5 Common Phases of Freight Brokerage Compensation Plans
The April 2011 Logistics Journal contains a number of great articles, but there was one in particular that struck me as foundational for a compensation plans discussion. Rick Jones, of Meadow Lark Companies, wrote an article describing his company’s “Engineering – Re-engineering – Re-re-engineering!” efforts and explained how the roles in his company have evolved over time. He gave good descriptions of the different structures with their roles and responsibilities, but he left one gaping hole (at least for me)…he didn’t mention how their incentive plans also had to change over the years to support the new structure. As we tell all our clients, role clarity is critical for good incentive design. The foundation Rick laid was perfect for developing clear and focused incentive plans. After going to all this effort to restructure the business it would be a shame to continue paying using the antiquated “5% of margin” approach for everyone. So let me hypothesize about what some compensation arrangements would be for the different roles Rick describes.
Phase 1: “You eat what you kill” or “Cradle to Grave” brokering
Initially, Rick and his wife used the common “one person does all things” approach, which I call the “Broker” role. Each person in the office is a little office unto themselves. You could set up a P&L on that person, and you might even consider “charging” them a fee if they need an assistant for support. This approach works for some organizations, but not many, and it didn’t work for Rick because productivity per person was limited to 3 loads per day (vs a goal of 5). Very quickly the person gets swamped with existing business and ceases to call on new customers or (as in Rick’s case), the carrier relations get neglected and service failures start to happen.
However, if you are in the phase where you are still using this role, this is the appropriate place for a more traditional % of margin commission plan, and it will likely be highly variable (less from salary more from incentive) as you are running an office of de-facto agents that you happen to be calling employees. While it may be simple and easy to structure the commission identical to that of an agent (a fixed split of the margin), this will hinder your ability to grow as your staff’s motivation is limited to their own desired income level. Once they reach that point, they will stop. There is little downside and no leverage. Leverage is the ability to make more without proportional effort. When you add a good administrative resource to your team, and your productivity spikes, that’s leverage. Your producers are able to produce more because the routine tasks have been given to someone else, but your costs have not doubled because the administrative resource costs less. The same concept applies in compensation plans.
Let me explain. Many of you are familiar with the concept of a threshold, or point below which no incentive pay is earned. Many of you peg this number to a multiple of the employee’s base salary or to a fixed productivity number based on time in position. What you are almost universally neglecting, however, is any “upside” to go along with the downside. Once they’ve cleared their threshold the only way they can double their pay is to double their productivity. However, there is a point where you, as the owner, have covered all of your fixed costs and can afford to give a bit more to the employee and in fact, would be happy to do so because every additional dollar beyond this point is dropping straight to your bottom line. It’s at this point that you need to add a kicker or escalating commission rate, in order to motivate your staff to get to that higher level of productivity. For example, you may pay them 0% until they reach their threshold and 5% on all margin above threshold. At some higher level of productivity (call it expected performance or target performance) that commission rate could and should increase – possibly to 10% or even more. This creates leverage (they can double their pay at less than 200% productivity) and creates a “sweet spot” where everyone wants to get to and where you want them to be because now it’s all “gravy”.
One of the tricks here, however, is NOT to make the rate retroactive. Retroactive commission rates are powerful but very dangerous because the amount you have to pay out in incentive for $1 in productivity can be huge. A graph will illustrate.
The red line shows a retroactive rate, as follows:
0% paid until $10,000 is reached, then 5% paid upon reaching $10,000, retroactive to the first dollar (5% x $10,000) = $500
5% paid on everything until $20,000 is reached, then 7.5% paid upon reaching $20,000, retroactive to the first dollar (7.5% x $20,000) = $1,500
In this case the $1 that took the person from $9,999 in productivity to $10,000 was worth $500 in incentive, and the $1 that took them from $19,999 to $20,000 was worth $1,000. You can see how this is motivational…the employee will do just about anything (including perhaps unethical or dishonest things) to get that $1 additional in productivity. The other problem with a retroactive rate is that people tend to “live” at the top of the step, with limited motivation to get beyond that, particularly if they reach the step close to the end of the month. The additional payout beyond the step bump-up may not be motivational enough to drive them to stay past 4:00 once they’ve reached the top of the step.
The green line shows a marginal rate, in this case:
5% paid on all dollars produced between $5,000 and $10,000 (so the payout at $10,000 is $250 because 5% x ($10,000 - $5,000) = $250)
10% paid on all dollars produced between $10,000 and $20,000 (so the payout at $20,000 is $1,250 because 10% x ($20,000 - $10,000) = $1,000 + $250 earned at $10,000
15% paid on all dollars produced above $20,000
While a bit trickier to explain, the marginal commission approach is by far the preferred method among compensation professionals for the reason that it smooths earnings while still providing motivational upside – and in fact can provide GREATER upside to top performers (compare the 2 lines at $25,000 in productivity).
Without overcomplicating things, a marginal commission approach is likely the most appropriate way to compensate your pure Broker roles, but don’t forget to consider adding on strategic elements (such as a new customer bounty) and/or a team-based incentive and secondary and tertiary components.
Phase 2: Split New and Existing Customers
The next phase that Rick describes represents the beginning of role specialization. He split his brokers into those who focused on new customers and those who were more order takers for existing customers. What he doesn’t mention is that the compensation plans arranged for these two rules MUST be different or inequity will rapidly creep into your system, where the order takers are making more money but working less hard than the sales people who trying to get new customers. A pure commission approach that only rewards for volume generated does not adequately address that all loads are not created equally – some are easier to get than others. Some are more strategically valuable than others. The existing customer “Account Manager” should be paid a higher portion in fixed compensation (salary) than the new business developer, but should have less upside as successes are not as directly tied to their efforts as the customer is already an established business partner. That doesn’t mean NO upside, just less upside. When your new business developer hits a home run, he or she should be able to make 3x their target incentive. For an Account Manager, a home run might mean they earn 2x their target incentive.
The strategic component of the incentive plans will be different as well. You would clearly want some kind of additional reward for a new business developer who lands a premium new customer, but for your Account Manager the strategic objective may be about improved levels of customer service or adding additional lanes or locations or types of freight to an existing customer (expanding and deepening the relationship).
Phase 3: Split Customer and Carrier Sales
In phase 2, Rick notes that his people were still booking and moving all their own freight, and this was reducing throughput. So, he created dispatcher roles to focus on the carriers, and CSRs to focus on the customers. They operated as a tightly connected two-person team. Again, this BEGS for a different compensation approach - one that recognizes the individual efforts of each, and yet rewards them for working together as a team. Also, there would be different approaches for those teams that are dealing with existing customers vs those teams that are working to find new customers. Over the years, I’ve seen many variations on this theme, with two person teams, 4 person teams, or teams of CSRs and teams of dispatchers, which no explicit connection between a CSR and a dispatcher (the dispatchers often are organized regionally by origin or destination whereas the CSRs are assigned specific customers). Each structural choice presents its own opportunities and challenges, and requires a different incentive approach for each role within the structure.
Phase 4: Full-blown specialization
What Rick finally landed on is a structure that has full-blown specialization. In addition to the operations splits already described, he has outside sales reps who travel to see customers as well as outside carrier sales who focus on building carrier relationships and travel to see the carriers. Clearly the incentive plan for these two should not be the same, and their objectives are different. While he does not mention it, there may be some inside telemarketer types as well, whose job is to drum up leads for the outside sales reps, perhaps set appointments, and/or to actually get some new customers among the smaller shipper targets. And you guessed it -- this job would have a different incentive plan than all the others: different target total compensation, different pay mix, and different performance measures. For many of the operations roles in this phase of an organization’s development, commission-based incentive plans will become problematic and may need to be replaced with goal-based incentive plans, but that’s a topic for another article.
Phase 5: Differentiated Sales
The Editor’s Letter in the April 11, 2011 issue of the Journal of Commerce pointed to what may be ahead for Rick and the rest of the brokerage industry…differentiated outside sales roles. Paul Page describes the growing trend among logistics providers toward customer segmentation: differentiating between strategic customers and transactional customers. This is also sometimes referred to as “contractual” vs “transactional” selling and Dr. James Kenny presented a fine overview of the difference in approaches required for each in his pre-conference course at the April 2011 TIA Conference in Orlando. What the strategic customers require from their sales person is a different type of relationship. They expect their rep to get to know their business and solve their broader problems, not just offer a quick, cheap, no frills solution. They are willing to pay more when they can get a more customized, intimate level of service. There will always be transactional customers who just want “quick and cheap” and you should not ignore them as this business can fill in holes and create opportunities for future growth, but the type of sales resource you direct to them will be vastly different then the person you send after your biggest strategic targets. Needless to say, the pay arrangements for these two selling roles will also be different, with the likely use of MBOs/KPIs or milestone bonuses for the “big game hunters” and a more traditional commission approach for the “small game hunters.” One of the biggest mistakes we see in this industry is paying an on-going commission for outside sales. When they land an account (big or small) they should get an incentive for that account for a time, but not forever, and the incentive may not be a commission, but could be a goal-based bonus based on the anticipated 12 month value of the account. This eliminates the annuity (also called a “phantom base salary”) and ensures that your outside sales reps will remain motivated to do what you need them to do…find new customers. The message here is role specialization is here to stay in the Logistics industry, and for many of you that are growing rapidly, how you appropriately compensate these different roles will become an increasingly pressing concern. Done the wrong way, you can create conflicts of interest and completely undermine all the hard work you’ve put into your new org structure. Done the right way, you can build on the great structure and really motivate people to do the tasks that you’ve outlined for them…by directly aligning their incentive pay with their top 2-3 priorities. You’ve built the car, now you just need to be sure you are putting the right fuel in the tank.
This article was originally published in the December 2011 issue of The Logistics Journal when Beth was an owner of The Cygnal Group.