SalesCompInsights

Paying for growth in a regulated environment (fourth in a series)

NewSigma had the pleasure recently to join a diverse set of leading financial institutions to discuss sales compensation and regulatory compliance trends for 2011.

This group included American Express, Chase Card Services, Citizens Financial (RBS), Discover Cards, Fifth-third Bank, RBC Royal Bank and Visa.  We discussed practices and issues pertaining to sales compensation design and governance given the increasingly regulated financial services environment.

Notwithstanding the universal challenge across this group of balancing growth initiatives with regulatory requirements, we observed a range of practices stemming from a variety of needs:

• Quickly on board salespeople and plans following acquisitions;
• Increase the efficiency of the plan design process given a distributed decision-making structure;
• Restructure the incentive management function to optimize governance and transparency;
• Stratify job roles and plans to avoid a “one-size-fits-all approach” when aligning plan structure with regulatory guidelines;
• Simplify reporting of plan performance in an increasingly complex environment.

Pertaining to plan design, there appears two prevailing principles for making plan design changes that demonstrate alignment with regulatory (the Fed, in this case) guidelines:

1. Get ahead of the regulators by proposing and getting buyoff on standards and approaches; and

2. Wait and see what other banks are going to do.

Each position has its tradeoffs.  In getting ahead of the regulators, the firm proposes to the regulators an approach that’s workable for the firm.  Remember that the Fed’s guidelines are rather vague and leave room for interpretation.  By making a proposal to the Fed, the firm says, “here’s how we plan to meet the guidelines.”  One bank in our group made this move, the Fed endorsed the firm’s proposal, and now the firm can focus its attention on other matters rather than fretting about meeting the Fed’s requirements.

The tradeoff of proposing to the regulators what you plan to do, rather than waiting to see how other banks interpret the guidelines, is you potentially put into place policy that’s unnecessarily burdensome.  Let’s say you establish a payment deferral approach for the incentive earnings on account managers.  And in reviewing your bank’s approach, account managers find another bank has no such deferral.  All things being equal the inquiring account manager is likely to select the bank that provides more earnings upfront (go figure).

Thus the advantage of waiting and seeing is you potentially are in a better position competitively, assuming your current approach does not run afoul of regulations or sound business practices.  The tradeoff here is that regulators, now having detailed practices from those “get ahead” firms, may require this level o detail from the wait-and-see firms.  Think of how this could play out — the Fed memo arrives on November 20 and requires a report demonstrating compliance two days before Thanksgiving.  D-oh!

In evaluating various plan design practices, we are heartened to see this group taking a rather pure approach to payment delivery for business development/origination-type sales jobs (i.e., “hunter”).  In principle we struggle with the notion that a hunter, when bringing down an elephant, has no idea whether his bounty will produce months of feast or a mere snack.  Management’s effort to true-up the sales credit through a deferral makes cloudy the line of sight and encourages hunters to keep an eye on the deal after he or she has made the sale.  This is exactly not what you want your hunters to be doing with their precious time.

Account or portfolio managers (“farmers”) are a different bunch.  Here you can legitimately argue for a deferral to ensure the incentive credit aligns with the underlying health of the business they’re responsible for managing.  Surprisingly only two in our group of seven use deferrals for their farmer jobs.  Both are LCBOs* and for their commercial portfolio managers and financial consultants, one bank deferred the payment for three years and paid a portion of the credit in RSUs, the other bank deferred for four years and has the deferral back-end loaded.

*LCBO = large commercial banking organizations as established by the Fed.

Clawbacks are another feature suggested in the Fed’s guidelines but seldom used within our roundtable group.  Only one firm mentioned using clawbacks.  Clawbacks as a policy are commonplace in commercial lending pay plans.  In practice, though, managers are loathe to actually claw back incentive pay if the deal went south months after having paid the rep for that deal.  So while a number of banks may say they include clawbacks, they’re probably not using them.

Following the discussion of plan design practices the group turned to incentive governance.  This includes the process, people and decision accountabilities used to ensure effective management of the incentive program.

Many of the firms in our group have significant opportunity in this area.  The struggle comes from what is a typical incentive management structure for many financial services firms – a distributed (or decentralized) organization.  By centralizing the incentive management function the bank removes some of the autonomy previously enjoyed by the lines of business.  These leaders can and often do put their feet down when a group such as HR attempts to centralize things.

One of the banks started to centralize the function last March on a mandate from its CEO.  Over the next five months the bank established these governance milestones:

1. Formed a working team including representation from the lines of business, finance, legal, risk, compensation and compensation admin/operations.  Included is a member of the bank’s strategy team, a group responsible for the field’s successful adoption of new policy.

2. Segmented all incentive plans into one of four categories, with Tier 1 (high-profile) plans receiving the highest-level (board comp committee) review and approval.

3. Established a systematic approach for reviewing and scoring the performance of all plans.  This included a simple scorecard that shows for each plan the participation rate (% of eligible participants receiving incentive pay from the plan), % spend YTD relative to budget and % to plan YTD of the business in which the plan resides.  Based on the results of these data the scorecard gives a green, yellow or red signal.  Each quarter the bank runs this report and furnishes it not only to the governance working team but also the Fed, which had reviewed and approved this approach in advance.

Thus, one of the lessons coming out of the two-day benchmarking session is to keep it simple – don’t try to impose all regulatory guidance on all plans unless required to do so, and find simple ways for communicating the health of your incentive management system.  We’re encouraged that many firms, as demonstrated by our roundtable group, are finding practical solutions to the increasing regulatory pressures while keeping an eye on sales compensation plan effectiveness.

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.

In our last post on this topic we shared ways that companies in the banking and other regulated industries change their incentive plans to address regulatory concerns.

Now we’re turning our attention to the management side of the equation — i.e., processes, standards, decision accountability and tools.

My first experience managing incentive plans in a regulated environment was with a large brokerage firm.   The industry was still reeling from a few high-profile incidences where brokers were found pushing mediocre investment products in part because those products paid them the most commissions.  Our company vowed to NEVER wind up on the front page of Section C in the Journal.

One of my first observations was the fragmented nature of our company’s incentive management practices.  For example, product groups would develop promotions and offer incentives for the salespeople to sell certain products without any consideration of how those sales could distract from other sales initiatives.  Similarly, sales managers could run their own campaigns without any thought to program ROI, regulatory compliance or sound incentive design principles.

The second issue was the degree of transparency related to how the company’s various programs paid.  While I started to build an inventory of the various incentive programs out there, it wasn’t complete and I could not easily say how much the company paid each sales person or for each product.

That last question is one that for many incentive managers falls in the “nice-to-know-but-I-have-bigger-fish-to-fry” category.  For me it did until one Tuesday in late November.  The NASD (now FINRA), governing body for the securities industry, issued a request for the payment amounts going to each salesperson for a particular bond type over the past two years.  Date request due: November 29 — the Tuesday after Thanksgiving.  I’m reading this memo on the Tuesday before Thanksgiving! Man how I would have loved to, after first ensuring the email wasn’t a prank by someone, push a button that would crunch the numbers and issue the report while I was packing up for the Thanksgiving holiday.

This wasn’t to be.  My group worked the entire weekend (downtown San Francisco is terribly depressing on Thanksgiving day — not so much as a turkey sandwich is available). We had no formal way of collecting pay program details and ensuring those programs were in line with our standards (of which we had very few).  Worse, we did not have a centralized database for storing performance and pay information.  Trying to collect this information was like a scavenger hunt.  Reporting these data in some coherent fashion was yet another humbling exercise.

Somehow I survived and the firm is still in business.  But the memory still stings.  The lesson: know what plans you have and how they pay.  This goes for regulated and unregulated firms alike.  If you can’t answer this question within 48 hours and a few easy key strokes, then prepare to miss your favorite holiday.

Better yet, take note of these steps:

Step 1: Document Who’s Accountable for Which Decisions and What Information

Critical processes such incentive plan redesign work best when the company has established clear accountability for each process step and decision.  Use a reliable accountability matrix, such as RACI (Responsible, Accountable, Consulted, Informed), to delineate roles.  Some regulatory bodies require the involvement of your company’s board or risk officer for major incentive policy decisions.

Step 2: Map and Optimize the Critical Processes

We think of processes for incentive management falling into four buckets:

1. Evaluation of Results
2. Design or Redesign of Plans/Programs
3. Implementation of New Plans
4. Administration, Reporting and Dispute Resolution

Within each bucket is a set of processes to ensure these things get done effectively.   At it’s core, incentive management focuses on the administrative processes — after all, if you’re salespeople don’t get paid, they don’t sell.  Yet there’s much more.  My Thanksgiving from Hell required processes for reporting and evaluation, but a lot of the pain came from the fact that the company had no good process for designing new programs.  Each bucket is important and requires clearly mapped processes.

Step 3: Establish Standards for What Makes A “Good” Plan

In the first part of this series we discussed many of the guidelines that banks are using in an effort to align with the Fed’s pay-risk-mitigation principles.  These address plan features and policies like base-incentive pay mix, types of performance measures and goal, etc.   There are principles and standards for the management practices as well.  E.g., number of acceptable pay adjustments per total payees, number of times the steering committee meets to review plan evaluation results.  Each of the four buckets above should have a set of standards that management compares to the company’s actual practice.  Any gaps between standard and actual form the basis for change.

Step 4: Leverage Tools Appropriate for Your Incentive Management Requirements

Many companies we encounter can effectively manage their incentive programs using spreadsheets and emails.  Many cannot.  This was certainly the case for the brokerage firm mentioned previously.  The company knew what it had was inadequate but viewed the solution as being too complex and too expensive to pursue.

Tools for incentive management can be relatively complex.  Many companies use multiple systems to determine sales performance and complex plan rules for paying the salespeople.  Yet there are good systems on the market today for managing such complexity, and you needn’t try to automate all processes at once to make an impact.   Focus on the critical processes first, optimize those processes by removing design features that add complexity but aren’t necessary for meeting your strategic goals,  principles and requirements.

*   *   *   *

Building solid processes, decision accountability, standards and tools enables a well-functioning incentive system and just might help your work-life balance.  After all, requests for information always come right before a holiday.

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

Here’s the situation: years of sustained growth, multiple acquisitions, complex sales compensation plans, manual and unreliable systems, ongoing disputes from the sales force on payment accuracy.  We met with a sales operations team of a large financial institution back in 2007.  They were done with the band aid approach to fixing the system.  Time to transform the entire operation, get ahead of the curve, become a strategic resource to the organization.

The situation is not unique.  We’ve listed what are common issues that can drive a complete transformation of the incentive management function:

• Incentive management (IM) technology platforms are disparate and lack functionality;
• Processes for plan adjustments and redesign lack analytical decision-making rigor;
• IM staff is reactive, not proactive, in keeping the incentive plans aligned with the needs of the business;
• Leadership is unclear as to the effectiveness of its incentive compensation investment.

In solving these issues, the company needed to ensure its incentive compensation plans were effectively managed, and aligned with the needs of the business, and enabled through a robust technology platform.

The solution approach focused on three discrete areas:

• Incentive operations: people, processes and tools that report performance and payment data, address disputes and adjustments, and provide analysis for ongoing incentive plan alignment;
• Incentive compensation plans: structure and policy for motivating the required behaviors and delivering compensation to specific sales and service job roles;
• Technology: applications for measuring and reporting sales and service performance, and facilitating incentive compensation management, including goals, payments, analysis and ongoing administration.

Subsequently, the project approach included three work streams designed to identify current state practices, desired-state practices, gaps and action plans for closing those gaps.

The company formed a task force to execute the three-phase initiative, along with an executive steering committee to guide progress and decide on structural elements.  The 30-week effort provided these outcomes:

• Formation of a formal IM governance structure, including:
  • Decision rights and accountabilities for the analysis, redesign, approval, implementation and ongoing management of the incentive plans;
  • A cross-functional incentive advisory panel chartered with the delivery of outcomes tied to an annual incentive management calendar;
  • An executive incentive leadership team chartered with addressing recommendations from the incentive advisory panel;
  • The role and staffing requirements for staff positions responsible for execution of incentive management functions;

• A comprehensive redesign of its incentive compensation plans for key jobs to realign goals and payment opportunity with the company’s strategic objectives; the redesign included development of plan design principles and operational standards to guide future plan realignment efforts;
• Funding and implementation of a “best-of-breed” incentive compensation management application.

By using a comprehensive approach, the company transformed its incentive management function to one capable of meeting the needs of the business for years to come.    The business impact includes:

• An increase to the company’s return on its sales compensation investment – more revenue and net operating income relative to the sales and service compensation spent;
• Increased sales and sales support productivity through a reduction in the number of sales and staff time previously engaged in IM activities;
• A reduction in the time required to cost-model and introduce incentive components and campaigns for new products;
• A reduction in the number of performance and payment reporting errors tied to sales credits.

Granted, this is a tough pill to swallow, but it’s a very comprehensive approach.  Just fixing the plans, the technology or organizational structure is piecemeal.   It’s a band aid.  Sound familiar?  Time to transform.

We’ve noted more than one discussion lately on the LinkenIn incentive discussion boards regarding changes to incentive comp in the banking industry given TARP, Fed and federal banking-industry reform initiatives.  The hypothesis: lots will change.

Well, we’re not seeing it — not yet anyway.  Certainly many banks within our client sphere have been active on the topic, those having assessed the business risk inherent in their sales compensation plans, and some having taken a philosophical shift on the prominence of incentives in the total sales compensation value proposition.  To us, though, these are trends consistent with normal business cycles.

Though what happened to the banking industry in 2008-09 was extraordinary.  From an incentive management perspective, most of the effort went into executive compensation.  It’s reasonable to suggest, then, that incentive comp will focus more on production jobs.  As lending markets thaw and employment numbers improve, banks will care more about the competitiveness and effectiveness of their sales compensation programs.

Late last year we completed, in conjunction with Varicent, a survey with regional banks to identify trends  shaping sales compensation in the regional banking industry.  We plan to run the survey again next quarter.

Highlights from last year’s study include:

• 40% of respondents indicated the level of plan change for 2010 “typical” for the branch, investment and small-business units.
• 30% indicated no changes to 2010 plans in branch, wealth/private banking (PB) and commercial groups.
• 20% said change in the wealth/PB group was going to be “higher than normal.”
• Responses for wealth/PB and commercial units are most divergent, as these groups are experiencing significant market growth and dormancy, respectfully.

To read the complete white paper, visit Varicent’s website:

http://www.varicent.com/docs/cms/The_Scope_of_Change_-_Regional_Banking_Sales_Compensation_in_2010_20102111640.pdf

Stay tuned for a fresh set of data on this topic next quarter, and please let us know of your comments in the meantime.