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By Mark A. Stiffler, President, Synygy, Inc.
A new sales incentive compensation trend is emerging that is replacing traditional territory quota schemes at many of the world's largest companies, including Du Pont, Wyeth-Ayerst, Schering-Plough, Bausch & Lomb and Hoffman-LaRoche.
Instead of relying on territory quotas, these companies are taking a different approach. From a pool of dollars (which grows or shrinks depending on the success of the company or a region), they are providing sales rewards based on performance relative to peers. This is a radical departure from existing methods, but the logic behind the approach is overwhelming.
How can you truly pay for performance? Provide a level playing field and then let salespeople know that the best win the largest share of the pool and poor performers could earn nothing. This approach eliminates the entire quota-setting process and the many problems associated with the use of territory quotas.
This trend began in the pharmaceutical industry where there has been a rapid shift in the past four years. According to Hay Group's 1995 survey of pharmaceutical companies, more than 80 percent of pharmaceutical salespeople were on a quota-type plan.
Synygy Inc., a Bala Cynwyd, Pa., consulting firm that implements and administers incentive compensation plans for more than 16,000 salespeople, estimates that approximately 40 percent of pharmaceutical salespeople are on a quota-type plan today.
The practice of eliminating territory quotas may soon be catching on in other industries.
Quotas Riddled with Problems
Quotas are sales goals that are set for each territory in advance of the sales effort. Pre-set territory goals, although in widespread use, are problematic because they are:
- Virtually impossible to set accurately, especially for new products
- Often perceived by the sales force as unfair because goals are set in a "black box" (although salespeople don't really care if they don't
- understand the quota-setting process when they're making money)
- Unable to adapt to changes such as new product launches, additional salespeople and realignments (unless goals are reset, which defeats the purpose of having pre-set goals).
Territory quotas often result in disruptive and damaging cycles. These cycles consist of a "blow the budget" phase when quotas generally are set too low across the whole company, followed by an excessive employee turnover period when quotas are set too high.
Furthermore, quota-type plans often are supplemented with sales contests to handle special objectives or to get more money into the hands of salespeople when payments are below target and turnover starts to occur. But, contests easily can skew the sales effort toward the product under contest and away from the company's true strategic focus.
Paying for Performance
"Paying for performance" is paying the top performers a lot more in incentive compensation than the average performer and paying the bottom performers a lot less. Given the underlying trend across all industries of "paying for performance," quotas create a difficult challenge because it is impossible to predict the degree to which each person will exceed or fall short of his/her quotas.
Therefore, it is impossible to guarantee a desired payment spread between bottom and top performers and to set up an incentive compensation plan that guarantees the top performer will earn significantly more than the average performer.
Undesirable Field Behaviors
An incentive compensation plan is based on changing people's behaviors before they get their next paycheck. The problem with quotas, however, is that they promote a number of undesirable field behaviors, including:
- Salespeople who stop selling when they achieve 100 percent of that period's quota. They know that if they sell more, their quota will be higher for the next period.
- Salespeople who reward themselves by coasting after earning a desired amount.
- Salespeople who simply give up because their quota is unattainable.
Consequently, quotas encourage not selling and field behaviors that do not result in the company achieving the highest possible sales.
Four Fundamental Plans
Understanding alternatives to quotas is a matter of understanding how to benchmark performance and translate performance into earnings.
There are two primary ways to benchmark the performance of salespeople:
- Absolute performance benchmark. For example, compare territory sales to a pre-set territory quota set in advance of the sales effort and ask, "Did the territory beat its quota?"
- Relative performance benchmark. For example, after the sales effort is completed, compare territory percent sales growth to the company percent sales growth and ask, "Did the territory grow faster than the company grew?"
Two essential ways to translate performance into earnings are:
- Variable earnings distribution (i.e., earnings depend on how well each person performs with the total earnings being unpredictable)
- Fixed earnings distribution (i.e., a forced spread in earnings occurs between bottom and top performers with the total earnings determined in advance).
When the two ways of benchmarking performance and the two ways of translating performance into earnings are combined, four fundamental types of incentive compensation plans emerge.
Relative Goal Attainment
A "relative goal attainment" plan is similar to a territory quota plan, but with one major difference: A sales goal attainment is calculated for each salesperson and all of the salespeople are ranked to determine their payments. In other words, these plans are "force ranked sales goal attainments."
These plans have the same strengths and weaknesses as "territory quota" plans, but with one major advantage: They're more controllable financially since the total payments are based on a pool of money.
However, these types of plans can be difficult to understand. For example, a salesperson is likely to ask, "What do you mean I beat my quota and still didn't make any money?" They also are anti-team because they involve "forced ranking."
For these reasons, it is easy to understand why such plans, despite their low budget risk, are not in widespread use.
Indexed Relative Performance
With "indexed relative performance" plans, there are no pre-set territory quotas. Each salesperson's performance is measured relative to a benchmark that is determined after the sales effort is completed, such as the company's percent growth in sales.
A "performance index" for each product (or product line) is calculated by dividing the salesperson performance by the benchmark. Then, performance indices for each product are combined and a "payment table" is used to translate the overall performance index for each salesperson into a payment.
These plans have the same strengths and weaknesses as a "pre-set earnings distribution" plan, but are not in widespread use because of a few major weaknesses:
- It can be difficult to understand all of the different indices.
- A desired payment spread between bottom and top performers cannot be guaranteed.
- The desired sales effort between products is skewed toward those products with greater performance spreads (because the upside earnings potential is greater when the performance spread is wider).
Pre-set Earnings Distribution
With pre-set earnings distribution plans, there are no pre-set territory quotas, but often there is a link to company or regional goals. Instead, relative payments for everyone in a sales force are set in advance.
For example, the payment schedule might indicate that the "worst performer gets zero," "the best performer gets three times the average," and "the average performer gets an average payment." Each salesperson's performance is measured relative to a benchmark, such as the national average performance, and the relative payments are determined.
Although there are many strengths to pre-set earnings distribution plans, they have a few potential weaknesses:
- They can be "anti-team," especially if people are force ranked.
- They have no pre-set absolute territory quotas or goals, rather, the goal is simply to "be the best."
- They cannot specify in advance that a specific amount of sales will result in a specific payment. The plan says, "If you are the best, you will be paid X times the average performer."
These potential weaknesses can be ad-dressed easily through proper plan design, for example, by avoiding any forced ranking, tightly linking territory earnings with region or company goals, and including a team component to eliminate any anti-team effects.
The strengths of such plans will over-whelm any remaining weaknesses. When properly designed, pre-set earnings distribution plans:
- Eliminate the need for pre-set territory quotas, the problems of accurately setting them, and the perceptions of unfairness
- Eliminate the "black box" mystery since all assumptions and calculations are explicit and more motivating than territory quota plans (according to research by Lazear at Stanford)
- Reduce turnover of top reps (based on a study by Boehringer Mannheim)
- Are flexible and easily adapt to changes in business conditions, evolving strategic objectives, and new product launches without the messiness of changing the plan structure or resetting goals.
Pre-set earnings distribution plans also have tight financial control. Synygy's study of more than 12,000 salespeople indicated that pre-set earnings distribution plans have a budget variance of only 10 percent, while territory quota plans range from underpayments of 80 percent to overpayments of 300 percent.
Furthermore, companies that implement these plans are able to guarantee a desired payment spread between bottom and top performers -- truly "paying for performance."
Analysis by Synygy showed for pre-set earnings distribution plans an average payment spread between bottom and top performers of 30 percent to 250 percent of the average earnings. Territory quota plans had an average payment spread of only 90 percent to 110 percent of average.
For companies with multiple field forces selling different products, these plans provide an equal opportunity to earn the "upside potential" regardless of the salesperson's particular product mix.
The behaviors a company wants from its sales force are driven directly by the performance measures used and can be influenced by having multiple measures and varying the weights between products. Maintenance measures, such as volume or share, encourage salespeople to "hold on to what you have." Growth measures, such as percent change in sales, encourage salespeople to "grow the business."
However, the most important desirable behavior may simply be "never giving up." That's because the goal with a pre-set earnings distribution plan is to be "number one," not simply to beat the quota. The elimination of the inaccurate, unfair and misunderstood quota may truly be a salesperson's dream!
Founded in 1991, Synygy is the largest provider of incentive compensation
software and services. Synygy's IC Expert(tm) software has been used to
implement and manage more incentive compensation plans for more plan
participants for more of the world's largest corporations than any other
solution. Offering enterprise software, ASP, and plan management
outsourcing solutions, Synygy's range of services was recently described
by the Aberdeen Group as "unparalleled in the industry today." Synygy's
success and rapid growth have been recognized on the Inc. 500 for the past four years.
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