In most cases, I am against binary incentive compensation schemes. By this I mean any plan where achieving a single, specific milestone has a large cash payment tied to it. I call these schemes Captain Ahab bonuses, in memory of the gold doubloon the Moby Dick character nailed to the mast, to be given to the first sailor to spot the great white whale. The commonest example of these schemes is a cash bonus paid when the sales rep reaches exactly 100% of quota.
My view is controversial, because we live in a culture of setting specific, measurable goals and then striving mightily to achieve them. It seems only natural to attach great significance to achieving such goals. But binary incentive schemes are a bad idea for several reasons.
1. Not many are really motivated by them. The ideal comp plan doesn’t just reward the right behavior, but motivates it in the first place. Ask yourself if a large bonus for reaching 100% of quota will actually motivate in these sales rep situations:
- The big producer, for whom achieving 100% is not the issue. Not likely this person is probably shooting for 200%, or 300%, or more.
- The sales rep whose year is in the dumper, regardless. Not likely especially late in the year, it may be more rational for this person to start next year with a clean slate, with one or two deals already in the bag.
- The sales rep already at 101% (or more) of quota. Certainly not a bonus check thats already been written wont motivate anyone to close another deal or two.
- The sales rep extremely close to quota say, 99.5% early in the year. Not likely most reps aren’t worried about eventually generating that extra 0.5%.
- The sales rep at 99.5%, late in the year. Hmmm. What might a rep consider doing to generate another $2,000-$3,000 in business in order to get a $20,000 bonus? The term some would use for this situation is moral hazard.
2. They use up oxygen. The commission budget is finite, and you can use all of it for straight commissions, or set some aside for the Captain Ahab bonuses. In the example below, 10 sales reps each have target incentive pay of $100,000 for achieving quota of $1 million. Scheme A below is straight commissions only, and Scheme B includes a $20,000 bonus for achieving quota:
Incentive Compensation Budget Scheme A Scheme B
Total quotas $ 10,000,000 $ 10,000,000
Commissions $ 1,000,000 $ 800,000
(average commission rate) (10.0%) (8.0%)
100% Achievement Bonus $ 0 $ 200,000
Total budgeted incentive compensation $ 1,000,000 $ 1,000,000
In both schemes, the total incentive compensation is the same if every rep is at 100% of quota. However, if you accept the premise of Point (1) above that the 100% achievement bonus does little or nothing to motivate most reps, most of the time then Scheme B has no extra motivational effect. Unfortunately, at the same time Scheme B reduces the commission rate by 20% compared to Scheme A (8% vs. 10%) and thats a difference every rep sees, every time he or she is looking at one more deal opportunity.
3. Who cares, really? The notion that individual sales reps each should achieve quota has a logical flaw: Its a great feeling to have the engine firing on all cylinders, but isn’t the company’s objective simply to achieve the total revenue commitment it made to its stockholders? Does it really matter which sales reps brought in that last couple of deals that got the company over the hump?
In a future post, Ill talk about situations where binary incentive schemes can make sense, and how to implement them. But most of the time, while they may look good in theory, in practice they have little or no motivational value, and dilute the impact of incentive schemes that actually do motivate.