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By Mark A. Stiffler, President, Synygy, Inc.
Originally published in "Solutions" Magazine, September 1999.
The following guidelines can help the reader avoid common problems in an incentive compensation plan. The compensation plan, as a management tool, will either help your company increase its bottom-line or create or deter the company’s goals.
When it comes to designing, implementing, and managing an incentive compensation plan, you could easily end up on one of two very different roads: the single lane, pothole-littered road to failure or the multi-lane, high speed highway to success. Which road you end up on will have a significant effect on your company’s bottom line.
The highway to success has several key milestones along the way:
- Embody your company strategy in the design of the incentive compensation plan.
- Implement and manage the plan efficiently.
- Frequently communicate results that are understandable, accurate, and timely.
- Drive the right behaviors to successfully implement the strategy.
At the same time, if you’re on the wrong road, each milestone for success is a pothole for failure. And each pothole can do more damage to your bottom line than you ever thought possible.
The Road from Strategy Formulation to Strategy Implementation
Pothole #1: Your strategy is not embodied in your plan. A good incentive compensation plan design embodies your strategy. Coming up with a plan that achieves this primary goal is not as easy as it sounds.
Many companies have "incentive task forces" or similar groups of people internally who design their plans. Other companies use consulting firms to assist them in the design of their plans.
Companies incur the most cost when the plan does not accurately reflect the company strategy. At this point, exacerbating factors add to mounting costs when:
- The plan (although conceptually sound) literally cannot be implemented
- Running the plan produces unexpected financial results in real-world conditions
- Rolling out the plan fails to help people understand how their behaviors need to change
Before rolling out the plan, check the plan against these three questions:
Can the Plan be Implemented?
There are many reasons why a plan cannot be implemented. The most common is that the required data to measure performance is not available. Or if it is available, acquiring it is a complex process that is prone to errors and delays, such as when data is coming from several different distributors, each with varying degrees of technical proficiency.
When a plan cannot be implemented, the rework of the plan—and more importantly, the delay in implementation of your strategy—can be very costly.
What Scenarios Might Cause Unexpected Financial Results?
To avoid unexpected financial results, model a proposed plan design and test a wide range of scenarios. Make sure the model includes the costs of both incentive compensation payments and the costs of employee turnover when payments are too low.
For instance, what happens to your incentive compensation payments when you sell five times as much as you planned to (such as during a new product launch)? Or half as much (such as when a hot new competitor leaves you spinning your wheels in the dirt)?
What are the effects on employee turnover and the costs associated with turnover if this occurs?
Once you’ve designed and a plan that can be implemented and have thoroughly run a wide range of scenarios, there’s one more place to focus your efforts to avoid costs—roll out of the plan and organizational change issues associated with the roll out.
Will People Understand the Plan and What Behaviors They Need to Change?
The key to people understanding the plan begins when the plan is first rolled out. Success depends on making sure there is time to implement an effective communication strategy.
Some techniques for communicating the plan are to:
- Make sure people understand your strategy and how the plan relates to your strategy.
- Focus on behaviors that will lead to individual success.
- E-mail teasers about different components of the plan
- Use the Internet to both communicate the plan and allow people to do "what ifs" in a learning environment.
- Show people report mock-ups of how the plan results will be communicated at the same time the plan itself is rolled out.
Pothole #2: Plan implementation and management is inefficient and costly. A good plan, however, does not guarantee the plan will drive the behaviors needed to implement a strategy.
There are three options available to companies when it comes to implementing and managing incentive compensation plans:
- Build, maintain, and operate a homegrown system.
- Buy, customize, and run packaged software.
- Outsource
Homegrown Systems
Most companies use internal IT resources (or an outside software development house) to implement their plans and a group of analysts or administrators to manage the plans internally.
Although very common, homegrown systems are typically hard coded and inflexible. And operating the systems is an expensive, manual process prone to errors and delays. According to the Aberdeen Group, the costs to build, maintain, and operate such homegrown systems can run $1500 per plan participant each year.
Packaged Software
Recently, several companies have begun offering packaged incentive compensation software. Corporations can buy this software and have a third party customize and implement the software. The purchaser of the software then runs it to facilitate the management of their plan.
Buying packaged software provides cost savings in the form of reduced overpayments, decreased IT spending, and lower administrative costs.
But a packaged software solution still leaves money on the table, so to speak. That’s because the management of incentive compensation plans is really a process problem—not a software problem—and companies realize additional cost savings when they redesign processes to fundamentally change the way that they are managing their plans.
Outsourcing
Companies like American Home Products, DuPont, and Bausch & Lomb have for many years realized these additional cost savings by outsourcing the implementation and management of their incentive compensation plans.
Relative to homegrown systems and packaged software, outsourcing offers the greatest costs savings—both in terms of the up-front costs of implementing plans and the on-going costs of managing plans. The implementation savings may be as much as $1,000 per plan participant versus homegrown systems or packaged software.
Other costs savings associated with outsourcing include:
- Eliminating the investment in and maintenance of hardware and software.
- Converting fixed costs of headcount and infrastructure into variable costs.
- Further reducing IT and administrative support.
- Being able to more quickly implement—and change—the plan.
- Utilizing best practices to proactively avoid problems.
Pothole #3: Communication of Results are Infrequent and Not Understandable, Accurate, or Timely
The biggest potential cost of even a well designed, implemented, and managed incentive compensation plan is the cost of not effectively communicating the results and using these communications to reinforce how the plan works.
There are four components to improving communications:
- Make sure that the content of incentive compensation and sales reports drives understandability.
- Create management processes that result in accuracy.
- Implement delivery technology to improve timeliness.
- Provide frequent communications to reinforce how the plan works.
Content Drives Understandability
The key to understandability rests in the content of the report and how that content is used to explain how much the person is making and how that was determined. There are three good tests for understandability.
Test 1: If you provide a report showing an individual’s incentive compensation results to a person who is not familiar with your plan, can the person explain to you how your plan works? If they cannot explain it from the report alone, then you are missing an opportunity to reinforce how the plan works and to change people’s behaviors.
Test 2: Do your reports pass the "calculator test?" If a person has to get out a calculator to determine their payment or figure out how it was calculated, your report flunks the calculator test and reduces its effectiveness.
Test 3: Are your incentive compensation reports consistent with and supported by your sales reports? If there are discrepancies in the data or inconsistencies in the measures used on the various reports that you provide your people, the credibility and understandability of the plan will be diminished.
Management Processes Result in Accuracy
How you manage the plan directly impacts the accuracy of the communications and the credibility of the plan itself. A heavy emphasis should be place on data validation and quality assurance processes. To do this, check every piece of data—both inputs and outputs—against a set of business rules to generate exception reports that can be used to uncover problems.
Delivery Technology Improves Timeliness
To be timely, people should receive incentive compensation results within one to five days after the data is available. Technology can improve the speed of delivery of reports. For instance, you can:
- Develop an automated mechanism to send an individual’s report as an attachment to a personal e-mail message.
- Use the file distribution technology within your sales force automation system to create a seamless integration of incentive compensation reports within the system.
- Implement an Intranet to allow people to access their personal incentive compensation information.
Frequency Reinforces How the Plan Works
The last piece of effective communication is frequency. If the content of your reports passes the three understandability tests, frequent communications will reinforce how the plan works, improve understandability, and change people’s behaviors—before they get their next paycheck.
A good benchmark is to provide intermediate-tracking reports at least monthly or at least twice during each payment period. For instance, if you make payments annually or quarterly, tracking reports should be provided each month. If you make payments monthly, a tracking report should be provided once each week along with a payment report at the end of the month.
Pothole #4: Your plan drives the wrong behaviors and leads to poor implementation of your strategy. There’s still one more potential pothole in the road to cost-effective design, implementation, and management of incentive compensation plans.
Picture things several months down the road. You thing you did everything right. Created good design that embodies your strategy. Good scenario testing. A very successful roll out. Great communication of results. Enthusiastic feedback from your people.
But now you learn that the plan is driving the wrong behaviors. Sales might even be up, but managers are telling you they could be up even more—if only the plan would encourage the right behaviors. Now you’ve got to make a U-turn back to design town for adjustments to the plan.
To problem of unanticipated behaviors is often hard to avoid, but can be minimized by:
- Explicitly defining the desired behaviors prior to starting the design of the plan.
- Devoting sufficient time to the discussion of anticipated behaviors after a conceptual plan is designed, but before it is rolled out.
- Adjusting the final plan design to account for any gaps between the desired behaviors and the anticipated behaviors.
Opportunities for Success
The incentive compensation may be full of potholes, but successfully navigating around each one is an opportunity to improve your bottom line—whether directly through lower implementation and management costs or indirectly as a result of the improved motivation and effectiveness of your people.
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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