How to make ‘incentives’ pay in your business

CAD Partners CFO On Call shares their Q&A on how to make ‘incentives’ for staff work for your business.

Incentives are a very easy area to get wrong. Businesses can end up paying people incentives based on wrong targets.  CAD Partners presents some fantastic advice on how to get it right:

Question
I have a client in a warehouse/distribution business with KPIs and budgets in place.  I’m interested in setting up ‘Incentives’ that would apply to sales staff, logistics and purchasing managers and also the finance department.  Issues to be covered in the agreement would include: timing of the payment (e.g. in quarters or at the end of the fiscal year), payment of a bonus if the organisation’s net profit is not achieved, but individual targets are met and a cap on bonus payments.

Answer
Never mix sales commission schemes with bonus schemes. Sales commissions are a separate area and are unique in that they reward the sales staff for their primary function of achieving sales.  Sales commissions are usually paid monthly and at least quarterly.  And paid as promptly as possible, so that there is a clear connection between performance and the amount of payment received – this means the way of measuring and so calculating commissions must be simple enough that it can be completed promptly and fairly.

Bonus plans can be put together for just about everyone else other than salespeople.  These can be a lot of work, as the KPIs for people will vary; you rely on input from a great many managers and from a purely practical viewpoint you need to try to pay these annually .  While it may be appealing to pay these more regularly, it is usually just too time consuming to collect all the required inputs to be able to pay these more often (as usually this job is just added to someone’s existing duties. I expect that if a new position were created – that of bonus calculator – then these may be able to be paid quarterly, but you would still need all the KPI managers to give their prompt quarterly feedback – a task which in my experience is never completed on time).

The bonus needs to be split.  Part needs to be calculated on the specific employees’ achievements so that they have some direct control over the size of bonus.  And part needs to be based on company performance (to avoid the situation where a company could be up for large bonus payments to the production and logistic teams as a result of their good performance, but the company lost money as the sales team did not perform well).

There doesn’t seem to be any magic formula here so I find that a 50/50 share is most common.  50% based on company performance (e.g. against budget) and 50% on personal performance eg against KPIs.

The company performance could be: $1,000 bonus if the company achieves its budget income.  A sliding scale down, e.g. $500 for 90% of budget, $250 for 80% of budget and 0 for 80% or less, and an upside where the $1,000 is increased by 10% for every % over budget.

The personal side is usually based against KPIs.  KEEP THESE SIMPLE! AND OBJECTIVELY MEASUREABLE!!  Some managers love to set 8 or more KPIs for their staff.  That’s fine, but make the bonus scheme dependent upon one, two or three KPIs i.e. ask the managers choose those KPIs which will truly benefit the performance of the business.  This helps to focus both the manager and the employee, and keep the whole scheme manageable from a practical viewpoint.

Try to have the bonus payable within three months of year end – again to keep it relevant to an employee.  And try to keep everything simple as these things can become huge to manage. e.g. anyone who leaves the company (i.e. a normal resignation) before the payment date for bonuses received means no bonus, similarly anyone who is terminated for poor performance.  Occasional exceptions for anyone laid off for particular reasons.

And generally try to make the bonus equal to at least 10% addition to salary, as anything less does not seem to really work as an incentive, except for those with very low salaries.

Question
Is paying salespeople’s commissions monthly a good idea?  They could have a boomer few months, receive a big commission then rest on their laurels.  An annual payment regime or even 6 monthly for them may not be a bad thing?

Answer
The most effective way round is to boost their commission rate for the rest of the year once their sales are over target.  E.g. once they hit the target for the year, pay for the rest of the year at 125% instead of 100%.  That way, if they’re tempted to delay closing sales until the following year to give them a good start to the new scheme, the choice becomes to forego 125% now for 100% in the new year.

What a great example of logical thinking and how a ‘Numbers Brain’ can benefit all businesses!

For more business advice, contact CAD Partners CFO On Call or visit their website.