Sales Compensation 101 - Transportation & Logistics Industry
I often tell my clients that the good news about incentives is they work...but the bad news about incentives is...you guessed it, they work. What this means is you need to be very careful how you design your incentive plan or you just might end up dealing with some unexpected consequences, and possibly paying out more than you intended, or worse, getting no measurable return (or negative return!) for dollars you are spending.
There are many books written on the topic of sales compensation and most of them are long, technical, and have examples that are not especially relevant to the logistics industry. In this article you will learn the basics (hence sales compensation 101) necessary for developing well-thought out incentive plans for logistics companies. There are six high level task categories for incentive design, and they should be tackled in this order (it is easy to get the cart before the horse, and start talking about pay frequency or commission vs bonus BEFORE you've even established your business objectives, but this can lead to confusion and yelling among the design team members, so it's best if you just take it one step at a time).
Steps for Incentive Plans
Define your business objectives & sales strategy
Define your selling roles and determine incentive plan eligibility
Establish total compensation, pay mix & leverage for each role
Determine the appropriate performance measures & weights
Develop the plan mechanics, including optimum pay frequency, and
Develop a thorough and comprehensive implementation plan.
1. Define your business objectives and sales strategy.
You don't start off on a trip with no idea where you are headed, nor should you develop an incentive plan without an idea of what you want it to accomplish. An incentive plan is a powerful tool that should accomplish far more than simply delivering pay to your people. Spend some time with your leadership group developing a clear business plan, with defined objectives, and then figure out the appropriate sales strategy to help you accomplish these objectives. For some logistics companies this may be targeting large contracted business relationships, whereas for others is may be maximizing volume on low margin commodity freight. The sales strategy for these two extremes is of course, quite different, and would require a different skill set (and incentive plan) for the types of reps going after the business.
2. Define your selling roles and determine incentive plan eligibility.
Once you have your sales strategy defined, you need to determine what roles will best support this strategy. What are the characteristics of these roles - are they primarily hunters or farmers? Are they selling transactionally where they are providing a low cost solution to a customer who wants minimal hassles or are they selling consultatively where they are crafting a custom solution to suit a particular business need? The transactional hunter has a very different profile (typical van freight broker) than the consultative farmer (the account manager for a multimillion dollar outsourced logistics contract) and they should not have the same incentive plan. You may have a large game hunter who finds the multimillion dollar account but who then hands it to the account manager to grow and develop. These also are different roles. One of the most frustrating things for sales people is to not have a clear understanding of what their role is and what is expected of them, so this is an absolutely crucial step in the process of developing incentive plans. As for eligibility, a common mistake in logistics companies is to attempt to develop incentive plans for everyone in the organization. Customized incentive plans are a powerful tool that must be carefully managed. They take money, time, and effort to get them right. I've seen too many companies burn too much of each in an attempt to develop and calculate customized incentives for all of their people. Customized incentives should be used only for roles that have a direct and measurable impact on business results. If you find yourself trying to pay someone for accomplishment of something that really doesn't impact the bottom line - stop! If you find yourself trying to pay someone for something they have no direct impact on or which is not measurable - stop! Customized incentives should be used for these types of roles in logistics: broker, assistant broker, dispatcher, load coordinator, driver or carrier manager, sales or branch or terminal manager, team leader, operations manager, outside and inside sales rep, and account manager. Generally, with few exceptions, other roles should be on a corporate plan which payouts out annually based on overall company results.
3. Establish total compensation, pay mix and leverage for each role.
Here's where the TIA survey comes in very handy. By matching your defined roles to the roles in the survey, you can determine how much (salary + incentives) you should be paying at 100% performance. Some companies establish a philosophy of market 50th for base salary, but market 75th for total compensation. This strategy would help attract and retain top performers. Your business objectives should help inform your compensation philosophy. Pay mix is the amount of pay coming from salary, and the amount of pay coming from incentives as a % of total compensation. A 50/50 pay mix means equal amounts come from salary as from incentives. For most farmer-type roles, the pay mix should be skewed more toward base salary (70/30 or 80/20, for example), whereas most hunter-type roles should be skewed more toward incentives (40/60 or 50/50, for example). While role plays an important part in this decision, so does company philosophy. Some companies are by nature more aggressive than others, while some are more team oriented. More aggressive means more emphasis on incentive pay. More team oriented means more emphasis on base salary.
Leverage is the amount of upside. It's what happens when someone does a really good job. Typically you want there to be more upside the more pay is at risk. As a general rule of thumb, plans with 80/20 pay mixes have 2.0 leverage (2x the target incentive is earned for a really good job), whereas 50/50 pay mix plans may have 3.0 leverage (3x the target incentive is earned for a really good job). These are not hard and fast rules, but guidelines. What's most important is relativity within your company. If your 80/20 plans have 1.5x leverage, then maybe your 50/50 plans will only be 2.5x. Lack of leverage is the NUMBER ONE mistake being make by logistics companies. If you use a straight commission, by definition there is no leverage. Someone must double their volume to double their pay. This is next to impossible. Likewise, any quota bonus plan that pays 101% of incentive at 101% performance is doing the exact same thing, and it's incorrect. The ratio should increase above 100% performance to 1.5, 2.0 or greater multiples, so that for example, 103% of incentive is paid out at 101% of performance. But be careful - you can't continue this forever. You will need to decelerate the payout curve at some point above goal or you could end up paying out far more in incentives than you ever intended.
The next blog will tackle the more technical aspects of plan design: selecting performance measures and giving them weights, developing mechanics (commission vs quota bonus, tiers or linear, quota-based commission, etc.) and setting payout frequencies (monthly, quarterly, annually - and how these can be different for different parts of the plan) and developing a thorough implementation plan so your people understand their plan and can make positive changes to better your results and their pay.
4. Determine the appropriate performance measures & weights
One of the best moments I have with any client is the "ah ha" moment when they realize they can do far more with an incentive plan than they ever realized -- when they realize that it's not a question of mutually exclusive choices, but of crafting a system that incorporates different parts of their business strategy. The first taste of this comes with the selection of performance measures. A performance measure must be objective, relevant, controllable, and measurable. The best measures are often found on your income statement or in your business plan or sales strategy. Common performance measures in logistics are: gross margin dollars (net revenue), revenue, line-haul, operating income, gross margin percentage, number of new customers, number of loads, safety, on-time percentage, driver retention, closed leads, renewed contracts, and customer satisfaction.
The Design Team's task is to consider for each role which are the best performance measures for that role. The answer should be different for hunters vs farmers, and for managers vs line staff. You want to start by casting a wide net and thinking about all the potential measures for each role. Some will not work because you can't measure them (customer satisfaction often falls into this category), others will not work because they are not controllable by the individual and may need to be pushed up to higher levels of management (operating income is a good example, as it may be fine for a branch manager, but probably not for a broker).
The second step is to consider scope. Scope is the level of measurement selected, such as individual, team, region, or company. When you combine scope with performance measure, you have created your first plan element. Once you have tentative list of elements, you need to assign weights to them. The weights must add to 100%. For example, if your broker role has a target incentive of $20,000, you might use 3 elements weighted as follows: individual gross margin 50%, individual new customers acquired 30%, region gross margin 20%. A broker would earn $10,000 for individual gross margin at target performance, $6,000 for new customers, and $4,000 for region gross margin. What if you'd also really like to include gross margin percentage and on-time percentage, but they aren't important enough to assign a full piece of the incentive plan to? You can use these types of measures as qualifiers (a minimum requirement for payout under another element) or modifiers (a way to increase or decrease payout under another element), but be careful not to over-complicate the plan. The KISS rule most definitely applies to sales compensation design. Try to limit your weighted elements to no more than 4, with no more than 1 modifier or qualifier on the most important elements, and no less than 20% weight per element.
5. Develop the plan mechanics, including optimum pay frequency.
Once you have your elements selected and weighted, you need to figure out how you are going to calculate pay (mechanics) and how often you are going to deliver pay (frequency). There are two fundamental approaches to calculating incentive compensation, and the terms used to describe them are widely misused and misunderstood. They are "commission" and "goal-based bonus." When you are talking about a sophisticated incentive plan design, these terms mean something very specific. A commission is a way to deliver incentive pay that pays a piece of the action, such as a % of gross margin or % of revenue. Commission-based plans pay based on volume alone - those who sell more make more. The other end of the spectrum is a goal-based bonus based plan, which pays for goal attainment. A goal-based bonus is not subjective or arbitrary, but instead is tied to attainment of a pre-defined goal. (We strongly discourage the use subjective bonuses, by the way). If Sally has annual volume of $500,000 and Joe has annual volume of $250,000, then under a commission-based plan Sally will make 2x a much as Joe. However, many managers will understand that perhaps Sally has 2x the volume because she has been given house accounts or contracted business, or something that makes it unfair for her to earn 2x as much as Joe (who may be working his fanny off building a new line of business or breaking into new lanes). In this case a goal-based bonus plan would level the playing field. Under a goal-based plan, Sally would earn the same amount at 100% of her assigned goal as Joe would earn at 100% of his assigned goal. Yes, if you were to calculate the rate (pay divided by volume), they would have different payout rates, but by structuring the plan this way you are acknowledging that some business is harder to get than others, and paying accordingly. You can also combine the two approaches and use a goal-based commission, whereby the rate paid below goal is less than the rate paid above goal. A good rule of thumb is that a commission approach will work if everyone is starting from the same place and has the same opportunity (this doesn't mean a commission is the right approach, just that it is a reasonable alternative to consider). If there are inherent differences in assigned accounts, in ability, or in support, then you might want to consider integrating a goal-based bonus approach. One of the nice things about using multiple elements in a plan design, is each element can have a different pay frequency. In the example above, you may choose to pay the first element monthly, the second element quarterly, and the third element annually. The main considerations for pay frequency are alignment with business cycle and amount of pay delivered. If the annual target for an element is $1,200 then you probably don't want to pay monthly as the amount after tax would hardly be enough to go out to dinner. You want to be sure the check received will be meaningful.
6. Develop a thorough and comprehensive implementation plan.
You don't want to go through all the trouble of developing a great incentive plan only to have no one understand it, so be sure to allow plenty of time to communicate (over and over) the new plan design. These steps show a typical communication plan:
High level power point presentation to the managers (review their plan first, and then explain their staff's plan)
High level communication to the staff as a group (one off communications only lead to misinformation). Ask them questions and have them reiterate key parts of the plan back to you.
Provide plan documents (see my article in the March Logistics Journal for more info on plan docs), so they have the full legal wording necessary to understand and abide by the plan rules. Give them a chance to ask questions in a one-on-one setting.
Give them quota or goal sheets which show how much pay is earned at different levels of performance.
Track their performance throughout the pay period, there should be no surprises.
Give them individual performance reports to go along with their incentive checks so they understand exactly why their pay was what it was.
These steps for plan design are the outline, but it is only a starter map, as the combinations of elements and mechanical design choices are truly limitless, which is what makes designing plans so much fun and why there is truly no correct answer to the question "what is the right plan design for a broker in the 3PL industry." The only right answer is the one that is right for you.
This excerpt was originally published in the April 2010 issue of The Logistics Journal.