Base pay for performance on relative results, not budgeted results.

When rewarding Pay for performance, look at the results in relation to the business environment

Picture yourself as the chair of the sales compensation committee you’re asked to approve a pay for performance bonus for the company.

Sales erosion and your above your pay for performance goals

Our goal for the sales group was to grow sales 10%. The sales manager came in and reported that at the end of year, he’s happy to report, we were able to grow sales 12%. As a compensation committee approving bonuses, we would likely be bound to give those guys maximum bonuses. They had a goal of 10%. It was an 80/120 plan. They hit 120% of their goal. They had 12% growth. Sales manager says max bonuses. We’re likely bound to pay them.

But if the situation was we were in the telecommunication sector and we were selling into that sector, the year was 1999, how does it impact your thinking about paying maximum bonuses when you realize that in telecommunication equipment, sales — the whole market has a whole, went up and increased by order of magnitude of 50%.

How do you feel about pay for performance and rewarding your sales people for growing sales 12% in an environment where the rest of the industry was growing 50%.

What we’ve just done is just paid maximum bonuses for a huge erosion of market share.

Now, the pay for performance plan design is what compelled us to do that, but if we don’t contemplate what’s happening in the economy, we have a huge risk of overpaying or underpaying. We pay for the results that were environmentally driven, not the actual results of what people were doing.

Underperformance deserves a pay for performance bonus?
So, if you take that forward and take the year 2001, kind of again, a 10% sales growth. In this situation, the sales manager came in. He’s happy to report that sales grew 5%. He realized that wasn’t the 10% we originally budgeted, but the economy was significantly worse.

And he recommends that we give everybody maximum bonuses plus some, otherwise everybody’s going to quit.

Well, we look at the pay for performance plan. The plan says, hey, you’ve got to hit 80% of the goal or you don’t get anything. 5% growth is only 50% of what’s out there. Are you going to risk not paying everybody?

Well, if I add the additional fact that the industry we’re in is a semi-conductor sector and in 2001, something happened that had never happened in semi-conductors before and probably hadn’t happened since, the market didn’t grow at all that year. It actually fell 20%.

So, how do you rate your sales people relative performance with they could grow sales in a market that’s shrinking 20%? All of a sudden, that 5% sales growth is pretty phenomenal.

So, the whole point behind base it on relative result is to focus people on the fact that I need to make my performance go, based on the environment I’m operating in.

Edited remarks from the Rapid Learning Institute webinar: “How to Avoid Incentive Pay Plan Disasters” by Steve Player