Viewpoint: Variable Compensation–Linking Individual Performance to Business Success

By Jenifer Kihm (MBA ‘92)
Founding Partner
Operant
713/527-0779  
jenifer.kihm@operant.net

Jenifer Kihm, PhD. (UW MBA-1992) is an industrial psychologist and a founding partner of Operant, a firm located in Houston, Texas, that specializes in the design and implementation of high-performance variable compensation plans for sales reps, customer service reps and other production roles. Visit Operant at www.operant.net.

Consistent performance at target levels by your team members requires three things: 1) having the right people in roles, 2) proper training, and 3) reward systems that pay well when they perform at target levels.

Most organizations invest large sums of money to recruit and hire the right individuals, and invest even more in training programs. Few organizations, however, have mastered building and deploying high-performance variable compensation plans (VCPs) for key roles (e.g., sales and customer service reps). The former two investments, although important and necessary, only provide an organization with individuals who are ready to perform. They offer no guarantee that they will actually produce results. With the right role-based VCP, once the initial investment in plan design is made, outlays are made only when results are produced. The relatively small up-front investment is like buying incremental future revenue or profit.

Many organizations have one or more VCPs, especially for roles like sales reps (commission), but very few of the plans drive performance that supports the company’s strategy. Furthermore, most leaders are simply not aware their plans lack strategic focus and fail to drive optimal performance. In many cases, a plan actually rewards “outcome B” when the organization wants “outcome A.”

One of the most common VCP flaws is a focus on quantity. That is, the organization considers variability to only mean the amount of production. Individuals in production roles typically control quality as much as quantity and both are important to value. For example:

The: 1) number of units sold, 2) price at which they are sold and 3) the ability of the client to pay on time, all matter to an organization. Sales reps control which client organizations they target (size and stability) and how they position the value of their product or service (typically reflected in price attained). Therefore, their pay should not be linearly related to quantity only. A high-performance VCP uses a matrixed approach that rewards for quantity and quality in relation to one another. Paying the same level of commission on new business, regardless of the value to the organization, ensures that quantity will become the reps’ sole focus and will encourage reps to compete on price.

To build a high-performance VCP, consider the following:

1. Do not tie role-based pay to overall company performance. No individual role in the company has control over this (with the possible exception of the CEO). Year-end or quarterly bonuses or profit-sharing plans are great, but those are insurance policies or perks, and should not be part of direct compensation for those in production roles.
2. Reward for specific and measurable results. Do not pay simply for the behaviors that lead up to results.
3. Determine the characteristics of the outcome you are seeking that: a) are under the direct control of individuals in the role and b) affect the value of the outcome for the organization. These should be part of the pay matrix.
4. Pay different amount for results with different characteristics. It is rare that quantity of results is the only thing that matters.
5. Do not use bonuses that are paid at the discretion of leadership as primary income. The individual team-member should: 1) know specifically what is expected of him or her, 2) understand why it is important to achieve the prescribed results, 3) know what he will earn if he accomplishes X, Y or Z, and 4) be totally confident that he will be paid if he produces. The plan should instill sense of control over personal success.
6. Keep the plan as simple as possible and introduce it with a strong communication plan.

If you would like to submit a short article for the "Viewpoint" section of Wisconsin Business Alumni's electronic newsletter, please contact WBA at 608/265-0575 or alumni@bus.wisc.edu. The information appearing in this column is the opinion of the author, and is not endorsed by Wisconsin Business Alumni or the School of Business.