Part 1 - Complexity and Interconnectedness
We are often asked “what is ‘the right way’ to pay?” But there is no easy answer to this question. The “right way” depends on a variety of factors particular to each company. There are some definite wrong ways to pay, and this three-part article will outline the six most common compensation mistakes we have seen in our work with more than 40 transportation and logistics companies and over 14 years as a sales compensation consultants working with private and public companies from a variety of industries, ranging in size from small privately held companies to multi-billion dollar global giants.
Top Compensation Mistakes #1: Not realizing that compensation is part of a complex and interconnected system.
There are two variations to this mistake. First, managers fail to understand that compensation both supports and reflects a company’s unique objectives, strategy, structure, and culture. When leaders want us to just “tell them the answer,” or “tell them how XYZ broker pays,” or when they think they can “just use the plan from their last company”, they are making this mistake.
In order to develop the “right” plan for your company, you are going to have to do some work – there is no easy answer. Here are just some of the questions you need to answer before you even begin to think about a commission rate:
1. Define your business objectives and strategy:
How are you going to succeed? What has worked in the past? What has not?
What is your competitive advantage? Do you offer a low cost solution or a high service solution? Do you have a technological advantage or a relationship advantage?
What do your clients think of you? What do you want them to think?
Are you focused on short-term growth or long term stability?
Are you positioning for acquisition, developing a legacy, or do you need to think about a future change in control?
2. Define the optimal organization structure and roles for your organization:
What is the right business flow?
How much interdependency exists (or should exist) between people, roles, groups, and divisions?
What risks come from different structures (TIP: some org structures make it easier for employees to leave and/or start their own brokerage than others).
What structures will allow for clear and focused incentive plans?
(TIP: if you have more than 10 people and every person has a different incentive plan, or everyone has the same incentive plan, you don’t have role clarity and need to work more in this area).
3. Define your organization’s optimal culture:
Do you want a culture of competition or cooperation or someplace in between?
How much control does management need or want to have over the way things are done?
How much variation in pay is optimal for your culture?
How paternalistic is the company?
Does your organization allow people to take risks and learn from their mistakes or are there many rules that control choices?
Does the organization promote a higher purpose than simply making money?
(TIP: none of your employees are going to be enthusiastic about work if they know they only reason they are working is so you can buy your next Mercedes or your next vacation home.)
4. Define your competitive position in the labor market:
What do current and potential employees think about the organization? What do you want them to think?
What benefits do you offer?
Is the company well regarded or does it have some reputational issues?
How well-trained and regarded are the managers?
Is there a good training program and opportunity for continuous learning?
Is the environment high spirited and fun or somber, relaxed or professional?
Does the company use a performance management system allowing for salary increases? When was the last time you gave raises?
How are successes celebrated? How are failures managed?
What career advancement opportunities exist?
(TIP: if your company scores high on many of these questions then you may be able to pay a bit below market rates in your cash compensation plan; if you score low then you will, literally, need to over compensate.)
The answers to these questions will provide a picture of your company that is unlike any other and your compensation plans should reflect and support your unique strengths and help to overcome any weaknesses you identified.
The second variation to this mistake is to develop compensation plans for highly interconnected roles separately from one another. We are often asked for a plan for sales, or for carrier coordinators, or for account managers, because that may be a particular pain point at that moment. However, it is likely that a change to the incentive plan for any one of these roles will have a ripple effect on the other roles. It’s not easy, but the right way to develop new incentive plans is to consider all of the roles in your organization at once so you can be sure the plans encourage people to work together and not against each other.
Also, it is essential to do the economic modeling for the full system at once to be sure the total cost of compensation lands in the right range for where your company is on the life cycle and the type of freight you have.
(TIP: 33% is often cited as the “right” cost of compensation as a % of net revenue (margin), but it is not the only answer nor is it the right answer for all companies…companies with a large volume of contract or EDI freight could be much lower than this, while start-ups, small companies or companies dealing in OD/HH or other “high touch” or specialized freight could be higher and still be perfectly healthy).
Top Compensation Mistakes #2: Thinking about compensation as only an economic deal with the employees.
Compensation is about more than money and those who think about only the math are missing at least half of the point. We tell our clients that using an incentive plan is like putting a megaphone on your business strategy. Whatever is in the incentive plan will get a disproportionate amount of attention from employees, so isn’t it sensible to spend time thinking about the message being sent? The plan shouts to employees the company’s priorities, ethics, team philosophy, how valuable they are (or aren’t) to management, and how much opportunity they have for growth and advancement. Getting the psychology of incentives right is at least as important as getting the math right.
Another mistake in this category is to think about incentive compensation only from the perspective of “how much can I afford to pay.” In the sales compensation world this is called a “cost of sales” philosophy. As organizations mature and cash flow becomes less of a concern, management recognizes that knowing the market value of a job is important to attract and retain the type of talent they want. This is called a “cost of labor” philosophy and is used by all sophisticated companies once they reach a certain maturity and size. It is at this point that compensation surveys become very important and companies look to the market to understand what is required to pay a competitive wage (and what isn’t). In some cases companies will find they are overpaying the market due to legacy issues from the plans they put in place during their start-up phase (see Mistake #3 in Part 2). Developing an understanding of what other companies are paying for the same roles can give management the confidence needed to make adjustments.
Another economic mistake is to think that if a little incentive is a good thing, then a lot of incentive must be better. It is rare that paying 100% variable pay to employees (100% commission plan) is a good thing. Employers loose almost all control when an employee has no salary. The employees may engage in practices that are detrimental to the company’s business, customers, carriers, and ethics. The employees are also more likely to jump ship with “their” customers… (excuse me, WHOSE customers?!) and go for a better offer or start up their own brokerage based on the training, marketing, and technological support you gave them.
While a bit of “hunger” can be a good thing to drive performance, desperation is rarely an effective motivational tool for the long term. If you want your employees to act like used car sales people, or to run your business the way subprime mortgage brokers ran theirs, then by all means use a 100% variable approach. (TIP: AIG and Lehman Brothers were big success stories once upon a time and everyone wanted to know their secrets (see Mistake #1). One of those secrets was a highly variable and highly leveraged incentive plan, which rewarded excessive risk taking and was a proximate cause of the economic collapse of 2008). If you want an organization with more class than a used car dealership and less risk than a sub-prime mortgage brokerage, then you will likely need to have some part of your employees’ pay coming in the form of a fixed salary.
Companies also get so focused on the economics of compensation that they will spend dollars to save pennies, losing sight of the psychological benefits. The best example of this is the development of expensive administrative systems to track adjustments and short pays. Provided you have systems in place to prevent egregious errors, there are usually better solutions than holding back, charging back, clawing back, or otherwise demotivating your employees trying to satisfy some overly heightened sense of fairness and economic precision. (TIP: In some states these practices are actually illegal, see Mistake #5 in Part 3). You are losing hundreds, maybe thousands, of dollars in lost opportunities tracking and arguing over these issues. Would you rather have your employees on the phone getting new customers or in your accounting department asking to reconcile every load on their last check?
Related to this point, companies often struggle with paying incentives when the company has not hit its profitability goals. This requires a shift in thinking from incentive pay as “profit sharing” or a “bonus plan” to an integral part of your employees’ total compensation package. For incentives to be motivational they must become part of the expected package and employees must be able to predict their pay in advance and be able to affect the outcome through their own efforts. Just as your employee’s base salary is not dependent upon your company hitting its EBIT goals, nor should their incentive compensation (except for the highest levels of management). Incentive compensation is a strategic investment made to get results, and if you withhold that pay from your top performers in a down year, then it is likely that your results will be even worse the next year because you will have taught your key people that working hard and getting results doesn’t matter.
In Part 2, we will explain Top Compensation Mistakes #3: Not considering short-term and long-term unintended consequences and Top Compensation Mistakes #4: Not clarifying goals to enable the shift from transactional to growth-focused plans.
In Part 3, we will finish up with Top Compensation Mistakes #5: Not understanding the legal ramifications of incentive compensation (yes, there are laws about incentive pay!), and Top Compensation Mistakes #6: Not communicating and supporting the plans, and not following up with solid tracking and feedback.
This excerpt was originally published in the May 2012 issue of The Logistics Journal