, what the changes mean and how best to win under the new plan. 

Unfortunately, “many” doesn’t mean the same thing as “all.”   Based on several years of survey data, we’ve observed that in 20% and 30% of responding companies, the incentive plans are designed by corporate staff, with limited input from line management.  These companies would argue that a corporate approach makes the most sense for a variety of reasons.    

More concerning is the design process that is supposed to include sales management but doesn’t.    There’s the scenario where the VP Sales is chartered to design the plans, but is not involved in the final decisions.   Or the scenario where the VP Sales doesn’t believe any change should be made and avoids the design team meetings.   Then there is the arms crossed passive aggressive meeting participant;  I’m here, but don’t ask me to do anything that could hurt my people.  Any of these scenarios can lead to the dreaded “look what they did to us now.”  With the credibility of the plan now in question, a significant change management opportunity is lost and the odds of success go down significantly. 

As we enter the final weeks of 2010, it is critical that sales management supports the new plans.  The bigger the change, the more important it is that you’re sales leaders are armed and ready to effectively communicate with their team members.   If there is any question about their support, address it immediately.   With so much riding on the success of your incentive program, you can’t afford to have your most important stakeholders waving goodbye as the rest of the troops head off to battle.

Facebook, WikiLeaks and the Power of Peer Pressure

During Thanksgiving dinner my extended family (NOT pictured left) seemed intent on discussing Facebook.  How it’s necessary, how it’s evil.  Why in heck does Uncle Lou have a page?  Dude — stop texting at the table!  And so on.  The following week I’m inundated with news on the latest WikiLeak — scandal, crises, gossip — over state department wires.   Then yesterday I’m in a debate with a company’s sales and HR leadership over company policy on employees sharing their earnings info with co-workers.

So we’re in a controversial age over privacy and promotion of personal data.  I hadn’t thought this subject yet hit the shores of sales compensation land.  But  having now thrown it around our brain trust here at SCI (pictured above left), I’m confident saying the trends that have seeped into so many areas of our daily lives, driven mostly by technology and the Internet, has applicability to policy and preferences over the privacy of pay data.

Let’s be clear.  We’re talking about sales compensation specifically.  Please don’t go posting all your employees’ base salary levels on the company’s website as a way of demonstrating your hipness.

There are varying degrees of appropriateness and purpose here based on the structure of your comp plan.  To be safe, take base salary out of the equation.  So then do we socialize actual incentive earnings?

Many companies frown upon the idea.  Some go as far as suggesting that if a sales rep utters a word over his or her earnings to anyone other than spouse, then they’re fired.  This was basically the declaration of one executive in the meeting yesterday.  He had reason to be upset.  Despite the company’s efforts to keep its sales compensation data confidential, someone on the inside — a salesperson presumably — was disclosing details on Vault.com.  Management could try to fire the person or people responsible but had no way of identifying the perpetrators.

Consider companies where using personal pay references during team coaching and recognition events is encouraged, and celebrated.  My first experience with this was during a job interview for a sales position where the hiring manager said, “Our top salespeople made $xxx,xxx, $yyy,yyy and $zzz,zzz last year.  Here are their names.  You can call them.”  I felt a rush then, and always have since in meetings and ceremonies where personal pay is put forth for consideration.

If your salespeople are driven by both internal and external competition, and you have statistics to be proud of, then post it.  Get it out there.  Not only the ranked performance levels, but the corresponding pay also.  Attach names.  Get personal.   Your average performer will react differently to the pay figure versus the performance of Rep #1.   And for #23 out of 200?  Shame on him.  Perhaps the DMV is hiring.

This sounds harsh, but it’s characteristic of the increasingly-transparent world in which we live.   I took quite a beating over stuffing and cranberries due to the low number of “friends” reported on my Facebook page.   And that’s probably okay if this metric is important to me.  Point is, variable pay opportunity should be important to your salespeople, as should peer pressure be effective for motivating action.

Granted, details on your company’s incentive pay opportunity may not be ready for public consumption.  Maybe comparing competitors’ pay to your company’s own reveals a weakness, or your salespeople can’t figure out how the top five reps in the ranks made what they did.  Better then that you don’t publish this stuff.  Ignorance is bliss.

We caution such policies of secrecy, if only because everywhere we turn, it seems the genie is out of the bottle.

By Elliot Scott, NewSigma

On January 1, 2011, many of the provisions of the Patient Protection and Affordable Care Act (PPACA), a.k.a. Healthcare Reform, go into effect.  From the standpoint of incentive compensation professionals, the most significant piece of the legislation is the Medical Loss Ratio (MLR) requirement.  It specifies that in the Large Group market, 85% of premium must be spent on medical expenses.  In the Small Group and Individual markets, the number is 80%.  The rest can go to administrative expenses, profit, marketing, and…direct sales, account management, and broker compensation.  Adding to the complexity is the fact that the Obama administration has yet to issue formal guidelines regarding how MLR is to be calculated.  And there has been much lobbying around what is to be included and excluded.

Nevertheless, companies that are already near or below these minimums or who may be at risk of being below them are considering a variety of steps to help ensure compliance.  For sales and marketing organizations, this means taking cost out without decreasing overall productivity.

How Are Health Insurance Sales Organizations Reducing Overall Compensation Cost?

1.       Lowering Broker Costs

Commissions to brokers are perhaps the most significant line item, but hard to affect.  No insurer wants to be the first to make an across-the-board reduction in broker commission rates, particularly during a time of change and uncertainty, when employers are relatively open to change and reliant on the guidance of their brokers.  Nevertheless, there appears to be a consensus that rates will come down, particularly in the individual and small group markets, where MLRs are generally farther from their targets than in the large group market.  One change that has already been implemented by some insurers is moving from a commission that is a percent of premium to a flat commission per new member. 

But for many companies, cutting administrative costs related to brokers, particularly those that are less important to the company or less dominant in their markets, is a less risky approach.  To lower broker costs, companies are examining their portfolios to see where they can de-commission underperformers with minimal impact.   They are analyzing which brokers are really growing the business and which are maintaining or potentially even eroding it.

2.       Lowering Direct Sales Costs

By the same token, an across-the-board reduction in total cash compensation to the direct sales force is seldom a winning strategy.  It causes the best performers to leave and de-motivates the rest.  More effective and less damaging steps include re-aligning coverage, modifying compensation performance measures, and increasing the pay-for-performance orientation of the plans.

a.       Changing Coverage

Cost reduction from changes in coverage come from moving coverage responsibility to lower cost channels (e.g., inside sales) for certain segments, reducing the number of specialized sales roles and increasing the product responsibility of generalists, and reducing field force headcount.  There are few health insurers operating at peak sales force efficiency, and healthcare reform is providing the motivation to get there.  And when headcount goes down, the goals and commission rates need to be carefully re-calibrated to guard against windfalls and ensure equitable incentive opportunity. 

Cost pressures are also pushing insurers to give up the notion of trying to cover the entire universe.  They are abandoning some segments entirely so they can focus more resources on those where they have an advantage.  For sales operations groups, that means identifying and prioritizing accounts, brokers, and consultants within the attractive segments, determining the level of sales force effort required, and sizing and deploying the sales force accordingly.

b.      Modifying Performance Measures

Although changing performance measures is seldom seen as a way to lower costs, many companies have found that changing the performance measure definitions can be useful.  For example, some companies have recently moved from paying a commission on premium to paying a commission on contracts.  When premiums go up due pricing changes, and commission rates are not adjusted, there is increased compensation cost for the same level of performance.

c.       Increasing the Pay-for Performance Orientation of the Plans

Even without changing the compensation budget, paying more to top performers and less to lower performers will generally result in a decrease in overall compensation cost as a percentage of revenue.  In recent years, base salaries have drifted upward relative to incentive pay, and the below-target part of the payout curve has in some cases been flattened, to retain individuals who might have suffered during the economic downturn.  But with heightened cost pressure brought on by the MLR requirements, more companies are saying they cannot afford that and are taking a good look at thresholds and payouts below 100%.  Others are looking for ways to lower fixed pay over time, perhaps with the use of temporary draws, to make a tighter alignment between pay and financial results.

3.       Reducing Compensation Administration Costs

A final area worth mentioning is plan administration cost.  Gathering and validating performance data, making adjustments, calculating payouts, getting sign-offs, communicating payment, and processing corrections multiple times per year can require significant administrative man-hours in a company with multiple channels, products, and customer segments.  Few companies do this as efficiently as they could and most understand that if they did things differently, significant administrative cost could be taken out…”but we can’t think about that right now, we’re too busy calculating commission payments!”

Documenting Your Sales Comp Plans, and Preparing the People Who Must Use Them

If you’re like us, this month has you focused on documentation of new compensation plan rules.  This is a thankless yet critical endeavor.  Done exceptionally well, clear, complete documentation might put a significant dent in the numbers of queries and disputes coming from the field.  Done poorly, communication of sales comp plan changes could put a dent in your company’s sales productivity or contribute to a class-action lawsuit.

We’ve all heard the request, usually from a sales leader, to “get the plan details on one page.”  The request is reasonable from a sales manager’s perspective.  As a sales rep my attention span lasted about one page, assuming the text font was around 10 points.  If I got to Page 2 and didn’t see any dollar signs, I checked out, and trusted the company wasn’t out to screw me.

But tell your company’s legal counsel your aim is to document all the pertinent plan rules using 300 words or less, and they’ll say your setting the company up to be screwed by the sales force.

Can’t we all get along?  Indeed, you can meet both needs.  Salespeople need a concise summary of what’s changing and what they must do differently to maximize their income.  Sales managers need coaching on how to use the new plan to motivate necessary behaviors.  Lawyers need a document that leaves no room for misinterpretation of sales credit eligibility.

Sounds easy but consider a story of things going awry.  John Jones – not his real name but since this is true story I can’t have you all LinkIn-ing the real guy (and sorry to you real John Jones’s for getting drug into this by chance) – takes a job as a territory rep for a software company.  The company’s comp plan is about 20 pages.  For me, it’s a good read.  But John doesn’t think so and tosses it aside.  John understands from his boss his annual sales quota and the list of accounts he’s to target for new business.  Unbeknownst to John, one of his target accounts was recently acquired by another firm, headquartered outside of John’s territory, and covered by another territory rep.  Cut to the chase.  John discovers through some account tracking system that this target account bought a bunch of product, and thus as rep for the account he should earn credit.  Well, he didn’t because the other rep worked the target’s HQ contacts for a big deal that just happened to ship the product into John’s territory.

Any reasonable person would conclude John is not eligible for credit, because he did nothing to motivate the sale.  But John, like the loving family that went berserk when rich grandpa went on life support, turned his back on reason to focus on the big bucks at stake, and John’s attorney apparently thought the 30-page plan document enough unworthy to pursue a case against the company.  I’ll spare you the gory details.  Let’s just say you have the power to avoid such nastiness by ensuring your salespeople, sales managers and the company’s legal representatives know what they need to know about the incentive plan.

In this case, John could have gotten by just fine with the documents he actually read – nothing more than a quota sheet and list of target accounts.  Once he earned credit, the plan was such that he didn’t need an Excel spreadsheet to calculate the payment.  John’s boss should have known from the 30-page document that that accounts with locations outside the HQ’s territory are under the jurisdiction of that region’s sales manager (a peer of John’s boss, in this case).  And the company’s legal counsel might have determined – and I’m only speculating here – that the document was not sufficiently clear on the circumstances under which a territory rep does not earn credit for a sale into his/her territory.

Fortunately most of companies we work with do a good job on the 30 pager, meaning that it’s exhaustingly thorough on the conditions for credit eligibility, and ineligibility.  Their lawyers review and eventually sign off on the documents, and it stands the test of time, for a while anyway, because it pertains to all plans and programs and gets positioned as the final authority for any plan-related questions.

Unfortunately most companies do a poor job of ensuring their reps know how the plan converts sales credits into variable pay, and managers know how best to manage their people in line with the plan rules.  It’s absurd, but way too many sales managers, when asked by a rep, “Can I do this, or how do I get paid on that,” delegate the answer to a document or a phone number or a website.

Neither you nor I will solve this chronic dereliction of duty overnight.  It’s a journey, takes a village, and so on.  We have only a few more weeks, not counting Thanksgiving week, to finish documenting the plans before primping the dogs and ponies for our “Get Rich 2011” new plan rollout world tour.  Before hitting “send” to distribute your final draft to the approval powers, test 1.5 page summary and manager’s talking points with your mom.  Seriously.  She’s not going to violate your company’s confidential information, she’ll better appreciate what you do all day (my mom always says, “I think Scott does something in finance” – thus I apparently don’t walk my talk), and if she gets it, you can be reasonably assured your sales managers will also.  I’m not implying your sales managers have motherly instincts, or that they’re not capable of reacting to test material.  It’s just that I’ve found sales managers as testers of content tend to pass on the level of critique that such material deserves.  Maybe they don’t want to hurt the comp guy’s feelings for fear of getting thumbs down on a future exception request?  Or perhaps they do not want to admit they don’t understand something they think they should?  Probably they’re focused on hitting their numbers before year end.  Mom has no such agenda.  Get her on your calendar.  She’ll appreciate the gesture, and you’ll execute that much-needed simplicity check.  Two birds with one stone.

Assuming then you’re square with mom, you’ve gotten approval on your docs and decks and are ready to board the tour jet, think about how best to use the feedback you’re likely to receive during the road show.  This allows you to ditch those hypothetical Q’s that get used in the back-office production of Q’s and A’s.   Frankly, I struggle to come up with good questions during my sleep-deprived, turkey-induced late-November state of mind.  And delivering answers on the fly during the road show can come back to haunt you.  Explain you’re still working through some of the plan’s finer details, you want feedback, and that sales management can expect to get a full briefing on the complete set of questions and corresponding answers before the plan becomes effective.  Remember, you ultimately want your sales managers to answer the questions, versus passing the buck.

I could dedicate an additional 1,100 words to what needs to happen after the plans go live, since this is another area in dire need detail.  For now though, having exceeded by 1.5 page limit, I must trust that you are now prepared to or comfortable with mitigating some of the risks inherent in documenting your plans and preparing the people who must use them.

David Stein, founder/CEO of ES Research Group, Inc. and publisher the popular blog “Commentary on Sales Leadership” for leaders of customer-centric enterprises, recently sat down with our own Mike Meisenheimer to discuss trends in sales compensation.

In this column, “Show Me The Money,” David and Mike observe companies having seemingly everything in place for sales success — hot product, well-oiled sales methodology, tools, support, references, technology, training, coaching, leadership.  But if the sales compensation approach is poorly designed or managed, salespeople won’t stick around, or the company faces the difficult scenario of having to correct an overpay situation (and then the salespeople won’t stick around).

Mike describes during the interview what are three common symptoms of poorly-managed plans:

“1) Under-merchandising the plan launch. Rather than a robust strategy that involves sales management and engages the field, an email comes from corporate; 2) Limited progress reporting; plan participants don’t receive regular updates on their performance; and 3) Lack of detailed incentive reporting.”

There are good insights to keep in mind as you work over the ensuing weeks to redesign your company’s sales comp plans for 2011.

A recent article focusing GlaxoSmithKline’s decision to eliminate the use individual sales targets for calculating incentives has garnered a fair amount of attention the last few days.   Our friend Justin Lane, a veteran of the sales performance management space and author of a similarly titled blog, interviewed Scott about the announcement and the implications for other industries. 

From our perspective, the decision in and of it self is not cause for worry or celebration.  What’s important is whether the plan change aligns with the priorities, roles and behaviors the company is looking to motivate.  Justin’s interview, along with his insights on the sales performance management space, can be found at:  http://spmnews.com/

Paying for Growth in a Regulated Environment (Third in a Series)

In this series so far we’ve used the banking industry as one currently at odds with growing the business in an increasingly regulated environment.  It’s within this context that NewSigma and Varicent recently surveyed 35 regional banks on their current and projected sales compensation practices, and sponsored a webcast to review survey highlights and hear perspectives from a panel of incentive managers from within the regional banking industry.

For a rebroadcast of the web event, to go:

https://www1.gotomeeting.com/register/753683233

Based on the survey’s findings, here’s what regional banks are doing to balance growth initiatives with regulatory compliance:

1. Increased sales compensation governance:  35% of the responses said their bank has the board’s involvement in sales compensation review and decision making; 26% said their bank has resources dedicated to enhanced plan management practices (e.g., plan evaluation, redesign and communication).

2. Focus on more sophisticated reporting and analytics: 59% of the responses said that better reporting and analytical tools represented their bank’s best opportunity for improved management of the sales compensation program; 32% of the responses indicated their bank plans to adopt new systems for reporting and analytics of incentive compensation measures.

3. Shift to longer-term and organizational level measures: banks surveyed most frequently selected profitability, longer-term and organizational-level measures as new or more-emphasized components in their sales compensation program across the multiple lines of business.

4. Stronger alignment between goals and performance of the individual salesperson and that of the organization:  33% of the responses in Wealth Management, Private Banking and Investment Services, and 28% in Commercial Banking indicated goal alignment as one of the best opportunities for increased program effectiveness.

From client work and surveys we see a relatively high deviation in practices – i.e., show me five regional banks and I’ll show you five different approaches for sales compensation.  Regional banks operate in different geographic markets and thus can differ in terms of challenges and priorities.  This makes sense.  But what’s less obvious is the rationale for differences in philosophies and strategies for addressing federal regulations and local market growth opportunities.  For example, one panelist spoke of the high level of uncertainty in her market, and conservative approach (“hand holding”) for compensating and motivating the sales team.  Yet another spoke of her commercial division’s “dramatic” shift to a production focus, with sales compensation being a “driving force” so that the sales team can get back to what it was hired to do (i.e., sell).

We like to see that some banks are dusting off their playbooks for effective sales performance management.  Unfortunately for the majority of banks in the survey, many of their current sales compensation practices are at direct odds with sound principles for motivating sales behaviors.  Too much emphasis on organizational measures removes the salesperson’s individual accountability for production.  Half-baked measures for profitability leave the salesperson feeling powerless about outcomes that influence his or her pay.  Too little pay in the variable bucket makes the salesperson indifferent to high and low levels of performance.  Too heavy a reliance on manual processes for calculating payments, reporting performance and analyzing trends takes time away from selling.

Knowing what makes the salespeople tick, and what ticks them off, is a critical ingredient in the formula for getting a good return on the sales compensation investment.  Shockingly, a reported 72% of those banks surveyed said they do not seek salesperson opinion when evaluating the effectiveness of their sales compensation program.

Can you imagine rolling out out a consumer product and not knowing how your target market will respond?  Banks have done a good job recently meeting the expectations of the federal pay regulators.  Now it’s time to get with the people responsible for growing the business.

On July 28^th,  Scott and I had the opportunity to join Steve De Marco, Vice President of Sales at Xactly Corporation  for a web session on motivating 2^nd half sales.   The session focused on tips and techniques we’ve observed companies use to improve sales results through the last six months of the year.  One interesting takeaway was the higher than expected number of people who registered for the discussion given the summer timing.   We think this might be a reflection of the fact that within the current economy, sales performance is all over the place.   Companies like Apple (www.apple.com)  recently reported their best quarter ever while others, such as Goldman Sachs (www.GoldmanSachs.com), experienced a significant drop in earnings from 2009.  The session participants were asked to categorize their 2^nd half focus and responded to a range of options including “survive,” “make up ground,” “make hay,” and “current course and speed.”  Approximately 80% characterized themselves as looking to make up ground or make hay, possibly reflecting cautious optimism moving forward.    

The tips and techniques discussion focused on the use of enhanced communication, goal setting and incentives (cash and non-cash) as tools to achieve those second half-priorities.  From our perspective the most effective approaches reflect the organization’s strategy, budget limitations, culture and incentive history.   Like any incentive discussion, no solution will be perfect and it is about balancing the trade-offs.  Similarly, we observe several pitfalls to avoid:

• Minimize payments for 1^st half business
• Make the award appropriate
• Avoid cancelling programs in production
• Be mindful of unintended consequences
• No once and done communication
• Ensure realistic objectives

When asked to characterize which approach was most effective in their own experience, 31% percent of the session participants said cash.   Somewhat surprising to us was that 30% responded that they did not use any of the techniques.    

A recorded version of the event will be available on the Xactly website (www.xactlycorp.com) in the coming days.

In 2009, the United States unemployment rate was on average a shocking 9.275% – a statistic laden with layoffs, company closures and forced retirements. As if that weren’t enough of a stressor, the impact it had on remaining companies and sales teams quickly caused a major case of the blues.

The combined fear of losing their job, not reaching quota, and not finding enough prospects, put a damper on a sales rep’s motivation.  Rather than wallow in sorrow, smart companies realized this was an ideal time to reignite the competitive fire and hunger of their top sales people and took extra steps to increase motivation – a topic covered in Scott Barton’s blog post, “Time to Renew Your Vows? Reengaging with your salespeople.”

Of course, motivating your way out of a down economy is not the only time to put special compensation programs in motion. Engaging in midyear SPIFs or contests is a strategic way to ensure that sales  performance remains aligned with business objectives and revenue momentum continues. It is also a way to test-run some comp plan adjustments before going live. On a regular basis, Xactly launches compensation programs to generate extra motivation around new product launches, monthly promotions, and other similar campaigns. Our customers have implemented similar processes and have seen remarkable ROI around selling optimum product mixes, decreasing discounts needed in order to close the deal, and closing sales earlier and faster.  

While these midyear SPIFs and contests are ideal ways to keep your sales teams chomping at the bit and drive increased revenue, they’re also perfect times to review, evaluate and begin to plan for the next year’s compensation plans. One leading challenge that prevents new comp plans from being implemented is the fear of the unknown – uncertainty around staying within a compensation budget, reception from the sales team, and other frightening factors. By test driving some temporary compensation programs, comp admins can preview a new plan by modeling it to minimize the risk of launching an imperfect plan.

As Xactly and our customers have experienced, the beauty of fully automated compensation with modeling capabilities is the ability to adjust, preview and launch new plans at any given time. Doing so ensures that your sales reps are constantly working towards achieving their top performance and plans stay fully aligned with business objectives during the ebbs and flows of the external environment. For example, Xactly’s sales compensation plans have been modified to drive Xactly reps to do more creative things such as offer more attractive business terms rather than discount or sell more products to make deals work for customers. (Of course, having on-demand visibility into compensation payout only furthers the motivation to close the sale). Customers also benefit from this flexibility as we work with their needs to achieve a common goal, which is hugely important to us.  Eating our own dog food, our recent comp plan changes and enticing incentives for our sales reps aided Xactly in achieving its best quarter ever. Maui, anyone?

To learn more about motivating midyear behavior and evaluating existing compensation plans, please attend our webinar with Scott Barton and Mike Meisenheimer, “Selling More by Incenting Right in the 2nd Half of 2010” on Wednesday, July 28^th at 10:00am PDT.

Christopher W. Cabrera
Founder, President and Chief Executive Officer
Xactly Corporation

Christopher Cabrera is a seasoned executive with more than two decades of successful senior management experience at both early-stage and public companies. At these companies, he has managed sales, marketing, operations and business development.

Mr. Cabrera is a noted industry expert in issues relating to sales performance management, sales compensation, and enterprise and on-demand/software-as-a-service delivery models. He is also the co-author of Xactly Sales Compensation for Dummies (Wiley Publishing, 2006), as well as a contributing writer to such industry publications as Selling Power Magazine, destinationCRM.com, BusinessFinance, SandHill.com, CustomerThink, CRM Buyer and the Sarbanes-Oxley Compliance Journal. Mr. Cabrera speaks frequently at leading industry forums and events, such as salesforce.com’s Dreamforce end-user and developer conference, the Software Information Industry Association (SIIA) OnDemand Conference and SaaScon. Mr. Cabrera also serves as a board member of the San Jose Downtown Association.

Paying for Growth in a Regulated Environment (First in a Series)

Events playing out in the banking industry over the past 18 months serve as a reminder of how government regulation over sales and marketing can impact incentive practices.  The scenario is a familiar one to those in the retail investment and medical device industries.  There are lessons from those industries that now pertain to regional banking, or any other business, that must motivate its salespeople to sell while adhering to government regulations.

If there’s a silver lining in all this it’s that well-managed, effective sales compensation programs typically use a set of principles to guide specific practices, like which components to use in the incentive plans, and who makes what decisions regarding plan changes.

Regulations pertaining to pay usually come in the form of principles or guidelines.  In the banking industry, the Federal Reserve (Fed) and related agencies recently released its guidance for banking incentive comp practices.   Typically these memos are vague yet consequential.  If ignored, companies under jurisdiction of the agencies face enforcement action and bad publicity.

It’s no surprise then that over 85% of regional banks participating in a recent NewSigma/Varicent survey said federal legislation has had some or a significant impact on the bank’s incentive comp approach for front-line sales and service (non-executive) employees.   That leaves more than a handful of institutions trying to figure out what to do.  For those banks having taken action, many still question how best to design and manage their sales compensation plans in a way that meets the guidelines, but still promotes business growth.

Part of the dilemma when considering these and other regulatory principles is they seem to be in direct conflict with traditional principles of sound sales compensation design.  We think there is some common ground, however.

Let’s take the first principle in the Fed’s recent guidance for banks: “balanced risk taking.”

Management in all industries must strike a balance between risk and reward in the compensation plan, and use the pay mix – the amount of cash pay that base salary versus variable – as the primary lever.  The more pay that is variable, the more risk a salesperson bears in the form of income loss from poor performance.   While a higher base salary mix shifts this risk to the company, it mitigates the risk of bad behaviors that can come from lucrative upside pay.

The most common incentive plan change we observe following regulatory intervention is a reduction to the variable pay mix.  With some extreme cases aside (e.g., residential mortgage brokers), we think this is a mistake in banking.  Mix levels for most sales positions in the industry were below those for comparable jobs in other industries — before the credit crises.  Banks capped the upside pay for most if not all of these jobs, so that instances of bad behavior stemming from lucrative upside pay were remote.  The bigger problem was and still is lack of urgency by the salespeople due limited variable pay mix/risk.

Another risk comes from the misalignment of goals between the salespeople and the enterprise.  E.g., salespeople make a lot of money while the company posts a loss.  A common lever for balance is to link a portion of the salesperson’s variable pay to organizational goals, like company operating margin.  Like a reduction in variable pay mix, this shift reduces the amount of pay tied to the salesperson’s individual production.  Thus, we’re not fans of this practice, either.

Alternative practices for strengthen goal alignment include the use of qualitative, or risk-adjusted, performance measures.  The principle is to measure and pay based on the quality of the transaction or deal.  There are two general approaches for doing this.  One is based on net present value, the other on actual performance of the asset at some later point in time.  Both have tradeoffs.  Qualifying performance at the time of the initial transaction involves some guess work and can over or underpay relative to the asset’s performance over time.  We like this approach though because salespeople responsible for the transaction know up front the value of each type of deal.  We find the reconciliation approach cumbersome, particularly when “clawing back” amounts previously paid.  It makes an incentive opportunity increasingly ineffective as the time horizon, or number of variables, used to value the asset increase.

The whole point of an incentive plan is to motivate people to perform, and present real consequence when they don’t.  Reducing the variable mix, or tying variable pay to organizational measures, misses this point.

More to the point is how management defines performance.  Indeed, the amount of pay at stake can certainly drive behaviors, both good and bad.  But the sales transactions that contributed to regulatory outcomes weren’t good ones that became bad because of pay opportunity.  Paying less on these sales would not have made them better deals.

Banks and other industries faced with regulatory pay guidelines can strike a balance between paying for performance and for responsible behaviors by focusing first on the job roles and underlying performance expectations.

In our next discussion on the topic, we’ll provide an incentive-plan perspective on the the Fed’s other two principles recommended in its recent guidance.

And if you haven’t already devoured the Fed’s 47-page guidance memo, let us recommend some weekend reading:

http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20100621a1.pdf