Our recurring series on the Deadly Sins of Incentive Compensation will sometimes focus on plan design choices that appear sensible at first glance, but on further consideration are expensive and ineffective. Here’s one of my “favorites”:

..Deadly Sin #4 – Too much in “all-or-nothing” bonuses..

I’m referring to significant bonuses, sometimes called “spot bonuses,” tied to a very specific accomplishment that is either achieved or it isn’t. The commonest example in sales commission schemes is a bonus of, say, $20,000 for reaching 100% of quota for the year. Other examples include a bonus tied to achieving a certain percentage of total production from new-name accounts, or exceeding some sort of product mix target.

So what’s wrong with this approach? After all, we want salespeople to exceed quota, and new-name business is critical to many fast-growing companies. Well, let me count the ways:

• Motivation. To the extent that these bonuses motivate, they only motivate those within striking distance of achieving the target. For those with little or no chance, and for those who have already achieved it, these bonuses may instead encourage them to let business slide into the next year, giving them a head start toward next year’s bonus.

• Cost.  Businesses typically allocate a specific amount of money (or percentage of revenues) for incentive compensation, which includes both regular commissions and spot bonuses. The more compensation that’s earmarked for spot bonuses, the less that’s available for regular commissions to salespeople across the entire performance spectrum, and the lower the average commission rate the company can pay.

• Who cares? Obviously, every enterprise wants to maximize revenues, and generate new-name business, and get as much traction as soon as possible for its newest products. But what’s so special to the company about one particular deal that puts one particular sales rep over his/her annual quota?

A more effective way to signal that achieving quota is important would be to pay higher commission rates above 100% of quota. And a better approach for rewarding new-name business would be to weigh new-name dollars more than repeat business dollars – that would send a message to everyone about the importance of new-name business.

Don’t get me wrong… I’m well aware of how much salespeople like to make side bets – just watch a bunch of them out on the golf course, or betting on balls, strikes, and foul balls at a baseball game. It’s OK to allocate a modest percentage of the commissions budget toward achievements like being the first sales rep to close a deal in the telecommunications industry, or the first rep to bring in more than $100,000 in sales of its newest product.  

But as Yogi Berra might have said, some compensation ideas sound better on paper than they really are.

Post by Randall Bolten and Bob Berry.