We return to the rich, fruitful topic of “boneheaded compensation plan ideas.” A capped compensation plan is one that sets an upper limit on the total amount of compensation, even if the calculation formulas indicate a higher amount. Capped plans are one of those often well-intentioned and unfortunately common incentive compensation plan characteristics that can have disastrous consequences.
The motivation behind capped compensation plans is usually the idea that there is an upper limit on what any employee should be able to earn. After all, why should a lowly sales rep make more money than the CEO, let alone several times what the CEO earns? Others argue that there’s too much luck involved in what sales people do to justify a gigantic paycheck. But if so much luck is involved, then sales people shouldn’t be on commission in the first place, so let’s just ignore that argument.
Some arguments against capping compensation plans:
1. Perverse incentives. Why would any sales rep bring in a deal when his commission rate is going to be zero? Most likely, a sales rep in that position will simply let all additional deals slip into future time periods when new business starts earning commissions again.
2. Possible turnover. The effect of capped compensation is to drive the biggest producers away, to other companies where sales earning potential is unlimited.
3. It’s unfair. Sales people put a significant portion of their expected compensation at risk. Companies that cap compensation have no problem paying zero commissions to a sales person producing zero revenues, so they’ve taken away the upside but not the downside.
4. Why? Why should a company’s commission expenses be different – i.e., less – if sales production is concentrated in a handful of big producers?
Reason (1) above is by itself a strong argument against setting upper limits on sales compensation. Together with the other three arguments, I find capped compensation plans just inexcusable.
Now I’m going a little beyond the usual scope of this post, but let me observe that many incentive compensation plans for people other than sales people are capped. The best examples of this are almost all management by objective (MBO) plans for general managers and rank-and-file employees. I consider that a shame – a well-crafted MBO plan without an upper limit could send a powerful positive message to the all employees without breaking the bank.