*Note: all numbers are illustrative and will vary dramatically by type of freight, experience level of the role, and company specifics. DO NOT adapt these numbers directly for your staff as they will likely be wrong.
Performance Measure Selection is Critical to Incentive Compensation Success
Defining these details for all of the roles in your organization can be tedious to say the least, but it is ESSENTIAL for a good plan design. It’s also essential that you have many heads working on this together. One person cannot think of all angles. For example, something is missing from the measures part of the table above that looks like it might be pretty important for this role. Can you see it? I’ve highlighted the miss on the next table and added in an incentive to cover it. Notice I don’t say what kind of incentive (commission, goal, bounty, etc), just “incentive” as it will be in the next phase that we develop the mechanics of the plan (we call this part Detailed Design, and it’s a lot of fun).
OK. This looks better. We have more of the important bases covered. Now we need to focus in on the four things we’ve identified as potential performance measures and see if they make the grade. This is where some horse-trading and compromising comes in, and where your team will have to get aligned with the company priorities. It is this part of the process that delivers 90% of the “side benefit” of going through a compensation design project…you are building alignment, focus, and agreement among your leadership team as to what is really important for the organization. You will find people who do not agree with you. That is ok. Allow time for healthy discussion and debate. Hear different opinions. Gather different ideas. Thing broadly and think of new approaches. Put more ideas down rather than less to start. We will weed through them in a minute. You may find some ideas are raised that are not appropriate for use in an incentive plan (# of calls, attendance, etc), but that may be really good in a performance management plan. Capture them now, so you can use them later in another system. Many of our clients say we provide more than compensation design consulting…that we force alignment, clarity and focus. It is THIS part of the process that delivers that magic.
However, you could easily start to feel overwhelmed at this phase (imagine looking at the above table for 10+ roles in your organization (we are currently working on a project for a major LTL carrier that has over 60 roles!!)), so you need to use some good project management processes to ensure you stay on track and some guidelines to help you made the trade-off decisions to pare down your measures for a good solid incentive plan. Here are the rules:
Rules for Performance Measures
Measures must be:
Relevant (what you are measuring matters to the business).
Objective (anyone can determine “good” or “bad” performance based on numbers; it is not based on subjective opinion of a leader).
Measurable (you can or better yet, already do, track results from this measure).
Controllable (the role impacts the outcome of this measure and has clear “line of sight” to how their performance changes the result).
There should be no more than four weighted measures (3 is better).
Nothing should be weighted less than 20% of the total
Performance Measures that Should Not be Used in Compensation Plans
Sometimes it’s helpful to look at what doesn’t work, to understand what each rule means:
Number of phone calls is the classic measure that fails the relevancy test. For any call center environment, which most brokerages are, number of outbound phone calls is an objective, measureable, and controllable measure. But, it is not particularly relevant in and of itself. Phone calls are a means to an end, but not an end that should be paid for. If you put number of phone calls in your incentive plan, you will get a lot of phone calls – but you may not get any loads and your plan economics will be out of whack.
Attitude is a commonly suggested measure that fails the objectivity test. It is critical to a business’s health to not have grouches around, but one person’s grouch is another person’s pragmatist. This kind of measure should be used very sparingly, if at all, in the incentive plan. It’s a much more commonly found in an annual performance review discussion.
Repeat Carrier Usage or Yield, if you are a trucking company, are GREAT measures that many companies would like to use, but have tremendous difficulty measuring. If you need to hire a team of programmers to develop the measure, and there is considerable argument about how it should be calculated (just ask any 2 trucking executives how yield should be calculated and you will see what I mean), then you may not be ready to include this measure in the incentive plan.
EBITDA or Operating Income certainly satisfy the first three requirements, but they fall down on controllability for most roles in the organization. Profit Sharing plans are great, and serve a wonderful purpose in an organization, but they are not the same thing as an incentive plan – nor should the two ever be confused. If you plan to tie all of your employees to Operating Income as their only incentive, don’t expect to see much change in their behavior.
Applying these rules should help you eliminate some measures. Now you need to deal with the next two rules: No more than 4, no less than 20% on each. Let’s recap one minute on what we mean by 20% (20% of WHAT?).
Tying Performance Measures to Target Incentive Compensation (TIC)
In an earlier part of the process documented in this article series, we set up our Target Total Cash (TTC) based on the market value of the job and we set pay mix (how much is salary/how much is incentive) based on the prominence of the role and the culture of the company. Let’s say for an example (don’t take examples as gospel – each company is different!), that for Carrier Sales we set TTC at $48,000 with salary midpoint at $36,000 ($28k to $43k range min to max) and Target Incentive Compensation (TIC) at $12,000 with 3x upside (leverage). This is a 75/25 pay mix. An outstanding performer could triple the payout to earn $36,000 in incentive (3 x $12,000) for $72,000 total pay. But we need to first allocate the target incentive ($12,000) and define how this will be earned in the first place. This is where the measures come in. We have said there are four key things we need to focus the incentive plan on for this role:
Individual Monthly Gross Profit $ Goal
Individual GP% Modifier
New Carrier Incentive
Team Load Count Goal
There are going to be the four things that drive the incentive payout, but only 3 of them carry weight (a modifier does not carry its own weight - it is secondary to another element). So…how much of the $12,000 target incentive do you want to allocate to each of the three weighted elements? (We do this in percentages as it makes it easier to deal with many roles at one time that have different Target Incentive Amounts. The allocations need to add to 100%, and no element can get less than 20%.)
Individual Monthly Gross Profit $ Goal with Individual GP% Modifier
New Carrier Incentive
Team Load Count Goal
Your weights should convey priorities. It has been said that putting something in an incentive plan is like putting a megaphone on it. Be sure your megaphone is saying the right things. It’s unlikely that all pieces are the same in importance, so I often add another rule that the weights cannot all be the same (25/25/25/25 for four measures or 33/33/34 for 3 measures or 50/50 for 2 measures). On occasion I allow this rule to be broken, but you have to know when and where this is ok, so be careful and avoid using even allocation if at all possible.
I will leave you at this point to argue it out with yourself, as to how you would allocate the incentive among these three measures, and we’ll pick back up at this point in our next article.
This excerpt was published in the August 2014 issue of The Logistics Journal (member login required.