What a Fantastic Q1 It Has Been…And What Compensation Problems it has Caused!
I recently returned from my 10th TIA conference in beautiful Palm Desert, CA, and it was one of the best shows I’ve been to. On top of the beautiful location, many old friends were there and a BUNCH of new faces as well. Someone told me the TIA has added 300-400 members in the last year. That’s fantastic news. The CEOs and owners are getting younger (!) and it seems the entrepreneurial spirit is alive and well with many stories of start-ups and mergers and acquisitions permeating the conversations.
There was another theme that I heard over and over again at the show…what a fantastic year 2018 has been so far, following on a pretty strong Q4 for 2017. Freight rates have been rising and business has been booming, but this has not come without its challenges – chief among them, from my perspective, is what I’m calling the “January Overpayment Syndrome.”
The most common metric used to calculate incentive compensation for brokers is gross margin (revenue minus purchased transportation) and this is the exact metric that has seen a huge boost from rising freight rates. In call after call with clients, old and new, I have heard the same thing… “I don’t mind paying the reps more, but they aren’t really DOING that much more…they are just making more because we can charge more for the freight.” To some, this may be ok because they realize that the pendulum has often been on the other side, with reduced rates making it hard to even break even for the reps. For others, who very likely cushioned the downside for their staff, they now are feeling the inherent unfairness of paying out the extra when it’s not aligned with additional effort.
The ones that are happiest are the ones that made the efforts to shift their pay practices BEFORE this happened, so they are not looking at runaway compensation payment from the early months of this year. But what if you didn’t do that? What do you do now? The answer depends in part on what kind of plan you are starting from.
There are two main types of calculations for incentive pay: commissions and goal-based incentives. A commission (in the strict sense of the word) is a payment that is calculated as a percent of revenue or gross margin. A goal-based incentive calculates payment based on a formula that correlates percent of target incentive to percent of goal attained. Under the commission mechanic, there are limited ways to adjust the economic relationship between production and pay. The commission rate determines the economics. Under a goal-based plan, management has complete control over what pay is earned for what level of production. One can see that a goal-based plan will allow management more control of pay levels in both good times and bad times. When freight rates are inflated in the marketplace, the goals can be increased and when they decline (as they will eventually) the goals can be adjusted downward. This prevents the amplitude of the pay curve from getting out of control. Under a commission plan, pay will swing in direct proportion to the market swing.
Moving Away From Straight Commission
For many, going from a straight commission to a goal-based plan is too big of a change to make in one step, and for some going fully “goal-based” may never be palatable. But there are things that you can do to help make your commission plan a bit more adjustable. In fact, there is a natural evolutionary path that companies seem to take to compensation usage, following roughly these stages:
1. Straight commission (e.g., 30% of margin, no salary, paid on collection); this is the quasi-agent model for an in-house employee. Typically, salary is treated as a draw.
2. Retroactive commission (e.g., 0% paid on the first $10k, but when $10,001 is reached, rate is 25% back to the first dollar). In this version, there may or may not be tiers beyond the “cover your costs” tier. Often commission is still paid on collection though performance tiers may be determined by loads delivered or invoiced in a defined month. The salary is often still communicated as a draw.
3. Marginal commission (e.g., 0% paid on the first $10k, 10% paid on the 2nd $10k, 15% paid on the 3rd $10k, etc., but the higher rate is only on the dollars WITHIN the band, not retroactive back to earlier bands - like tax rates.) This method pretty much requires that you are calculating pay on loads delivered or invoiced within the month (not on collection) as it would be really cumbersome to explain which rate is applied to the different loads as they are paid. Often, this method also comes with a shift in the use of salary in that it becomes truly a salary, not a draw, and may represent a more significant portion of pay. This method represents a significant philosophical shift and moves a company much closer to a “cost of labor” approach to pay than the start-up “cost of sales” approach.
4. Phases 4 and beyond involve some use of career levels, salary bands, and maybe customized goals by level, role type, etc. The possibilities here are endless.
Making the shift from Stage 1 to Stage 2 or 3 can really help a company manage pay a bit better through the economic swings because now there is something to change other than the commission rate. Once you introduce performance tiers, you now have something else to adjust. In a down market, maybe the threshold is $8k a month, but in an up market, it needs to be raised to $12k a month. Maybe the upper tiers, when the really big rates kick on, need to be likewise lifted (or reduced) to reflect economic realities, types of accounts, or types of freight being managed.
Don’t discount the economic impact a salary can have as well. In an up market, those brokerages with high base salaries and lower commission rates are reaping the rewards of those plans as the salary is not variable and doesn’t increase as volume or margin increases. Of course, in a down market they have to still honor the higher salaries, so budgets need to be managed carefully. We have been tracking pay levels and pay trends for this industry for 7 years and are definitely seeing this trend borne out. In the tough years, there are proportionally more cradle-to-grave brokers who are paid straight commission (the risk is shifted to the employee), but in good economic years we see a shift away from this model to more specialized roles that have more weight on salary (the company can bear the risk of higher salaries in return for lower commission payout on the higher volumes). We are also experiencing nearly full employment for the first time in years, and employers are hearing from prospective employees that a salary is a critical factor for them to consider a job. Car loans and banks underwriting mortgages do not like 100% variable pay. They want to see guaranteed income and a commission with a draw is, by definition, not guaranteed.
My advice, other than to build a time machine to go back to last August and fix your plan then, is to make the adjustments as soon as you can (but judiciously – you don’t want everyone to quit!), and to then take the long view for compensation management. How will your plan fair when the market swings back down? What will you need to change then? And when it comes back up again? How will you feel about pay through all of these cycles? Develop an approach that maybe isn’t ideal in either extreme but is one you can live with through both good and bad times.