Guidelines for incentive compensation in 2018

There is no topic I receive more calls about than that of incentive compensation. Here are just a few examples of questions that lead to these calls:

  • How do I make the incentive plan fair for all employees?
  • How do I best transition from a straight salary or hourly pay plan to a performance-based plan?
  • What is the best way to structure an incentive pay plan?
  • Is it best to tie total compensation to performance or just the bonus portion?

Anyone who has spent much time in a culture outside the United States will quickly realize just how materialistic we Americans are. Many American workers are motivated by being in control of either all or part of their pay, but there are also those who would rather know for dead sure how much they will earn in each pay period. So before deciding how to set up the plans, it helps to do your homework and attempt to estimate how your salespeople will respond.

Based on my experience, employees with the highest economic values will respond positively to an incentive- based pay plan, so the first step might be to access just how “hungry” your people are.

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Before you begin designing the plan, the second step might be sitting down with your key managers and brainstorming what results you want in measurable terms.

Most of my clients want their salespeople to sell more at a higher gross margin, so if this is also true in your company, you may wish to incorporate both sales dollars and gross margin into the incentive plan you put together for your salespeople.

Suggestion: Regardless of the method you are currently using to arrive at your salespeople’s pay, do the math and determine how much you are currently spending as a percentage of sales for both inside and outside salespeople. This will give you a good ballpark idea of how much you can afford to pay as a percentage of sales under your new incentive pay plan.

I mention inside and outside salespeople because a lot of companies in our industry use sales coordinators to punch up the business their outside salespeople generate, so companies that are paying both employee classifications as a percentage of sales, are likely “double-dipping.” What I mean by double-dipping is they are paying both inside and outside salespeople on the same sales dollars. If you don’t anticipate this sort of thing in advance, it can become very costly in a hurry.

If your salespeople have some degree of pricing authority, they are in a better position to influence gross margin than if they have no pricing authority. In my book “Gross Margin: 26 Factors Affecting Your Bottom Line,” I identified 26 factors that affect gross margin, so as important as pricing is, it is by no means the only factor to consider. Companies that are willing to invest the time to educate employees on how to achieve higher levels of performance will usually get the best results.

Most general managers want their buyers to buy better and achieve higher inventory turnover, so using a combination of these two measurements when designing the incentive pay plan has a lot of merit. I also have clients who throw in shrinkage as a third component.

The incentive compensation plan should motivate credit managers to improve average collection days and reduce bad debt expense.

Warning: An incentive pay plan does not eliminate the need for managers to still manage their employees. Managers still need to work closely with their people to help them avoid mistakes and make better decisions as they go about their day-to-day activities.

My old coworker and mentor, Lanny Moore, once taught me that all good managers must “inspect what they expect.” The most productive employees are usually the employees who have a good coach that is looking over their shoulder and helping them to improve their job.