Holiday Bonuses—why or why not?

The subject of holiday bonuses always seems to generate much interest, generally right about this time of year.

In past years and decades, holiday bonuses were quite common. It was not unusual for many, if not most, employees to get a modest-sized extra payroll check at the end of the year. I once worked for a large steel maker in the early 1970’s and each year I would get an extra check for about two week’s pay. No one ever told me why I received the bonus or how the amount was determined. It just appeared—a bit like Santa in the night. I am sure we were not the only company with such practices at that time.

These types of holiday cash bonuses have become much less common in recent years as employers respond to tightening financial conditions and also confusion over the role and objectives of the holiday bonus.

Should your company adopt or continue such bonus practices? To help with that decision, let me answer three common questions we hear most often asked about holiday bonuses.

1. Is it compensation or an employee benefit? If the company grants the bonus as my former employer did, it is hard to argue it is anything but an employee benefit. Now, both pay and benefits are valuable to employees, but they are very different animals. If the bonus is treated and viewed as a benefit, it can become an entitlement that is expected (as in the past), must be faithfully paid (good company results or bad) and can never be reduced without major angst.

However, if the bonus is treated and perceived as extra compensation (based upon something—like company results) there is no entitlement created. In my book, a bonus must be seen as extra compensation earned for a reason. For example: “If the company hits its profit goal this year, I get a $500 year-end bonus. If they do better or worse, I get more or less. If things are really lousy, I will get nothing.”

2. What purpose can (should) a holiday bonus serve? A holiday bonus can give an employer the opportunity to pay a little extra compensation to a broad group of employees in recognition for their contribution to success. Most of the employees who participate will never see, nor be eligible for, annual performance-based incentives or bonuses—other than in the form of a year-end bonus. Also, market data tell us that even lower-level employees will generally earn some amount of bonus compensation annually. A holiday bonus program can make perfect sense, and may even (silently) address the pay expectations of the 80% of your employees who are never considered “bonus eligible.”

3. If there is a bonus program, should everybody in the company get one? If you give it to one, you should give it to all. It is often best to offer everyone a year-end bonus of, say, between 0-3 week’s pay, based on company financial results. But, do not mistake a holiday bonus as a substitute for performance-based incentives for executives, managers or professionals. Normal incentives for executives, manager or professionals should then be layered atop the bonus.

We believe that a holiday bonus can be used as an effective compensation tool, if you follow a few basic rules of application:

• Tie the bonus to something collectively achieved—i.e.: company success (“Why am I getting this?”);
• Communicate the general relationship of the bonus to current or future success (“If the company does well I benefit, but I may not get this every year.”);
• Apply it fairly across all employees and groups (“The VPs and I are all on the same deal.”)

But, do not start or continue such a bonus program with good intentions and then let it devolve to an employee benefit. Once started (as you know), benefits historically can be very difficult to terminate.

The Effective Use of "Non-Financial" Goals in Annual Incentive Plans

We are used to seeing executives and sales representatives annually rewarded for meeting their direct sales or profit goals. They are often rewarded with an incentive or bonus determined by performance versus management or ownership’s expectations.  While these direct incentives and rewards are obvious there are also an entire series of incentives that can be also employed to these executives and employees that are based upon less direct measures of performance.

These components (in terms of goals or metrics) are often used with and as a complement to direct sales or profit incentives in order to let the company also focus upon (and pay for) the “building blocks” of sales and profit success in this and future years.

What are examples of these types of indirect goals or metrics? Sales success building blocks include:

• Focusing sales force time and attention on those customers with the highest potential;
• Convincing current customers to buy and use more of your most profitable and important products;
• Assuring that the company’s share of market is constantly growing or in line with strategic objectives;
• Closing ratios for deals (e.g.: 50% of proposals written); and
• Getting the highest price possible on each and every transaction (e.g.: gross profit of the revenue stream).

Similarly, executive (or business-unit) success building blocks include—

• Getting your sales force to get the highest price possible on each and every transaction (e.g.: gross profit of revenue stream);
• Productivity of capital employed;
• Aggressive product development and introduction (keep the product pipeline full);
• Control of overhead and cost;
• Improving productivity in all aspects of business operations; and
• Managing exposure to product, process and people risk and obsolescence.

While you are regularly paying executives for sales and profit success, you are generally also asking them to do the above tasks every day—so why not include some of them in the annual incentive plan, if you do not already do so?

This suggests that a company should rewards its leaders and operators both for those things that happen and can be measured this year (financial quantity and quality), and those things that are building the foundation for this and next year’s success (sustainability).

One way to do this is with a mix of pure financial (direct) along with indirect goals and metrics in the annual incentive plan.  This trend in incentive design has increasingly gained traction over the last decade. The following are real examples of two such plans:

“The use of these types of indirect incentives can be controversial.”

In the sales force—The sales representative is paid an incentive of $0 to $60,000 per year for the growth of their book of accounts versus management’s pre-established expectations for success. If the annual goal is achieved, $30,000 is earned. In addition, the sales representative can earn another $0 to $40,000 in the year if they—

• Sell over $500,000 of the company’s newest and most-profitable product to the sales rep’s top 6 volume accounts.
• Increase the gross margin of their account portfolio by 2% (nominally), or increase total account profit contribution by $200,000, or more.

In the executive suite—The top divisional executive is paid an annual bonus of $0 to $90,000 based upon the pre-tax profit of the business unit. An amount of $45,000 is earned if $1,000,000 in pre-tax profit is achieved. 2% of pre-tax profit is added to the executive’s bonus for all pre-tax profit over $2,000,000. In addition, the executive can earn another $0 to $60,000 in the year if they—

• Reduce company general and administrative overhead from 15% of sales to 12% of sales by year’s end.
• Complete implementation of a new direct sales channel that accounts for (as a running rate) of no less than 10% of company volume by year end.
• Introduce a new specific technologically-based product by mid-year and achieve $1,000,000 in sales orders by year’s end through all sales channels.

These incentives are sometimes called “non-financial.” We prefer to use the term “indirect,” because the metrics are generally both financially-based and readily measurable by normal accounting practices and systems. You are simply measuring sales and profit success in a different and more elemental way.

The use of these types of indirect incentives can be controversial.  Three basic objections are most often heard.

“These are really discretionary bonuses.” Clearly, the examples above are all designed to be quite objective and clear in terms of expectations and reward. Further, simple pay and performance tables can be developed for clarity of communication and ultimate year-end bonus calculation. However, we have seen indirect incentives that do fit the description discretionary. In our world, more objective and measurable metrics are better for everybody.

“They are just too complicated.” Well, guilty on that charge!  They are clearly more complicated than calculating a percent of sales or percent of pre-tax profit each month. But, your business is surely also much more complicated than the above-stated calculations. In my experience, we have found that we can describe an indirect executive or sales incentive plan on a single (and one-sided) page with accompanying payout rules. I generally also throw in a second page with an example or two, as needed. It just isn’t that complicated once you take the plunge.

“Management and ownership will need to spend all of their time on plan administration.” It’s true only if they like doing plan administration—and some do. The payout tables and rules I described above (combined with a little common sense) make incentive plan administration no more time consuming than a traditional commission plan, and likely less time consuming in the end.

So how do you put these ideas into action for 2012? Try this.

Consider both your sales force and your key executives. Choose three annual goals or metrics for each, (other than enterprise, unit or portfolio sales or profit) for 2012. A hint—start by focusing on improving margin, product mix, quality, or productivity. Tell the sales rep or executive where you will be looking this year and explain your expectations. Then measure and talk about your expectations every month. In our experience, you do not even need to attach money to get results and their attention.

Then, select the same or new indirect goals or metrics for 2013 and do it all over again. But now, make it part of their existing bonus plan, with dollars attached.

Remember, in the end, you are building annual incentives to focus your operators on three imperatives—quantity, quality and sustainability. If you ignore any one of the three you will eventually get into trouble.
If you have questions or seek other examples regarding reliable-indirect incentive structures or techniques, call me at (847) 823-5090.

Did you know...

…that making seemingly simple changes to long-standing organization or business processes can create significant opportunities for improved productivity?

Over the last 30 years we have redesigned a number of client sales territories to reduce travel time and provide a better focus on key-account contact.  In every case, we have found that the potential for at least 15% more sales calls is possible. This is the equivalent of adding one new sales representative to your sales force for every five you currently employ—at no cost.

Further, we have found that this 15% improvement ratio will almost always hold true with other types of well-reasoned change in organization or work process. It even is present when you start to merely measure performance and activity in areas heretofore considered un-measurable (by humans) or simply exempt from review. I call it “the 15% rule.”

Do 15% gains in employee or functional productivity sound good to you? Then, it could be worth taking a second look in 2012 at how things are done within your organization. Can I guarantee an across-the-board 15% improvement? No, but I will guarantee you have everything to gain.

How to help your average seller be more successful in 2012

We often ask clients if they can name their best sales representatives or account managers. Frankly, that is generally pretty easy to do. But, can you segment your sales force into their 3 natural groups: Top-tier (best), Mid-tier (average) and Lowest-tier (challenged) categories?

We suggest that companies look at their sellers in three such performance (and developmental) groups for purposes of future planning and investment. These sales-force groups or segments can generally be described in the following terms:

• Top-tier performers—Sales representatives and professionals who consistently can be expected to deliver high-levels of both absolute and relative performance. These sellers are both highly self-motivated and directed. [The top 1/3]
• Mid-tier performers—Sales representatives who provide adequate performance considering market circumstances. From time-to-time they seem highly motivated but you can never be sure whether they are on “their game” when it is needed. These are your average performers. You know they are capable of more. [The middle 1/3]
• Lowest-tier performers—Sales representatives who are consistently operating below expectations based upon any standard applied. Motivation is consistently low and it is often hard to get their attention. They often owe their continuing employment to the perceived difficulty and high cost of replacement. [The lowest 1/3]

Experience tells us that the greatest sales performance improvements can almost always be had by focusing upon the developmental and the motivational needs of the Mid-Tier, or the average seller. Can you complete the above segmentation with your own sales force? If so, stop and do it. It will make the following discussion more meaningful and useful in improving future individual and company sales performance.

2012 is a mere two months away. We believe there are a series of actions a CEO or top-sales executive can take in the coming months to make an average seller more successful in 2012. While we are focusing on the mid-tier performer, the following comments can generally (and selectively) be applied to the entirety of the sales force. We suggest four actions be taken in the next 60 days. 

1. Shake Up your accounts—A sales force can become complacent and call upon the same (comfortable and unproductive) accounts, month in and month out, unless the company steps in to disrupt the “spiral.” Change this “spiral” by reassigning 5-10% of your top-level accounts for 2012. Target making account changes where sales volume is flat and accounts are seemingly unhappy or ignored—you know who they are. It may likely cause a bit more travel, but who cares? (Of course, set some limits regarding seller productivity and client relationships, but remember, without some dislocation nothing will happen.) The reassigned accounts will see a new company face with some fresh ideas and approaches, and the sales force will need to prepare for sales calls (on “new” accounts) all over again. This is a little like increasing cold calling. It is an approach that can be effective with both top- and mid-tier sellers.   

2. Re-focus your sales management team to productive tasks and sellers—It is not unusual to find that sales management is spending the majority of its time attending to performance, account or employment issues that relate to its lowest-tier performers—maybe up to 3/4 of their time. Now, take a minute and go back up the page and look at our sales-force segmentation rules, definitions and ratios. Is it not reasonable for you to expect your sales management to spend the majority of its time (2/3) with the issues of the Top and Mid-tier performers in the sales force—i.e.: in sales-force planning, coaching and developing? But, the reverse is often true for pragmatic reasons. Stop this misallocation of resources immediately and refocus your sales managers to spend their time with the sellers who can deliver the highest return on the investment of manager’s time (ROI). This will clearly not happen by putting much of their energy into the Lowest-tier. [More on the Lowest-tier at the end of this discussion.]

3. Change the sales-measuring stick to “growth”—Typical sales-force performance is often measured (and incentives paid) based upon sales or a volume-related goal of some type. Turn that direction by 90º in 2012 and measure performance based upon salesgrowth—year over year. You can still use your legacy goals and goal-setting processes, but the real currency and acknowledgment for the sales force performance should become growing their portfolio of accounts over the prior year. Of course, management will assure that any sales growth achieved meets company standards for profit—or I assume you won’t book the order anyway.  Now you may ask: “But, each sales territory is different and $100,000 in growth may much harder in one territory than $100,000 in another.” This is correct, but is irrelevant for 2012. You want rapid growth in 2012 and if a seller does so they are successful. [Now that begs the issue of market share, but let’s keep it simple in 2012. By the way if you do not already calculate territory market share, stay around in the coming months and Wilkening & Company will discuss the how-to’s of estimating market share.] 

4. Finally, reward sellers who really grow their accounts—If you are going to focus upon growth, pay for it. We suggest a new sales-growth bonus where incremental (new) bonuses are awarded for both relative and absolute 2012 sales growth. It should be funded with “new money” that is the result of the new profit contribution resulting from sales growth (in addition to price increases). While the current sales pay plan should remain in place, we would scale it down size to highlight the importance of growth and the new growth-based bonus. The growth bonus becomes the cherry atop the sundae. For the plan to get its intended results, the math and rules should work something like the following:

• Seller with top growth gets (say) $20,000 or ½ target annual incentive;
• Next two sellers get (say) $10,000 each or ¼ target annual incentive;
• A handful of the next-performance group gets (say) $2,000 each; and
• Lower half of performers get no bonus.

We have not spoken much about the Lowest-tier performers. You know, no one speaks much about this group. They are often ignored as orphans, and that is an expensive strategy to adopt. As noted, these are generally the sellers with the lowest chance and probability of success. Training investment generally will yield a low ROI and this is the group where your sales management team is drawn to spend most of their time. If you have identified current sellers who fit into this segment, we suggest you aggressively:

1. Closely watch their assigned accounts (or territories) for competitive threats;
2. Find ways to off load the personnel and remediation tasks required of such performers to company specialists other than your line sales managers; and
3. Build a plan to begin replacement of your worst performers—and do it starting today.

So, with 2012 approaching, take 4 steps within the next 60 days that will help your average (and other) sellers get on the road to being a better (happier) and more confident producer. And, do not forget to measure success and progress every month (or week)—make sure you are winning.

Notes on Managing: Investing without IRR

Most CEOs and senior executives are familiar with making most or all investment decisions based strictly on the internal rate of return (IRR) of the project or investment. IRR is the annual rate of return on an investment considering its original cash outflow and its ultimate outcomes (in terms of cash inflow) over time. Such an analysis allows an investor to compare any investment to other similar investments or to a market-based standard. This is a common method used to make investment decisions of all types. IRR is a common part of the executive’s lexicon and tool box.

IRR has a tendency in some companies or situations to be used as a rigorous test for any and all investment decisions. Further, if the future return outcomes cannot be easily or reliably quantified, an investment may not even be considered. As a result, many investments are never made nor considered. Uncertainty becomes a disqualifier—and aren’t all financial outcomes uncertain, in reality? I once worked in a company where $100 wasn’t invested without a 2-inch thick (single-spaced) analysis being properly completed and approved by Corporate Finance. You had better “show” an IRR of a zillion %, or forget it.

While rigor is important when making an investment, we believe that as one gets higher in the organization the executive is expected to make some investments—of both small and large scale—without the benefit of a reliable outcomes’ analysis and forecast. Let me give some (recently-heard) examples of such investments and opportunity—

• “Let’s start a new marketing & advertising initiative that we think will give us increasing client mindshare. The cost is $25,000 per year but we may never know if it gives us a single new sale or project. But, it feels like the right thing to do.”
• “Our competitor is having quality (and ultimately financial) difficulty. Consequently, they are very vulnerable in New England. If we hire 2 new sales representatives and go after 20 of their biggest accounts we could (possibly?!) take a few away. The cost may be $250,000 per year and it may take 2 years to get a $1 back. It’s just too good an opportunity to pass up.”

The examples are numerous but you get the idea.

A CEO or senior executive is expected to make such decisions or judgments each year—with or without the information required for an IRR analysis. The ability to make such abstract decisions is part of what qualifies one for the job and title. Are you using your intuition when faced with such a decision, or are you relying too heavily on the Controller’s spreadsheets?

One way to find out is to take a little 1-year test. Budget a pool of annual investment—say $100,000 (clearly an arbitrary amount) at the beginning of the coming year. [I usually tell CEOs to put it in cash in a coffee can and place it in their lower desk drawer.] If by the end of the year, you have not spent most of your fund on non-IRR supported projects something is wrong. Most likely: 1.) not enough good and intuitive projects are making it to your office, or 2.) you or your staff may have too little tolerance for the inherent uncertainty within your business. Either possibility should allow you to take pause.

While no one is advocating reckless decision making, intuition does have its place. So begin 2012 with that coffee can full of cash in your desk drawer. How much to put in it is up to you. I know mine has less than $100,000 in it, but it will be there.

Trends in the use and size of executive long-term incentives

I was recently asked by a client about the use and size of long-term incentives (LTIs) when applied to executive positions below the top level of the organization (Chief Executive Officer). To help answer that question we referenced information from a nationally-known survey of executive pay practices—The Towers Watson survey. Our findings are briefly discussed below.

Long-term compensation plans are unique pay arrangements generally reserved for senior executives. These plans are designed to both retain top executives for the long-term and also allow top (and other select employees) to share in long-term enterprise success with stockholders or other stakeholders.

Long-term incentives are generally paid for multi-year (three years or more of) performance. They typically use performance/pay vehicles such as stock options or restricted stock in for-profit companies, and cash-valued arrangements in other firms or institutions.

The use of long-term incentive vehicles for the retention of services is generally reserved for a handful of top executives—often the CEO and their select direct reports. On the other hand, using long-term incentives for “enterprise-success sharing” is more widely used amongst executives, managers or other employees. So while long-term incentives can be experienced anywhere in the organization, they are most often  highly focused on senior executives—where both retention and success-sharing objectives are readily achieved

To answer our client’s inquiry, we looked at the prevalence of long-term incentive usage at various levels of executive (CEO through select functional executive [say VP]), and the comparative value of those LTI annual awards.

As a practice, executive participation in such plans is common at the CEO level and with their key direct reports—such as Executive Vice Presidents (e.g.: CFO),but then drops rapidly below these levels. This finding is very supportive of our experience with historical LTI eligibility.

However the biggest differentiator found amongst executives occurs in the size of LTI awards where the value of annual awards can drop 50% (or more) from level to level, below the CEO.

The table below (drawn from recent 2010-11 survey data) Demonstrates these findings by organizational level.

What does this analysis say? We suggest you take away two conclusions as you look at the use of long-term incentives with your executive team.

1. It is very common to offer long-term incentives to the top-2 levels of the organization—both to the CEO and the jobs directly below them. Below that level, inclusion is often the exception.
2. The CEO will always get the lion’s share of LTI award value—nearly double that of anyone else in the organization.

This is a clear case where less is more. Put your value-creation chips on key players and let them do their thing. That is an easy decision. Expanding LTI’s below top jobs should be very carefully considered and justified based upon need and dilution. In the end, most decide not to do so. Are your needs and objectives different? We doubt it.

Are sales forces really getting smaller? It depends…

When I speak to groups regarding sales-force effectiveness and pay, I am often asked about changes that we have observed with sales forces over the last 30 years.

Questions asked often touch upon the following issues:

• Are sales forces smaller today than in the past?
• Has the job of the average sales representative changed in the last three decades? If so, will that trend continue?
• Are there some parts of selling or the sales force that will never change?

The answer to all of the above questions is both, "yes" and "no." Let me explain by focusing upon three trends we have observed with sales-force growth and employment over the last several years.


Trend #1: The role of the inside-sales group has drastically changed

In past years, a sales representative was most often defined as someone out in the field calling upon (and traveling between) current and potential customers in their territory. This was the classic direct sales channel. The sales force was generally supported (directly or loosely) by an order desk and a dedicated customer service group—they were often called “inside sales.” The thought was that if we kept sales reps away from the order book and the warehouse expeditors, they would not be distracted by administration and be able to make more sales calls. And, more sales calls must mean more sales. This model was employed for decades and seemed to work.

With the advent of internet commerce and ordering, it was no longer necessary for the inside sales group to exist (at least on the order-book side). Consequently, inside-sales positions were eliminated in situations where ordering could now be done directly by the customer—with fewer hands touching the order and fewer chances for error. Also, as the supply chain has become increasingly more transparent to the customer, fewer phone calls are required to find out what happened to “my last order?”

We believe this trend will continue as more-complicated sales processes and the delivery of product advice and support are simplified by expert-systems that allow the customer to place more and more complicated orders, without intervention by a company order taker. This trend has generally reduced the size of the sale force—largely through inside seller attrition.


Trend#2: What has happened to the “traditional” territory field sales force?

This field sales job has generally evolved from the product expert operating at the customer’s location—small or large—to a product and business expert consulting with both current customers and prospects of strategic importance. Consequently, some sales forces now physically call upon 50-70% less customers today than they did 10 years ago—in the same territory and geographic area. The sales forces’ call list (portfolio) now consists of customers or prospects with significant growth prospects. Smaller customers (those whose collective sales have historically accounted for less that 10% of the entire customer base) get little, if any, attention. Today, many smaller customers have been cut loose and directed to use web-based services and support tools (in the absence of inside-sales [or any sales] support).

So, how have today’s sales forces filled the 50%+ of their freed up by the absence smaller-customer sales calls? On paper there is a newly-found focus upon prospective or new customers in the sales force’s day-to-day activity.

Increasingly, companies are asking the sales force to spend the time they used to spend with small accounts calling upon new prospects [Cold calling: Holy rejection, Batman!].

One would expect that there would be a direct replacement of sales calls from former small-accounts to cold calls on future high-potential prospects. In reality experience says that seldom happens, hence, annual company-wide sales calls required and made have likely fallen—in aggregate. Consequently, the sales force is either being allowed to be less productive or is now smaller. Note that this “downsizing” may have been allowed to occur—leaving scores of possible productive sales calls sitting on the table. In the 1980’s getting a field sales rep to call upon prospective customers was like pulling teeth—and it still is.


Trend#3: Where is the demand for talented sales professionals growing?

There are two areas where we actually see growth and stability in the sales force.

• Major-account executive (or national accounts manager) ranks continue to grow as companies increasingly focus upon major and strategic account sales channels. This area of focus and expertise barely existed in 1985, but today it is often the driving force of company sales growth and investment. And as major-account strategies expand, so too will the roles and number of major-account specialists. I had a large client who created a major-accounts group a decade ago—in parallel with their field sales force. Within 3 years, the sales volume attributable to the major-accounts group was nearly 50% of all company sales, in addition to continuing growth from the field-sales channel.
• There continues to be no better or cost-effective way to reach out to small business or individuals than by picking up the phone and calling them. Whether the subject of the sale is continuing education, financial services or business services, telemarketing continues to be a steady and safe niche as a sales channel. We are sure that in this economy telemarketing has continued to grow and is adding new positions (and businesses). Some would say that this growth is simply a repositioning of former inside sellers to telephone sellers. But, experience tells us that these two jobs require very different and distinct skill sets and personalities. Inside sellers almost never become successful (outbound) telephone sellers. Today’s ranks of telephone sellers are the successful major-account and sales representatives of the future as they build selling and relationship skills—the hard way.

During three decades, we have seen the traditional field sales-force practices of the past quietly evolve by the virtual elimination of inside sellers (as order writers) and the refocusing of the territory sales force to larger and more strategic accounts and prospects. These trends have generally reduced the number of sales positions required to call upon and service the same universe of accounts.

Countering these trends to smaller sales groups is the growth in major-account positions as companies redefine sales channels and priorities, and the apparent growth of tele-sales channels and jobs to better manage the cost of business development (cold calling) and account relationships.

In summary, we believe sales forces have generally gotten smaller on average in the last 30 years primarily through better management and increased productivity.  But, pockets of growth do (and will always) exist. Interestingly, some of this downsizing could (should) have been foreseen and avoided.

What does this all mean to the sales executive of today and how will it impact decisions that they will make tomorrow? We think three evergreen truths are clear.

1. If technological trends in areas of order taking and customer service have not yet impacted your business, it is because you just have not looked. Your competitor is counting on you being surprised by the obvious.
2. If your sales force continues to waste their time on the wrong accounts (defined in any way you please), your cost of selling will be double what it should be and you are asking for mediocre performance. As we have asked our readers many times before: Do you know where your sales force is today?
3. If over 15% of your sales calls are not on new and prospective accounts you are losing (or are about to lose) market share—whether you know it or not. Sales calls on new accounts are the life blood of any business.

Either effectively use your sales resources or you will eventually lose them to a budget analyst. Do not wait for these trends to overtake you. Get out ahead of them and beat your competitors.

Are there other trends in the market you believe must also be addressed? Write and tell me about them at bob@wilkeningco.com.

Revisiting the Importance of CEO Succession Planning

In a recent announcement Steve Jobs said that he is stepping down as CEO of Apple and has asked to be appointed chairman of the Board of Directors. He had signaled that this decision was likely coming earlier this year (January, 2011) when he took a leave of absence as Chief Executive.

At that time, we used his announcement as a reason to discuss both the importance of and methods for effective CEO (or other key executive) succession planning in an article in the January 2011 edition of the Corner Office Gazette E-Notes entitled: “Will Your CEO Be In Tomorrow Morning?” If you did not have an opportunity to read it at the time, a link to the January Corner Office Gazette follows [click here].

One of the questions that will always arise regarding succession planning and its value is: How will we know we have succeeded? In our January 2011 article we outlined a number of constituencies that are served by (benefit from) effective succession planning. These are:

• Investors
• Lenders
• The executive team
• The broader group of employees; and
• Customers.

If I was a member of Apple’s Board, how would I know we had done a good job of succession planning? I would start (and stop) by looking at the sustained and rising value of the company (as measured by stock price). For even in the face of the recent market correction, Apple’s market value has shown great and continuing strength. I suggest the Apple Board take comfort in the market’s confident response to the handling of this year-long transition to a new CEO.

In truth, no one can replace Steve Jobs. He has was one of handful of people who created an industry (and Apple in the process), and the only one who continued to be able to reinvent his business (again and again) to avoid a slide down the slope to a commodity statue with its corresponding loss of profit and market value.

We hope Steve Jobs goes on to find the time and energy to invent yet another industry and company or two. Good Luck.

Now's the time to build better incentive plans for next year

2011 is passing quickly. In no more than 90 days, it will be time to approve the 2012 edition of your executive and manager incentive plans. So how should you use the next three months to improve those incentive plans for the coming year? We suggest you consider the following.

First, ask your executives and managers what they like and do not like about their plans. You can gain such input in either one-on-one participant confidential chats (with a company outsider) or with a confidential 6-10 question survey (administered by a 3rd-party) providing plenty of “white space” for comments. Ask questions like these—

1. Is your plan fair, why or why not?
2. Does the plan drive you to do the right things? By the way, what are the right things?
3. Does your plan have appropriate levels or risk and reward for the job you are doing?  If not, what would you suggest is more appropriate?
4. Do the best executives and managers in this company get the highest rewards and recognition? [Some would argue that executives or managers should have no idea what others make—but, they often do.]
5. What drives incentive payouts in this company? Is that right or wrong?
6. Do incentives and goals get in the way of you or others doing a good job? How so?
7. What should the company do differently regarding incentives in the next 24 months? How will that make you and the company more successful?

Often a great way to ask such questions is by using a 7-point scale that ranges from: greatly agree (1) to greatly disagree (7). Comments should also be encouraged to allow each participant to fully state their thoughts.

Then, conduct an analysis of incentive results or payouts versus typical quantitative metrics of performance such as: growth, profitability, quality, cost savings or innovation. However, a metric we have found that often is the best measure of incentive effectiveness is qualitative. In short, take your executives and/or managers and rank them from top to bottom amongst their peers in terms of (or, using your assessment of their) effectiveness, success and contribution to the company—yes, top through bottom, without any ties.

Compare this ranking to their annual incentive earned (or to be earned). In other words, did your top-ranked executives and managers earn the most under the current plan—why or why not? We suggest that you look at this analysis over two years, if you can. This may also tell you something about the consistency of the incentive plan and its goals.

It should take you about a month to collect the information and data outlined in the above two steps.

Last, promptly convene a three-person panel comprised of a top-level executive, a vice president or mid-level executive (who does not report to the other) and a third-party outsider (say an advisor or Board Member). Titles aside, I think you can see who should on this panel.

One member should be appointed lead and another will be responsible for presenting and organizing the information for discussion—but all should have an equal vote in the outcome. The panel will consider the findings of the research conducted above—and add any additional findings or input opportunistically collected. At the conclusion of the session, 1-2 recommendations regarding the design of executive and/or manager incentive plans for the coming year should be prepared and forwarded to the CEO for review and consideration.

If the panel finds that one or two recommendations are not enough to “get it right” in 2012, we suggest that a two-year maintenance plan be proposed with actions for both 2012 and 2013. Another week or two of analysis by your CFO should test the validity and soundness of the proposed changes.

Announcement and implementation cannot be far behind.

So, what have you accomplished in 90 days?

1. You have asked participants what they like or do not like about their incentive pay plan;
2. You have actually tested incentive results (in payout $) versus participants ranked in order of value or importance to the organization—an exercise usually full of surprises;
3. You have asked three-high level thinkers to look at the above data and suggest a few 2012 changes that make most sense for future company success; and
4. You were able to implement change for 2012 well before year end, and can tell participants that their opinions were the driving force of this change.

If you plan to follow our above advice, you had better start collecting data tomorrow.

Does your sales force have the summertime blues?

I do not have to tell you that we are now being visited by the hot and lazy days of summertime. The calendar says so, and signs are all about.  And just like the weather, sales forces can have a tendency to get a bit lazy and rudderless when summer is in high session. I call it the "summertime blues." Here are a few sure signs to watch for— The number of physical sales calls drop like a rock—"you know, no one is ever around during the summer anyway, and they really prefer to speak with me by telephone." Prospects and potential customers get virtually no attention. It takes nearly 48 hours to personally get in touch with anyone from the sales force. The number of sales representatives meeting or exceeding their sales goals or quotas drop by half from the prior couple of months. There is no need to look at the calendar if the above is occurring, it is summertime and your sales force has a case of the blues. What causes this to occur? There is a long-held belief that sales forces are generally self-directed and only need financial motivations or rewards to be directed to achieve expected sales results. In such a world who needs a sales manager? Our theory is that while sales forces are more self-managed than other employees, job structure, high expectations and planning are still (and always) required to assure sales force effectiveness. Summer is a quiet time for managers as well as sales forces. It is our experience that normal expectations for the sales force become lax (or loose) during those months and sales representatives can tend to readily and quietly wander off task while no one is looking. It is a bit of a tradition, but does not have to be. And, such behavior is not isolated to only the sales force. What should the prudent company do? We think the cure is simple: double down on your summertime sales-force expectations! Here are four examples for how to improve sales energy level and focus for the months of June through August: Summer is a wonderful time for cold calling. Double your physical cold-calling quota for the summer months. If you expect 5 per month, increase the number to 10. Give your sales force the lead information required to support this effort and set a 3-month goal for closing business with new customers. Throw in a $1,000 bonus check or two to spice up the process and reward the people really doing the work. If you expect your sales force to make 15 calls per week on select customers, then they must continue to expend that same effort during the summer months. If a client is on vacation and unavailable, find then another client to call upon. No excuses, just plenty of hot-weather sales calls completed. [I actually like summer sales calls; I find one can be more productive.] Realign your monthly and quarterly sales goals at the beginning of the New Year and ask for more sales production and closes during the summer months—if you do not already. Having to reach a little higher makes people work a little harder. [Now, I do not want any cards or letters next year from any of you saying that you tried my idea in 2012 and all it did was create a bad case of "the spring blues."] Make summer a prime time for passing knowledge and skills from senior employees to those new to the company or sales force. Many call this process mentoring. As such, pair a senior sales rep with a rookie for a month or more—in either a territory or to develop and service client portfolio. We believe that it is a valuable exercise for both parties. Particularly, it makes the senior sales rep think about: What is important about each step the sales process; How they must execute each; and Most importantly, how do they explain this mystery of life to a rookie? While some would argue that there could be a loss in productivity in such a pairing, we believe that the formation of this loose team will likely both increase productivity and sales force focus. And, neither party is ever alone to get lost in those summer weeds. In short, keep your sales force busy during the summer and they will get more done. It may take a bit more work for the sales managers, but it will pay dividends for the employee and company. Is your sales force experiencing the summertime blues? If you do not like my work plan, create your own—the secret is acting before you lose the attention of the sales force for the next couple of months.

Will employers be dropping health-care coverage for employees in 2014 as the result of The Patient Protection and Affordable Care Act? New information is emerging.

In August 2010, Wilkening & Company discussed our view of the landscape facing both employers and employees as the result of enactment of the 2010 Patient Protection and Affordable Care Act (PPACA) in the coming few years. In short, we felt that employers would have strong incentives to drop long-standing employee health-insurance coverage for major groups beginning in 2014. Consequently, it can be expected that many will do so. 

It was our assessment that employers will be highly motivated to drop employee-sponsored insurance (ESI) in 2014 because insurance pools will become available as a ready alternative to company-sponsored employee health insurance, and new rules and financial penalties (incentives) will present cost-savings opportunities for employers. The economics were (and remain) quite compelling. However, our intuitive conclusions seemed to run contrary to the original Congressional Budget Office (CBO) estimates that stated only 7% of employers (representing 9-10,000,000 estimated employees) would drop coverage. We just seemed to disagree, at the time.

In early June 2011, the consulting firm of McKinsey & Company published the findings and conclusions of a study it recently conducted on the subject. It was entitled: How US health care reform will affect employee benefits. The report is the result of opinion and proprietary research. In their work, they surveyed 1,300 employers across industries, geographies and employer size. They interviewed each regarding such matters as: their current understanding of PPACA provisions, what they planned to do at its advent in 2014, and why.

The reported results of the McKinsey survey were more consistent with our earlier analysis and in stark contrast with 2010 CBO estimates.

There were many findings of the study, but we believe two were very material to the actions employers must take or consider in the coming months.

• McKinsey's survey results found that on average 30% of employers plan to drop ESI coverage for some or all of their employees in 2014 and that ratio could be as high as 60%. (It appears that those survey respondents that are more familiar with the provisions of PPACA today said they are more likely to drop employee health-care insurance.)  That is nearly eight times the CBO estimate and suggests 70-80,000,000 employees may involuntarily be moved to government insurance pools. The term "drop" is used above to describe ceasing employee health insurance coverage, but it does not mean you can (or will) wash your hands of the employee and the cost of health-care insurance. It is widely believed that companies that drop ESI will also use compensation dollars to bridge the part of the new employee insurance cost that is not picked up by the Feds. Also it is believed that when employees are in a position to select their own coverage, they will select more cost-effective alternatives tailored for individual need.
  
• Contrary to what many employers assume, the McKinsey report concludes that 85% of employees would remain at their jobs even if their employer stopped offering them ESI—and not go to another employer who retains insurance coverage. As we said above, dropping ESI does not mean a clean break with your employee—they are very likely to remain with you, company-sponsored coverage or not.
  

The McKinsey survey has proved to be quite controversial during the last month in some parts of Washington DC for obvious reasons. [They must not have read my August 2010 E-Notes.]

As you may recall In our August 2010 article, we made broad recommendations to our employer-readers regarding what they should do to prepare for 2014. We still believe these actions remain quite valid (and likely even more so in light of the McKinsey survey findings). Let me again reprint these below.

The prudent company will begin to develop its future employee healthcare strategy and corresponding compensation strategy as soon as possible. While we have only discussed a well-paid employee in our example, also recognize that lower-paid employees may be eligible for federal subsidies through exchanges that will impact your cost and decision making in a variety of other complex ways. We recommend that you strongly now consider— A full analysis of your work force and healthcare costs and demographics; An analysis of cost scenarios under current PPACA rules; Development of 2011-2014 healthcare and compensation strategies in light of PPACA requirements; and Creation of an action plan to respond quickly and implement required changes in the event of inevitable PPACA rule and deadline changes. While you technically have plenty of time to consider and act, we suggest you anticipate that changes will surely occur in this arena that will negatively impact your company if you are not ready to respond and act in your own defense—what do they say; the prepared will survive?

As an employer, you should also begin to anticipate questions from your employees regarding health-care economics and decision making. Many have never had to do this in the past and will likely need your help and guidance throughout the process. The greatest benefit you can provide is to support and restore the employee's peace-of mind as they transition through the uncertainty that 2014 will certainly bring—to everyone. Clearly, while you may choose to drop their ESI (and send them to the pool), they may still very likely remain your employee. You must assure them that dropping ESI does not mean being fired or enduring a large pay cut. (Help!)

A year ago we said that time was of the essence for employers wanting to prepare for 2014. Today nothing has changed, only you have a year less to do so.

Wilkening & Company has developed information and methodologies to assist clients in the selection of 2011-2014 insurance and compensation strategies. We will continue to cover this evolving and changing mandates for our readers in future issues of the Corner Office Gazette.

Planning to Improve the Effectiveness of your Compensation Committee

Wilkening & Company believes that it is essential that the Compensation Committee (or any other Committee) of the Board of Directors plan and allocate its resources to address those issues or decisions that they will regularly face each year. In addition, the Committee must leave time for those last-minute emergencies that always arise. This is a challenge that any Committee or Board can successfully address if it looks ahead.

By planning ahead, we mean that the Board should:

1. Establish or identify all known annual agenda items for the Compensation Committee to consider or act upon each year; and
2. Place each on an appropriate Committee meeting agenda.

Agenda items can either require action or merely provide background, information or updates to the Board or its Committee.

As an example of what we suggest, let us assume that the Board of (a fictitious) XYZ Corporation establishes four meetings each year for its Compensation Committee. This is a common meeting practice and frequency that is often tied to the meeting schedule of the full Board. Then, let us create a possible draft 2011-12 planning calendar for the Compensation Committee arranged by meeting. That example is shown below.

Draft Compensation Committee Planning Calendar for XYZ Corporation
2011-2012

Committee Meeting	Action Items Planned	Subjects for Board Consideration or Briefing
November 2011	Approve goals for 2012 annual and long-term incentive plans Approve salary structure and pay increase budgets for 2012 Approve benefit plan structure for 2012	Review year-end 2011 incentive forecasts and projected profit reserves Review of HR budgets, staffing & investments Review HR and compensation "dashboard"
February 2012	Approval of 2011 incentive payouts Approval of profit-sharing/benefit contributions for year past (distributed) in 2012 Selection of Board advisor(s) for 2012	Evaluation of current incentive plans versus best practices & select benchmarks
June 2012	Establish CEO compensation plan for coming 12 months Approval changes to 2013 compensation strategy or incentive plans, as recommended	Report on officer succession planning by CEO Report on CEO succession planning by Chair Annual evaluation of CEO performance Review HR and compensation dashboard
August 2012	Re-approve and acknowledge all compensation contracts (non-LTI) over pre-set limit	Compliance briefing on all federal, state or local regulations impacting people or pay Informational briefings, as selected by Board

Note that in the proposed November meeting subjects for Board consideration and briefing (last column); we include an agenda item called: "Review the HR and compensation dashboard." In our example it occurs in both November and June. This falls into the category of reviewing standard information and metrics regarding productivity, cost or risk. We find it helpful for management to discuss these metrics with the Committee at the opening of every (or every other) meeting. In our experience, such a report is brief (one page) and contains such matters as—

• Trends in employee retention or turnover;
• Trends in employee productivity—sales per, units per, profit contribution per;
• Trends in compensation and benefit costs in aggregate and per employee;
• Open and unfilled positions in key job titles; and
• Known and imminent risks to company impacting employees, pay or benefits.

Some may consider this too much detail for a Compensation Committee to see. Maybe, but I would suggest that a bit of forewarning could be an actual cost and time saver for the Board, and the company.

The proposed planning calendar presented above does not leave much time for the unknown issues that arise and will require the rapid attention of the Compensation Committee. In our experience, 25% or more of the Committee's time can be taken by those unknown problems that always seem to roll in over the transom. There is no way to plan for this other than to allocate extra meeting time. In short, more time than planned may be (will be) needed to conduct all of the Board's business. At least your planning calendar will determine the baseline requirement of work to be done at each meeting.

Does your company have a planning calendar somewhat like the one we have drafted for XYZ Corporation? If so, I am sure you will agree that it helps in improving the productivity of the Committee. If not, put one together before the next meeting and see what the Board thinks—bet they like it.

Clearly, a planning calendar can have benefits for all Board Committees, or the Board as a whole. I use one just like this for a Board on which I sit. Sure helps the Chair (me) be sure the Board and management are getting everything done—as agreed and on time.

Designing incentive plans for sales territories with “lumpy” demand

In last month's edition of the Corner Office Gazette E-Notes we discussed sales territories with "lumpy" demand resulting from the selling of disparate products to the same customer base, and the impact of such sales demand upon goal-based incentive pay plans.

We used as an example a distribution company selling specialized printing supplies to smaller art and print shops. The typical supply buyer purchased $2,000 to-5,000 in supplies annually. The supply orders were relatively small, ordering was frequent and the underlying business demand was stable. Hence, supply revenue was very predictable.

The same sales force also sold modestly expensive capital equipment in the form of printing presses and drying/curing units to their customer base. The average purchase could be up to $50,000 per unit, or above. The presses could represent a very large "lump" in the typical territory revenue plan, and a handful of printing-press sales could drive a sales territory well over its goal for the year—or drive it well under plan if press sales did not come in  over the transom. The demand for presses was believed to be unpredictable by the sale force, and equipment profit margins were much lower than those of supplies.

In an environment of predictable sales volume and demand (like that of printing supplies), one can successfully reward the sales force based upon achievement of each sales rep's territory annual sales goals using goal-based incentives. In other words, the sales representative earns an incentive or bonus based upon their annual results versus the territory's annual sales goal. A competitive incentive (say $30,000) is earned when the annual sales goal is achieved. Then more or less annual incentive is earned for achievement of results above or below the territory goal. But below a certain level of annual performance versus goal, no annual incentive is earned. An example of the workings of a typical goal-based incentive plan is included in our April 2011 E-Notes.

Goal-based incentive plans are most often successful if the year's sales (or profit) results can be expected to fall within a range of ±25% of the expected goal--i.e.: 75% to 125% of goal. When results outside of that range are routinely experienced, the plan will become high maintenance for company management and ultimately devolve into discretionary payouts. That was precisely the impact of throwing printing press sales into a steady stream of supply orders.

While this is an interesting example, let us stop for a minute and ask the question: Do you also have sales territories with lumpy demand? Use three criteria to try to answer that question. If you answer yes to two or more of these, you may qualify.

• An order for the diverse product (printing presses in our example) is 10+ times larger than the average territory order (for say, supplies);
• The demand of the diverse product is not part of the annual sales forecast—upon which compensation goals are based; and
  
• The sales demand for the diverse product can amount to 25% of annual territory sales volume, or more.

So if you think you have this problem, read on. Otherwise, read on anyway—we are about to offer a solution with broader applications.

We suggest using an alternative incentive approach that recognizes the two discrete streams of income with very different demand characteristics through the use of supplemental sales bonuses. With such an approach, the sales force will have a "normal" goal-based incentive plan for supplies (only) designed to work well in that supply-buying environment. Then as an extra or add-on (like a cherry on a sundae), there will be a special bonus paid for the sale of each press or other select pieces of capital equipment. The amount of this special bonus will generally vary by such factors as: number of machines sold annually (and dollars), type of product (i.e.: profit margin), key customer or strategic product placements. But, it must be a big sale to qualify. Also remember that a bonus (or any payout) must be material in size to get the attention of the seller. Hence if selling a press or other big-ticket item is a big deal, the bonus paid should be north of $1,000.

You can get pretty creative with such a bonus. It can both drive sales and simplify the communication and application of sales incentive. However, be sure that you now also insist that every sales territory and sales rep has an annual equipment goal in units and dollars. This bonus is just not gravy for the sales force; it recognizes important strategic actions in a straight forward way. And bonus or not, the sales team is responsible for achieving their equipment goals too. Further, if they begin to be able to reliably forecast these sales, you have not only solved an incentive-plan problem, but also a core business problem.

The incentive approach outlined above also can apply to any outlier product or service. We find the use of these types of add-on bonuses is very useful in solving real world marketing/sales problems and making sales pay plans more effective.

I would bet you can find a use for bonuses in your sales pay plans. Just look around a bit.

The Employee Policy Manual—Shorthand Version

When I worked for a Fortune 500 public company our corporate policy manual was at least 4 binders thick. I was told everything you needed to know about the company was written down in that book—right down to the furniture brand, model and color that the Sales Manager in our Burlingame CA office rated. While I was in a position where policy compliance was important (and was part of my job to assure), I do not remember ever opening or using this august 4-binder document as a reference or guide. I did not even know who had a copy. In short, the document was pretty useless to the conduct of business and to the average employee. In today's world I assume the 300+ pages of the above-mentioned manual would be available to employees on-line. It may be much more accessible today, but just about as useful as it was 30 years ago.

I have also seen situations where policies are not written by a company and are only available verbally when a question or problem arises. Whether 4-binders thick or unwritten, neither version is much assistance to an employee trying to do their job. Not a good situation in either case.

The reason I bring this up is because I strongly believe that every employee should know the key existing company policies, rules and resources that impact their job and conduct on a daily basis. And, they should be able to lay their hands (or eyes) on a summary of these within no more than 5 minutes. Let me refer to such a summary and document as: The Employee Shorthand Policy Manual. "Shorthand" means that it should be simple and be no more than three-pages in length—electronically or not. In my experience, it should address the following questions—

• What are the terms of my employment?
• What does the company expect of me?
• If I have questions or issues to resolve, what do I do or who do I see?
  
  

Let me summarize what definitions, directions or answers might be contained in each.

1. What are my terms of employment?—
1. What is full and part-time employment? What does that mean to me?
2. For what actions can I be discharged? [in short, a definition of "cause"]
3. What are the company's policies regarding performance and promotion?
4. How does the company generally compensate employees and how do I determine what benefits are offered for my job?
   

2. What does the company expect of me?
1. How can I determine the formal duties and responsibilities of my position?
2. What are the company's policies regarding safety and ethical behavior?
   
3. What are the hours of business and what constitutes professional dress and presentation in the work place?
4. How should I conduct myself as an employee regarding other employees, customers and suppliers?
5. What type of behavior is not allowed on company premises or in the conduct of company business, and what should I do if I observe such behavior? [How will my comments or outreach be handled—i.e.: confidentiality?]

3. If I have questions or issues to resolve, what do I do or whom     do I see?
1. Where can I receive information regarding the reporting relationships within the company—my boss, my boss's boss, etc.........?
2. In the event of a voluntary termination ("I quit"), who do I tell and what should I do?
3. In the event there is a question regarding my pay or benefits, who should I ask and what should I do?
4. In the event I observe or believe there is an unsafe condition in the company impacting me or others, who should I tell and what should I do? [How will my comments or outreach be handled—i.e.: confidentiality?]
   
5. In the event disagreements with other employees or managers arise affecting my job or the company what actions should I take?
   
   

Well, I think I did it. I got all of the salient stuff (I think) an employee might want to know in three pages or less.

Now an attorney might say that we must cover (write) much more to be prudent in such a document. I would respond to their comment by saying: give every employee the shorthand version, and in it, you can reference the more detailed multi-binder document that resides in HR or on-line (if you think it is necessary)—that no one will ever read anyway.

Notice that in the 3rd section ("Whom do I ask or see?"), we provide a series of potential issues or questions and then refer the employee to the appropriate company executive who will answer specific questions or resolve problems. Also note that I have brushed up against the issue of confidentiality in a couple of points. In our experience, this can be a serious issue or employee dilemma. Employees infrequently may need to raise an issue or ask a question that should "land" on the desk of a third party (non-employee) serving the company (perhaps your CPA). It is important to give them a path to do so.

Do you like this approach to policy writing? If you do not already have one, try writing your own Shorthand Policy Manual in the coming week. Can you readily answer the questions I have posed above—or provide a simple path to an answer? If you cannot, where does that leave your employees?

Cold calling: Are they really doing it?

On more than one occasion we have discussed the necessity and virtue of cold calling in this increasing-difficult (and here to stay) economic environment. Your goal should be to capture market share while adding enough new clients to your rosters to both grow and replace any defections you incur. [You can reasonably expect your competition to employ the same market-share sales strategy that you do.] It is a difficult and time-consuming sales strategy to pursue, and most members of your sales force simply do not like to do it. I do not know anyone who likes to be told "No," do you? When a company tells its sales force to do more cold calls, it generally expects that this will be done as part of the normal and routine daily sales activity—somewhere between solving vexing and high-profile customer problems, calling upon a favorite client for lunch in a far-away place or meeting with Marketing regarding the latest in new products. In short, cold calling has a tendency to get lost in the demands of today's clients. There are always 100 excuses—resulting in zero new customers. We would always advise that a way to make any activity a success is to both focus and segment. If you want your sales force to be more successful at cold calling try this: Do not overwhelm the sales force with pages of useless (yes, useless) leads. They should always each have 2-5 active actionable and higher-potential leads that are being worked. Little ones do not count and frankly get in the way. Make cold calling a discrete weekly activity: "We cold call for new accounts on Tuesday!" The sales force needs to answer for Tuesday's results on Wednesday. Do not allow the day-to-day get in the way. You have a customer service group—use it to keep your sellers in the field. Lastly, appoint a company-wide "Executive-In-Charge" for cold calling. [An up-and-coming sales manager is a good choice.] Is your sales force having problems getting cold-call traction? Try the above steps starting next week. Then, come back in about four weeks to assure that Cold-Call Tuesday remains in place and real results are being seen. If not, appoint a new executive-in-charge. For more discussion of cold calling, reread our October 2009 E-Notes article entitled: Let's talk about cold calling.

Limiting Payouts Under an Annual Incentive Plan—Why Some Companies Use Payout Caps

I have likely designed well over 100 annual incentive plans for sales forces, operating and staff managers and executives over the last 30 years. Many of these plans are goal-based in design and are generally built to reward the participant for meeting and exceeding management's expectations (i.e.: their goals).

Goal-based incentive plans are often designed to pay increasing amounts of incentives for increasing performance. In most cases, the participant is paid for partial progress between stated levels of performance (e.g.: threshold, meets expectations, greatly exceeds expectations, WOW...). A typical payout vs. (say sales) performance function looks a bit like the chart shown below.

As you can see in the above chart, a $20,000 incentive is earned beginning at a performance level of $1,000,000 (at threshold)—nothing is earned below that level. At the expected or goal level of performance ($1,600,000 in the example) a $40,000 of incentive is earned. And at a level well above goal (or $2,200,000 in this example or 150% of expected performance), a $60,000 incentive is earned. $60,000 may be the top level of incentive to be earned by a participant in the plan, or not.

There are dozens of ways to design such a plan, but my chart describes a very common structure and practice. The payout vs. performance relationship is commonly called an "incentive table." But, what happens when performance exceeds $2,200,000? Is it "capped" at $60,000 in annual incentive? Would that be de-motivating to the participant?

When such questions regarding incentive payouts and limits are asked (and they often are), the answer is not always a clear yes or no. In truth, it depends. So let's spend a few minutes talking about why we have found that some companies have chosen to limit annual incentive payouts at the top of the table.

Generally, there are three primary causes:

1. The company has difficulty in setting reliable performance expectations (goals) based on history, experience or information available at the time.
2. The company regularly experiences "lumpy" demand for its products.
3. The plan participant has limited impact on the end results for which they are being paid.

The three points stated above also represent reasons why (and situations where) goal-based incentive plans do not work. Let's briefly discuss each of the above in turn.

• Difficulty in setting reliable performance expectations or goals—This may mean that the company has been historically unable to set performance goals whose outcomes cannot be predicted with some reasonable probability of success. For example, a company may not have a transparent portal into its sales process and customer base. Consequently, its sales results may fluctuate unpredictably up or down from year to year and only the sales force seems to know why—not the company. Or, the participant may have historically been allowed to understate what they and their account base is capable of producing in any given year to assure that goals will be comfortably met and consequently incentive payouts will always be well over target payouts.  In either case, it is quite likely that there will be all-too-frequent cases where the achieved performance levels cause earned payouts at or over the top of the incentive plan "table."
  In a well-designed goal-based incentive plan, maximum payout levels should be only be earned 5-10% of the time (yes, once every 10 years or more). But, I have seen cases where the reverse is true. As a result, companies that do not have confidence in these probabilities of achievement will often impose incentive limits to avoid payouts that are strictly an artifact of bad or unreliable goal setting.
• Irregular "lumpy' demand is experienced—I once had a client who sold specialized printing supplies to 10,000 or so small art and print shops. It was a very predictable demand environment where the typical supply buyer purchased $2-5,000 in supplies annually. The supply orders were relatively small, ordering was frequent and the underlying business demand was very transparent—to anyone that looked. It was a great new-customer environment where new accounts (and price increases) made for predictable increased supplies revenue.
The territory sales reps were paid an annual incentive based upon achievement of revenue versus annual goal and could potentially earn two times target annual incentive for achievement of up to 120% of goal—not an unusual performance/incentive range in a highly predictable demand environment. But there was a wild card. The sales force also sold capital equipment in the form of printing presses and drying/curing units to their customer base. The average purchase could be anywhere from $10,000 to $50,000 per unit. So the presses represented a very large "lump" in the routine revenue plan. It did not take too much more than a couple of printing presses to drive a sales territory well over its goal for the year, and often off of the incentive table. The sales force also claimed (with some support) that it was quite difficult to predict press orders—"they are only replaced when they break down." Plus, the profit margins on the presses and equipment were much lower than those of the mix of supplies. When presses entered the calculation of incentives, this client chose not to pay more than the maximum plan incentive at 120% of sales goal.
• The impact of the participant on the end results is limited—It is not uncommon to see annual incentives paid for group or collective results, or for results not directly within the control of the plan participant. An example of this is having an annual goal-based incentive for company managers and employees based upon enterprise or business-unit profit contribution. This is often done to provide a collective focus on (or responsibility for) the key measurement of enterprise success. But, no single mid-level manager or employee is likely driving company profit one way or the other. Clients will often limit incentives earned under these type plans. Why? --because it is felt that the participant is benefiting from and not driving performance. However when performance is truly exceptional, the CEO or Board will often step up and elect to pay more than the plan's posted limit. And as employee gestures go, that is generally a pretty good one.

Are these good reasons to limit or cap incentive payouts? Is there ever a good reason? Some CEOs and Boards think not. What do you think?

When looking at incentive plans and payout potential, use this simple rule of thumb to consider whether you should consider caps: If you, the CEO or Board believe that you will ever be put in a situation where there is a perception that an incentive paid (or to-be-paid) is not an incentive earned, be assured that such feelings and discussions will surely become broadly known and that will be very damaging to individual relationships and company culture. The last thing you want to do is have your incentive plan and practices create such conflict. If you think this can happen, it is time to rethink the design and pay-out limits of your incentive plan.

Questions: Has your organization ever chosen to limit incentive payouts? Why have you chosen to do so? If for different reasons than mentioned above, please tell us and we will pass it along to our readers.