SalesCompInsights

Where Robin Hood Meets Santa Clause

What on earth, you ask, do MBOs, Robin Hood and Santa have in common?  Well, it’s like this: MBO’s, when used in a large sales population, take from the rich (your successful salespeople), give to the poor (your laggards) and are a gift to sales managers that are better at being one of the guys than they are leaders to their respective teams.

By the way, if you’ve stumbled upon this site in search of a holiday-themed Robin Hood DVD or tips for pulling off your own management buyout, give us a second to define before you leave the acronym as used in the comp world:  management by objectives – a.k.a., key sales objectives.  A guy in the U.K. told me once MBO stood for “My Bloody Obstacle to driving real pay for performance in this place.”

This statement pretty much sums up the issue.  Granted, it’s just one perspective.  Ask a sales exec who has worked over a prolonged period with MBOs and you’ll hear a woeful tale of administrative complexity and undifferentiated pay distribution.  But ask a line sales manager, “How’s that MBO program workin’ for ya,” and expect praise for the flexibility and fairness provided by MBOs.

There’s both math and psychology involved here.  Crunch historical data from a group of MBO payees and you’ll see over time a trend of decreasing pay distribution.  That’s because the supervisors and managers scoring their teams don’t have the heart to tell Larry Laggard his performance blows and he’s not earning a bonus.  To keep the budget in check, the scorekeeper trims a little off of what would have gone to Slammin’ Sam (the high-performing rep) and gives it to Larry.  Steeling from the rich to give to the poor.

There are legitimate reasons for putting MBO’s into place.  For example: a technology company needs its business development reps to stimulate product development and customer engagement across different markets.  One size does not fit all reps, and the product isn’t expected to be sales worthy for at least two quarters.  The structure of an MBO allows the supervisors to customize a set of objectives for each rep that will drive future sales.

At some point though, these reps will want sales and the compensation that comes with those sales.  After all, they’re sales reps, right?  Where MBOs get misapplied is when management requires a sales professional to do the job of a marketing or product specialist.  In a small organization, that’s likely and expected.  But it’s not optimal and should be considered temporary.  Again, salespeople sell.  Other jobs do, well, other things that aren’t directly connected to sales.

Indeed there are requirements to every sales job that fall short of sales-related activity: fill out reports, dial into weekly sales calls, drive the product team from Japan around to a few customer sites, etc.  The more your salesperson earns in variable pay as a percent of base salary, the more likely he or she will look to excuse him/herself from such chores.  And then you as the manger can get into a discussion around the reason they’re paid base salary and role of being a being a good corporate citizen and so forth.  Yet they look at you with glazed eyes.  You can tell they don’t care and won’t do what you ask.

It’s tempting then to put some of these non-sales tasks into variable pay, tied up all pretty in a MBO package.  Then they’ll care, right?  Wrong, if they’re good salespeople.  They want to sell, gosh darn it, and earn good pay for those sales.  MBOs are a wing-clipping for high performers.

I’ve not yet gotten into the gritty underbelly of MBO administration.  Best case, managers articulate and document “SMART” objectives, salespeople acknowledge them, managers submit the objectives for executive approval, and later meet as a group to calibrate scores before meeting one-on-one with the reps.  Uggh.  I’ve actually seen an MBO for a manager plan with the objective being proper administration of the MBO process.  Anyway, the savvy manager will attempt to sidestep all this admin stuff.  And who can blame them?

In the early days of my incentive management stint at a large brokerage firm – and sorry to those who’ve heard me tell this story for the thousandth time, but it’s a good one and is relevant here – during a tour of retail branches, I sat across the desk of the manager for one of the firm’s Manhattan branches.  It was mid-December and starting to snow outside.

Leaning back in his reclining chair, he says, “What I need is a very simple compensation approach for these guys (financial consultants and customer service reps).  Give me a stack of hundred dollar bills and I’ll hand ‘em out to those that are getting the job done.”

He was dead serious.  And his grey hair, pinstripe shirt with suspenders and large waistband suggested he’d been at the business a while and probably knew what he was talking about.  Yet I had an image of this guy in a red suit and white beard, with a sack on his back for all those bills.  Maybe it was the time of year.  Come to think about it, the assistant manager looked an awful lot like Little John.

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!”

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.

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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.

Anyone who has ever managed an ICM system transformation has a story to tell, and some advice to pass on.  We find particularly interesting those cases where the management considered third-party vendors – Callidus, Varicent, Synygy, Xactly and the like – but ultimately decided to build the system in house.

We recently caught up with Linda Quong, who as VP of incentives for a major brokerage firm helped lead a build-versus-buy decision that resulted in a build.  Her advice: consider the new system a means to an end, sell to your sales force and keep expectations in check.

SalesCompInsights: What was the situation when you were considering a new system?

Linda Quong: “We had new, very ambitious leadership that wanted a revolutionary compensation approach.  The plan we ended up designing required precise, daily data – actually intra-daily data – and included over 100,000 transactions each day.”

SCI: How did you determine which vendors to consider?

LQ: “ICM is a very niche, specialized market.  There were only a handful of vendors that had done anything close to what we were asking for.”

SCI: Were there any that stood out?

LQ: “Not really.  All of these applications appeared to do the same things, though each one got there a little differently.

SCI: What was the deciding factor to build a system in house?

LQ: “Budget and time.  The upfront costs of a third-party solution just didn’t compare to what we could do in house.  Plus, we had an extremely aggressive deadline to deliver the system.  To try and implement a new third-party solution in that timeframe would have been extremely risky.”

SCI: What about the ROI from reduced errors, more sales productivity and less administrative effort because of a more flexible system?

LQ: “Here’s the thing: we had very complex plans, unreliable data and deference to the sales force.  These were major barriers to getting a sufficient return on the investment.”

SCI: Understood, but didn’t the vended solutions offer a lot more flexibility and scalability?

LQ:  “Scalability, yes.  Flexibility, not in all cases, and certainly not without a steep price for customization and the potential issues that might have caused with future upgrades. Our in-house team could fulfill most one-off customizations we requested, whereas some of the third-party solutions hesitated a bit when confronted with some of our requirements. Ultimately, the vendors thought they could deliver, but in most cases we would have been the guinea pigs for their development teams.  To me, this defeated part of the purpose for using a third-party system, which was to rely on their established technology. That said, I think in hindsight that we would have been better off long term with a third-party system.  But in the short run, we couldn’t base ROI on reducing our administrative headcount 30%.  That just wasn’t going to happen unless the out-of-system issues I mentioned earlier were resolved.”

SCI: Interesting – if you had to do it all over again, you’d go with a vended solution.

LQ:  “That’s right, especially with the way the business environment has changed in the last couple of years.  Non-core functions are getting cut back, and more jobs are being outsourced.  And I think the vended solutions have continued to evolve and are much stronger now.  Before, we had a well-staffed, responsive IT team almost completely dedicated to us.  We could hire administrators to build a new plan in the system.  The company runs those functions pretty lean now.  More and more, outsourcing of non-core functions makes good economic sense.”

SCI:  Has the company simplified the plans, and become stricter on allowable adjustments and exceptions?

LQ:  “Not really, but I think a vended solution can more effectively address these things.  If you’re paying big bucks for a new system whose success is contingent on these issues getting addressed, well, those things had better get addressed.  Suddenly, there’s a lot more riding on resolving these issues than just background dissatisfaction.”

How do you do this?  What makes the vended solution different?  Certainly you were investing big bucks in your home-grown system to make it work.

LQ:  “The vendors do a very good job at showing off all the application’s bells and whistles.  This wasn’t so compelling for our finance team, because they were comfortable with their own models and access to data.  The sales force was a different story,  though. They had no comprehensive reporting or analytical tools, and were using various one-off solutions. Had we sold reporting and analytics to them, then sales leadership would have been powerful allies in fighting for the required budget.”

SCI:  We hear a lot of companies say that they’re skeptical of vendor demos, because demos are not a good reflection of how the system will run in the company’s environment.

LQ:  “Companies should be skeptical.  Otherwise, people get bowled over by all the cool features and lose sight of the work and the importance of having the right source data necessary to make these systems work correctly.  My point is sales and other functions in the company, like our business intelligence group, had a lot to gain from the reporting and analytical features in the system.  We had a very prominent sales leader who, if he thought a tool was critical, could see that we made it happen.”

SCI:  So sell to your sales department

LQ:  “Yes, if sales has a lot of influence in corporate decisions.  Keep in mind it’s a slippery slope.  If you oversell the system capabilities and then can’t deliver, you may be out of a job.”

SCI: Any other advice you’d provide to our readers?

LQ:  “Focus on one or two core functions, like reporting and analytics, which are really broken in the company today.  Build very detailed requirements on those functions and make sure vendors can convincingly demonstrate how their system addresses these issues.  Use your network to find companies using the application that you’re considering, and spend some time with those administrators and sales people to understand the application’s benefits and tradeoffs.  Take a hard look at where you will be in 3-5 years.  It’s easy to stay with the status quo to get you from quarter to quarter, but is that going to be good enough to meet future business needs? Finally, look at a system as a lever for addressing non-systemic issue, like unreliable source systems or burdensome management processes.  There’s no silver bullet, but a new system can be the impetus for a real transformation.”

The Wall Street Journal reported recently that more and more brokers are breaking away from the traditional wirehouse firms to boutiques, or to become independent advisors, and taking clients with them.  In 2008 alone, net outflow from the big firms was about $20 billion in client assets.  In the three-year period ending in 2008, the number of brokers serving retail investors at major firms fell 14% while the number of independent financial advisors (IFAs) grew 29%, the Journal reports.  

http://online.wsj.com/article/SB126256739671014281.html

Certainly the last two years were pivotal ones for the industry.  Thousands of brokers from the likes of Merrill and Bear flat out lost their jobs and had to go elsewhere to earn a living.  Yet the trend of breakaway brokers started before the crash, and persists through the recovery.

Incentive pay practices get creative when there’s lot of movement of the kind of people a firm wants to retain or hire.  Call this a golden moment for the incentive professionals in the retail brokerage industry.

We’ve thought for some time the incentive practices at brokerage firms were a bit primitive.  Despite a myriad of complex product offerings, radically-different margin levels across those products, and the heavy hand of regulation, the incentive plan designs at many retail brokerages look like what you’d expect for a car salesman –luxury and SUVs fetch 8%, compacts 3%, mid-sized 5%.  No wonder Phil Angelides likened selling investment grade mortgages to used cars when grilling Goldman’s Lloyd Blankfein during a recent government-sponsored, big-bank bashing session.

And yet this seemingly broker-biased structure generally gets poor reviews from the folks the plan is supposed to motivate.  In our work we hear too many brokers say they find the plan too complex, the goals too high and the pay opportunity not in line with what they can (or should) influence or in conflict with the customer’s interests.

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Big firms contend that turnover is largely that of underperforming brokers.  While the broker’s decision may be voluntary, the incentive plan forces their hand because of a steep reduction in pay when the broker’s production falls below a certain level.   Thus for those who can produce, bigger is better.

Regional brokerage firms, beneficiaries of the breakaway trend, provide a different view.  Bradley Hofmeister, executive vice president and associate national sales manager at Waddell & Reed, a Kansas-based regional advisory firm, says even strong producers at wirehouse firms grow disenchanted.  And while becoming an IFA works for some, it’s not for everyone.  Waddell & Reed, which offers independent brokers an open platform for trading equities and funds, saw 80% of its new advisors come from the wirehouse firms. 

“People want to be part of something,” said Hofmeister.  “Many wirehouse producers felt they were left out to pasture (from the industry’s implosion).  Here they discover a place where they feel they belong, where they’re wanted and valued.” 

What has surprised Hofmeister about many of the advisors coming from Wall Street is their strong desire for continued professional development, collaboration and teamwork. 

Sound like your average Wall Street broker?  Maybe the cut-throat-competitive culture that defined the retail-brokerage powerhouses of Merrill, Morgan and Smith Barney has run its course.  While we believe pay opportunity will remain on the short list of attributes for staying at or leaving a firm, dare we say that it’s the soft stuff that counts.  Even in the rough-and-tumble word of Wall Street.