Do you need both long-term and annual incentive plans for your executive team?

But first for the sake of definition, what is the difference between a long-term and an annual incentive plan? 

An annual incentive plan is a cash-based incentive or bonus plan that pays an executive (or other employee) for annual individual, group or enterprise performance. The value of the reward is generally based upon annual performance metrics and frequently measures results versus a goal or other standard. This is a concept and tool broadly applied in business.

Long-term incentive plans are less commonly used and represent a cash- or equity-based incentive or bonus that pays an executive for multi-year enterprise performance. The value of the reward is generally based upon the creation of measured enterprise value or achievement of pre-defined strategic objectives. Long-term incentives are used almost exclusively for senior executives, and then on a very selective basis. Stock options or restricted stock are common reward vehicles for publically-held firms, but most (or nearly all) privately-owned companies settle their plans in cash.

As noted above, the use of both types of incentives will vary, but typically annual incentives are nearly universally offered to executives. Long-term incentives are not. Look at the following table to see the differences amongst four typical senior-level executive positions. It shows differences in the frequency of use for reporting organizations taken from a recent Towers-Watson Data Services survey.

Three observations are obvious when you look at the above data:

• 80-90% of executives receive annual incentives (or have the opportunity to earn them).
• Long-term incentives are not frequently offered or paid by smaller companies (under 1,000 employees), but usage increases rapidly as company size grows.
• Long-term incentives are less frequently offered or paid (by about 20% less) as the size and responsibility of the executive job is reduced from (say) CEO to a Vice President, in any sized company. 

In companies over 5,000 employees, it is very likely an executive will participate in an annual incentive plan and the majority (50-90% of participants) will have both an annual and long-term incentive. If you are the CEO, participation in both plans is nearly certain.

Why do smaller companies hesitate to use long-term incentives? In our experience, most of these firms are privately owned and the mere mention of terms like “phantom-stock” or “equity” will bring an immediate halt to any discussion of executive incentives (and groan from the owners). I have been in some of these meetings.

What is done by other companies in the marketplace provides an interesting benchmark for decision making, but do you need both a long-term and annual incentive for your executive team? Let’s briefly look at each in turn.

The case for paying a performance-based annual incentive for executives (and other key employees) has been long made. It is an effective and tested way to focus the attention of the executive team on the annual goals of the company and helps constantly reinforce its strategy. You should be using annual incentives for your executives. But what about long-term incentives, are they also needed?

That depends. Try this test to see. If you can answer the following four questions in the affirmative, generally you should also be considering a long-term incentive plan for the “pivotal” members of your executive team.

1. Are there one or more members of your current executive team that are essential to the company over the next 5-10 years to assure success?
2. Do you need to recruit key executive talent in a marketplace where competitors are offering long-term incentives in various formats like stock options?
3. Can shareholders and other owners create a case for increasing shareholder value that involves “sharing” equity or future cash profits with the executive team and (in exchange) still coming out well ahead in terms of the increased value of their holdings? [i.e. - a value proposition]
4. Can key members of your executive team be seen as having the ability to uniquely drive growth in company value? [How? Who?]

If your answer to all (or some) of the above questions is “yes”, you should be considering the addition of a long-term incentive plan. Unlike the market, the size of your company will have little to do with your ultimate decision. Smaller companies may also (and often do) apply.

It has been our experience that a well-designed long-term incentive plan can begin driving success and performance in as little as a single year and instantly put executives on the “same page” with owners in focusing on increasing shareholder value.

Looking for a way to sleep better at night? Then delegate ownership’s value-creation problems to the executive team with a long-term incentive plan, and get some rest.

Talk With Your Sales Force

Each year we spend a half-day at the University of Wisconsin speaking with senior sales leaders about the principles and techniques involved with the design of effective sales-compensation plans. Invariably, the subject will turn to an analysis and critique of the current sales-compensation methods used by some of the participants—that they volunteer or describe. It is usually a pretty interactive and fun session with much give and take.

When the session concludes I provide the participants with a short list of next steps or questions to address. They are designed to help each apply the lessons learned in the session to the particular sales-pay challenges their company may face. One question asks them to assess whether their sales-pay plan is working, or not—as measured versus criteria discussed during the session. And to start that process, we strongly suggest they directly ask that question of their sales force. This is a technique and practice we have employed with success for the last 30 years. Going directly to the source makes a lot of sense to us and usually gives a pretty unvarnished view of what is going on.

But, it is our experience that many CEOs and sales leaders do not speak with the members of their sales force very often—with the exception of reviewing sales results or unwinding (often messy) customer problems. We think this is a mistake and a great opportunity lost. Further, it can leave company leadership blind to the needs of the sales force and the market, and can result in unpleasant surprises.

Most CEOs or senior sales executives will state they do not have enough time in their busy schedule to spend time directly with the sales force—unless there is a “problem.” Well, problems can come in many flavors and colors and the ones you do not know about are generally the most dangerous. Interested? You should be. Try this 3-step plan:

1. Schedule time out of your office and with the members of you sales team. Try planning to see or visit with 2-3 sales reps per month on their turf. You will routinely schedule 2-3 customer visits each month, so why not schedule equal time to be with the sales reps who call upon those very same customers every day?
2. Leave agendas and spreadsheets back in the office. Spend a morning making a sales call or two together, have coffee together and answer a customer question or two together. Make yourself part of the sales force for a day. Routine discussions of goals and performance should be off limits. Now be sure to schedule (announce) your visit well in advance, but even so, it will likely take a CEO or top sales executive about an hour to calm the rep down. You probably should plan to drive for the first couple of hours for safety sake.
3. Use your lunch effectively by having an open chat with the employee. Tell them your plans for the company and ask for their input. Also use this brief time to ask them to open up about both current market forces and those support processes that should be in place to make them a more effective and motivated seller. Ask questions like this:
1. What is getting in the way of you closing more business?
2. What are the competitors up to?
3. What are customers saying about us these days?
4. Is your sales compensation plan fair? What do you think should be changed in the future?
5. And finally, do you have any questions for me? 

Be careful not to make commitments or promises you cannot keep, but be sure to offer an open door and open ear for future dialogue. And, never “reveal a source.” If something needs an answer, call them back within a week—personally.

The cost of the above is a couple of days a month out of the office and on the road. The value is being able to get out in front of serious trouble—before it becomes serious trouble.

Try it for the rest of the year. Once you get into the rhythm and get some results you will not only likely continue into the future but also consider expanding the practice across the company with other top executives, if not already done.

In the end we do not care how you do it, but do get out of your office and into the field with your frontline sellers. You will be happy you did. And, so will they.

Wilkening & Company has advised clients regarding the design and implementation of long-term incentive &sales compensation plans for 30 years. Our practice has addressed client challenges in businesses ranging from manufacturing and industrial distribution to private equity (and financial services).