Extreme Compensation Plans Do Not Maximize Motivation
In the world of compensation options (and it’s a bigger world than most realize), we see two extremes: 100% variable pay, also known as 100% commission, and 100% salary. Extreme compensation plans do not provide the best motivational bang for the buck and companies who are using one or the other extreme are missing out on higher levels of motivation, reduced turnover, higher revenue, and lower compensation costs.
100% Salary Means Managers Have to Do All the Work
Let’s tackle the 100% salary model first, as it’s pretty easy to see what this is missing. Without incentive pay tied to performance, you are relying on your managers to drive employee engagement. This is great if you have great managers, but it requires a tremendous amount of energy on their part and often results in leadership burnout. We have one client who has relied on the hyper-activity level of a manager to drive employee motivation. When we were meeting with this manager about developing new plans, every 15 minutes or so he’d jump up and run out of his office, go around the brokerage floor clapping, praising, and generally “firing up” the staff. His enthusiasm was infectious and you could tell the employees loved working for him. But how long could he keep this up? He must go home exhausted. When you have incentive compensation, even when it’s a relatively small amount of pay (10-20% of total compensation), it gives employees a sense of control and ownership. This will not matter to all employees, but if you can release 25% discretionary effort from 50% of your employees, you have increased your productivity by 12.5%. I know many companies that would be more than happy with a 12.5% increase to their bottom line.
Let me add a word of caution on adding incentives to the 100% base salary model. You need to take care modeling your costs, and be certain that the incentive kicks in at an attainable level of performance that also represents increased performance over the prior year or your cost of compensation as a percent of margin will increase. However, you may be in a position where you need to make this investment – if, for example, you are losing employees because of pay or you know your pay is below market because you have done a market pay analysis by using a compensation survey (such as the one provided by the TIA). Adding incentive pay to bring your total pay closer to market will ensure increases only go to the top performers.
100% Commission is Fine...If You Want Your Staff to Act Like Timeshare Sales People
Now let’s look at the other end of the spectrum – the 100% variable plan. Many of you know this plan well; it typically involves a draw to cover expenses which is deduced from the incentive. If you carry a negative balance forward to the next period – this is called a “recoverable draw.” If you do not carry it forward, it’s called a “non-recoverable draw.” The recoverable draw is the most motivational (if you consider terror a good form of motivation) and will be found in organizations that have very high turnover. A recoverable draw will also not satisfy the minimum salary test if your organization is reviewing roles for exempt vs non-exempt status.
The non-recoverable draw is a salary in disguise. In this case the salary is used as a threshold, which must be “covered” before incentive pay is earned. This is less terror inducing, as there is at least some guaranteed pay, but you can never reward an employee through an increase in the draw amount without a corresponding take-away on the incentive side. It’s far better to decouple the two, and have a salary and an incentive plan that has a threshold level of performance which is tied to the economic cost of having the employee in the organization.
What Does an Employee Cost an Organization?
Once companies have made this step, they often will realize that the economic cost of an employee is far more than 1x salary. We see estimates of 2-3x salary when you factor in benefits, employer paid taxes, car allowances or other perqs, electricity, support staff, etc. Each company should use its own formula based on its unique economics and not assume that because XYZ uses 2.5x salary that is the right answer for everyone. If you provide “cadillac” benefits, your cost might be 3x. If you provide very few benefits and the employee works from home, your cost might be barely 1.2x. Once you have an understanding of the general economic cost of an employee, get over the need to be accurate to the penny for each employee. Some will cost more and some will cost less. All you need is a guide. You then set the threshold for compensation off of this guide…so that all employees in a given role have a threshold that roughly covers their cost. While many companies do it, you should not hard-wire the two numbers together so that you tell employees they need to cover 2.5x their salary before their earn incentives. You have now eliminated one of your motivational levers…salary increases. If the incentive threshold is hard-wired to the salary, then no salary reward comes without an incentive punishment, just as we saw with the non-recoverable draw. To motivate employees you need all motivational levers at your disposal.
Tap Into Many Areas for Maximum Motivation
Human psychology is varied. What is meaningful to one person is not meaningful to another, and business owners in particular have a really hard time understanding that employees are not wired as they are. Here’s a hint: if they were wired like you, they’d own their own company. Rejoice in this difference because without it you’d have a very lonely office. So if we take it as a given that employees are not wired like owners, you can identify some obvious differences. They will be less risk averse, they will need more external recognition, they will need more camaraderie; titles and positions of authority may matter more to them, and having a life outside of work probably is very valuable to them (owners live and breathe their work, and often are perplexed and perturbed that their employees do not do the same). Within your employee group, you know there are some people that are simply not motivated by money. You could tell them that if they stayed to 5:05 one day you would give them $1,000 and they would not do it, because whatever they are doing instead is more valuable to them. However, this person might be a great manager and be motivated to higher levels of performance by being given a team to run. They might still leave at 5:00, but now they have their cell phone with them and are willing to call in to help manage staff after they are gone. Other people are motivated by increases in titles, so having role levels such as Carrier Sales I, II, and III, can provide a motivational value in addition to any corresponding pay increase. For others it’s an improvement in office space or parking space, a travelling trophy or gift card, or extra time off. You need to be able to use all motivational levers at your disposal and completely eliminating salary (the 100% variable model) or incentives (the 100% salary model), takes away two of the most powerful tools in your belt for driving employee motivation.
This excerpt was originally published in the February 2014 issue of The Logistics Journal.