In my last post, I railed against the boneheadedness of putting caps on incentive compensation plans for sales people.  In this post, I want to expand on that topic, and speculate about whether capped incentive comp plans ever make sense, for employees in any functional area.  I’m thinking particularly about MBO plans designed for managers throughout the company, but this thought process can apply to all sorts of incentive plans.

The conventional wisdom is that MBOs should be capped at their nominal target.  So, for example, a person having an $80,000 salary and a 7% MBO target can expect to earn no more than $5,600 in MBO bonus.  Here are the problems with that approach:

• It’s demoralizing.  These plans are structured to have significant downside – either because the company doesn’t pay out full target bonuses that year or the employee doesn’t achieve 100% on his or her MBOs – and no upside at all.  Some employees may even look across the cubicle partition at the sales force and conclude the disparity is unfair.
• It’s cheap.  When you consider how much money many companies put on the table for sales compensation plans, on the grounds that they truly motivate desired behavior, it may seem odd that they’re reluctant to risk a couple of thousand dollars per manager, or even for every employee, to motivate that kind of behavior company-wide.

Now, I’m well aware of the conventional rationale for these MBO caps.  The path-of-least-resistance management path is to draft subjective, binary objectives – like “deliver the ABC project on schedule,” or “attend a training session on XYZ,” or “participate actively in interdepartmental meetings – where scores above 100% would seem odd.  But there are solutions, such as:

• Insist that MBOs be drafted so that they are objective and measurable.  Yes, it can be done.
• Continue to cap MBO scoring at 100%, but tie the size of the MBO bonus pooldirectly to company results.  So even though an employee’s maximum score could still be “only” 100%, the payout could be more than 100% if the company overachieved on its critical results.  
• Lower the target MBO bonus amounts slightly, but one way or another, permit payouts above 100% of target.  The result might be that dollar payouts stayed about the same, but the “optics” of the bonus scheme are that MBO payouts above 100% of the target bonus were possible.

If you act like incentive compensation schemes actually achieve their desired objective, that’s ninety percent of the battle.  More on this in my next post.

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