I was recently asked how to set up a compensation plan that's aligned with a company's strategic goals. That's a big issue, but I'll boil it down for you.
First, let's define what we mean when we say a "strategic goal." The word strategic is frequently misused as a proxy for "important" while tactical is used as a proxy for "unimportant." In fact, both types of goals are equally important, but that doesn't help us define "strategic goal."
Rather than get into a long-winded discussion of strategy and tactics, I'll just cut the Gordian knot and say that, in general, there are only two basic strategic goals:
- Increase revenue.
- Decrease costs.
You'll find that every type of strategic goal you set will fall into one or both of those categories. Note that increasing revenue while decreasing costs increases profit, but that accomplishing either on its own does not necessarily increase profit.
Compensation, of course, is anything of financial value given to an employee in return for their work. Compensation comes in seven flavors, each of which serves strategic goals in different ways. Here are those seven flavors, followed by a real-life example of their use.
A salary is an amount of money provided to an employee on a regular basis, unconditionally (assuming they show up for work).
Advantages: When competitive, salaries keep employees from leaving, thereby reducing recruitment and training costs. Salaries also create a predictable cash flow, which means fewer end-of-quarter or end-of-year surprises.
Disadvantages: Over time, employees tend to view a salary as an entitlement, thereby limiting its ability to motivate.
Stock consists of shares of the employing company that are tradable for money either now or in the future.
Advantages: Stock gives employees a sense of ownership, making them less likely to leave, especially when shares are offered as an option to be realized after a certain period of employment.
Disadvantages: In large companies, employees may not see the connection between the value of the stock (to them) and the value of their actions and activities to the company. In this case, stock just functions like an inconvenient form of salary.
A commission is a percentage of sales revenue (or, less frequently, sales profit) paid to the salesperson (but sometimes to the sales manager and the marketers).
Advantages: Because commissions motivate salespeople to sell more products and services, higher commissions generally increase revenue.
Disadvantages: Higher commissions also increase the cost of sales. In addition, commissions can drive salespeople to sell to customers who don't need the product, thereby decreasing customer satisfaction, which eventually decreases revenue.
A bonus is an amount of money provided on a regular basis, conditional on the achievement of a specific strategic goal. The achievement either can be personal (e.g., a salesperson making a sales goal) or involve the team (e.g., everyone getting a year-end bonus should the company become profitable).
Advantages: Unlike commissions, bonuses can be awarded for a wide variety of performance metrics other than sales. For example, you can offer salespeople a bonus if there are increases in the customer satisfaction ratings from their newly acquired customers.
Disadvantages: If a bonus is awarded every year, employees may start viewing their bonus as an entitlement. This reduces the ability of the bonus to drive specific behavior in service to strategic goals.
While a bonus is generally a regular event, an award is a one-time gift provided as the result of a specific achievement.
Advantages: Awards are excellent at driving innovation, which ultimately increases revenue. They're also relatively cheap, because they're typically given to only a few people.
Disadvantages: In most companies, only the top employees in each department are likely to win awards, making them limited in their ability to motivate an entire group.
These are privileges or items temporarily provided as part of the job, such as a company car.
Advantages: If the perk is something that the employee would otherwise have to purchase (like a company car), it serves as an alternative form of salary, which may have tax advantages. Perks also increase employee loyalty, thereby reducing recruitment and training costs.
Disadvantages: Perks limited to a small group (like top management) inevitably cause resentment among those employees who don't enjoy those particular perks.
These are items or services, usually provided by the company to customers for a price, that are offered to the employee either free or at a substantial discount.
Advantages: Compensation in the form of products and services turns employees into customers, which helps drive them to improve product quality. They also create employee loyalty, thereby reducing recruitment and training costs.
Disadvantages: None, other than the loss of revenue from a product or service that would otherwise be sold to a customer.
Now that I've gone over the types of compensation, here's an ...
Example of Using a Mix of Compensation
A software company has two products.
Product A is well-established, with solid market share in a mature market; it's responsible for almost all of the company's revenue, which has been flat for three years.
Product B is brand new in an early-adopter market. It has a high installation cost but is intended to return the company to growth.
Maintain revenue from Product A as cash cow while we build market share and visibility for Product B.
Because it's new, Product B is difficult to sell. It also generates less revenue per sale than Product A. The salespeople are currently paid straight commission, so they avoid selling Product B, because the extra effort decreases their take-home pay.
This problem (which is quite common) could be solved by any number of compensation schemes, but here's what I would recommend:
- Move the salespeople to salary plus commission, but make the commissions smaller. Reasoning: Reducing commissions as a percentage of take-home lessens the motivation to sell Product A to the exclusion of Product B.
- Create a sales bonus, not connected to revenue (and therefore not a commission), for selling a certain amount of Product B. Reasoning: This will motivate the salespeople to include Product B in the mix more frequently.
- Announce a one-time award for the salesperson who sells the greatest amount of Product B in the current year. Reasoning: This will create internal competition and some additional momentum for Product B.
- Create a corporate-wide bonus that will be awarded to everyone if the company sells a certain amount of Product B. Reasoning: This encourages the people who support the sales team to be extra helpful when the sales team is selling Product B.
Finally, don't confuse compensation with motivation! While compensation is one way to motivate employees, they are often motivated by non-financial elements of the work environment, such as peer pressure, pride in status, bonds of friendship, or a shared sense of purpose.