Top Compensation Mistakes - Part 3

Part 3 – Legality and Communication

We are often asked "What is the "right way" to pay?" However, 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’ve seen in our work with more than 40 Transportation and Logistics (T&L) companies, in over 14 years’ as 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.

In Part 1, published in the May 2012 Logistics Journal, we examined Top Compensation Mistakes #1: Not realizing that compensation is part of a complex and interconnected system, and Top Compensation Mistakes #2: Thinking about compensation as only an economic deal with the employees.

In Part 2, published in the July 2012 Logistics Journal, we examined 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.

We will now consider the last two mistakes:  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.

Top Compensation Mistakes #5: Not understanding the legal ramifications of incentive compensation.

Most of you are (or should be) aware that the misclassification of an employee as exempt from overtime pay can have significant legal and financial ramifications for your company, but you may not be aware that there are also rules that govern incentive compensation as well.   For starters, you should be aware that if an employee is non-exempt (paid overtime) and they are on an incentive plan then their incentive pay needs to be factored into the rate used to calculate their overtime pay.  Your payroll company should be doing this for you automatically, as this is common knowledge.  Of course, for exempt employees who are not paid overtime, this is a non-issue.

Many states also have rules about the handling of certain calculations which are common in commission plans and you should check with local legal counsel that specialize in labor laws in any state in which your employees work.   Of particular concern are “holdbacks” or “chargebacks.”  Some states frown on the notion that an employee can have “earned” an incentive but the company is holding that pay pending the performance of some future event (such as payment for a load by a customer).  It is far better to simply say that the incentive has not been earned until that event actually happens.  Charge-backs can also be problematic as you are now taking money away that was already paid.  Likewise, there are states that have rules about how and when employees (or agents) may be entitled to pay after they separate from the company.  If you think that you are not liable for payments after an employee leaves the company, you may find out the hard way that is not the case if your plan documents have not been worded carefully and signed by the employee to make it clear what happens after termination.

At the start of 2013, California legislation CA AB 1396 went into effect which stipulates that any commission plan must be documented and signed by the employee and the manager.  California draws a clear distinction between the terms “commission” and “bonus” and it’s helpful for employers to do the same to reduce confusion and potentially unnecessary legal scrutiny.  “Commission wages are defined as compensation paid to any person for services rendered in the sale of an employer’s property or services and based proportionately upon the amount or value thereof,”

While the world at large tends to use the word commission to mean any variable pay paid to a sales rep, and bonus to mean a discretionary year-end payout, compensation consultants use the word commission to mean a mathematical formula that determines payout as a percentage of revenue or profit.  A bonus, or a goal-based incentive, is a formula that determines payout based on actual results in relation to a defined goal.  Under a commission plan, someone who sells more makes more.  Under a goal based bonus plan, the person who exceeds his/her goal by the greatest percentage will make the most.  For whatever reason, state labor laws scrutinize the structure and rules of goal-based bonus plans less than they do commission plans.  Therefore we recommend using the word commission only when it means exactly what state legislatures interpret it to mean (a % of revenue of profit) and using the term incentive compensation when talking about variable pay of any sort.  This just helps keeps things from getting messy…why would you want to be scrutinized on your commission plan when it’s not really even technically a commission?

Top Compensation Mistakes #6:  Not communicating and supporting the plans, and not following up with solid tracking and feedback.

I have saved the worst for last.  If you’ve managed to avoid all of the other mistakes, but you still make this one then you will be no better off than when you started.  In fact you may be worse off because now you will have lost credibility with your staff.  When you launch a new incentive plan, you need to back it up.  You need to explain it, explain it again, and then explain it again.  People have numerous preconceived ideas about incentive compensation based on what they have seen in the past and they will see any new incentive plan through this lens.  It can be very difficult to change this mindset and you may not realize the points of miscommunication until after you’ve made the first or second payout under the new plan.  It takes two to three pay cycles for employees to truly internalize a new compensation plan.  It’s only at this point that you will really start to see lasting change in behavior.  If you have not reinforced the plan, shown them performance results and discussed how they can improve the next time, then you will not get the gains that you need from your plan.

The communication approach to incentive compensation should be as methodical as the design approach.  First, you need to be sure your leadership team is “on-board” with the new design and will support the change.  This includes managers and team leaders who will likely be the first line of defense for dealing with complaints (and there will be complaints!).  Bring them into the process early to get their input and buy-in.  Then, consider a phased approach for communication.  Start with a high level roll-out for larger groups of employees.  This allows everyone to hear the same thing at once and reduces the amount of “telephone” that is played around the office about the details of the plan.  Then set up one-on-one meetings with each employee to give them their goals or performance expectations and explain how they can succeed under the new plan.  The focus should be on how they can make more money than they have in the past. They may need to do things differently, but the opportunity for gain should be there.  After the one-on-one meetings, deliver plan documents that explain how the calculations work in detail and provide examples so the math is crystal clear.

When you write your plan documents, put some thought into how exceptions will be handled.  You will not be able to think of everything, but some common points of contention are:

  • Vacations or days off: will employees cover for each other? Will you guarantee a payout?

  • New hires: is there a probationary period or a guaranteed payout during the first few months?

  • Terminations: when is the last payment on the incentive plan?

  • Transfers: how would you pro-rate between plans?

  • Splitting credit (hint: avoid it if at all possible)

  • Disciplinary action: if someone is under a performance warning, will they get an incentive?

  • Gaming the system (our advice…do not tolerate this at all, terminate immediately)

Even now you are not done.  You need to provide regular performance reports so employees can monitor their results ahead of their payouts.  You will gain nothing if they only find out on the day they get their check if they did a good job or a bad job.  They should know ahead of time so they can adjust.  The best managers provide constant coaching and feedback and the incentive plan is a perfect “excuse” to do this.  You want them to make as much money as possible, don’t you? (You should if your plan is designed well because then the company is also making a lot of money.  Your interests should be directly aligned with their interests.)  By coaching them and communicating with them about their incentives, you will be working together to maximize their results and they will be happy and your company will see motivated employees driving profitable growth for the company.


This excerpt was originally published in the August 2012 issue of The Logistics Journal.

Sales Compensation 101 for Logistics

Top Compensation Mistakes - Part 2