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.

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.

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.

 *  *  *

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.