Few suggestions inflame passions faster than the suggestion that performance pay be abolished. It’s our contention, nonetheless, that, in an ideal environment, commissions and bonuses are likely to be in conflict with the goal of the organisation. Of course, traditional sales processes are not ’ideal environments’ and, as such, the traditional sales process serves as an illustration of the conditions under which performance pay is, in fact, appropriate! Let’s begin, accordingly, with the case forperformance pay.
The case for performance pay
Let’s envisage a situation where performance pay definitely makes sense. The situation that springsto mind immediately is outsourcing — or more generally — the use of contractors. If you have outsourced a task to a contractor, it makes sense to compensate that contractor on a per-piece (or results) basis. Because you are outsourcing, you have no control over the contractor’s production process (you can consider only inputsand outputs) and, as a consequence, it doesn’t make sense for you to gamble on something over which you have no control. Most organisations understand this explicitly. This is why most contractors (including service providers) are under pressure to quote on a fixed-price — rather than a time-and-materials — basis. Now, if you consider the structure of a typical sales process (as discussed in the preceding article), you’ll realise that the relationship between the salesperson and the organisation is more similar to a contractor-clientthan it is to an employer-employee relationship:
- Salespeople are responsible for the end-to-end sales process.
- Management has limited (if any) access to objective process data.
- Salespeople perceive that they own customer relationships (and in many cases they do!)
In this environment, it certainly does make sense to pay salespeople as you would a contractor. But, as you well know, we maintain that this isnot an ideal environment. What we now have to consider is how the radically different environment we advocate impacts on the case for performance pay.
The ideal environment
In summary, the essential differences between a typical sales process, and the process we advocate are as follows:
- Salespeople are responsible only for the conduct of (sales) appointments.
- All other tasks (including the sequencing of salespeople’s appointments) are allocated to a sales support function.
- Sales process management decisions are subordinated to the organisation’s constraint.
If you consider the first two points above, it’s obvious that we are no longer outsourcing the sales process, in its totality, to the salesperson. In fact, we have simplified the role of the salesperson to the point where he performs only one task (appointments*). As well as increasing (massively) the productivity of the salesperson, the elimination of multitasking provides management with the ability to micro-manage the salesperson. The thing is, if a salesperson performs one simple task, over and over, management now has access to a statistically relevant quantity of objective data. This data-stream is the critical feedback loop that enables a process of continual improvement. Now that the salesperson can be measured and managed intelligently, the case for performance pay is no stronger for the salesperson than it is for any (and every) other employee. Which, of course, raises a very interesting question: wouldn’t it make sense to provide every employee with performance-based compensation? Our consideration of point three (above) exposes the first of two fatal flaws in this common argument.
Fatal flaw one: the optimum is rarely the maximum
If you consider most performance-based compensation programs, their operation is simple. Employees’ pay is linked (directly or indirectly) to their productivity. Accordingly, the harder an employee works, the more he earns. This approach assumes that incremental increases in employee productivity are necessarily good for the organisation. Sadly, this assumption is dead wrong. The fact is, in any process, incremental productivity improvements in only one resource will impact on that process’s output. (This critical resource is the process constraint.) Productivity improvements elsewhere will have either no positive impact, or even a negative impact, on process output. (I’m referring now to non-constrained resources.) Consider a simple organisational process consisting of the following sequence of activities (each performed by a separate resource):
- Promotion (the generation of sales opportunities).
- Sales (the conversion of sales opportunities to orders).
- Fulfilment (the fulfilment of these orders).
If you were managing this fictitious organisation, would you be likely to exhort the people responsible for these resources to produce at their maximum possible rates? I hope not! Presumably you’d recognise that there is no benefit in Promotion producing sales opportunities that Sales can’t process. And, similarly, there’s no benefit in Sales generating orders that Fulfilment can’t fulfil. To provide each of these individuals with a financial incentive to produce at maximum (individual) capacity will waste resources, unnecessarily inflate expenses, generate chaos and damage customer service. It’s for this reason that the third attribute of an ideal environment (above) is that sales process management decisions are subordinated to the organisation’s constraint. What this means is that the output of the various resources within our process should be synchronised with the maximum sustainable capacity of the process constraint. Performance pay is likely to have the exact opposite effect.
Linking global rewards to global objectives
Now, if you think about it, the flawed assumption that incremental increases in employee productivity are necessarily good for the organisation does not have to ring the death knoll for performance pay. It’s possible to envisage a compensation program that links local rewards to global optima. For example, you could:
- Only reward team members at the process constraint for incremental increases in output.
- Compensate team members at non-constrained resources for maintaining optimal (rather than maximal) output.
Now, this (smarter) approach to performance pay overcomes the sub-optimisation* problem. It does, however, introduce two questionable assumptions of its own — and it fails to address the second fatal flaw in the argument for performance pay! Let’s consider the two assumptions first. The first is that the process constraint will stay in the one location. If it moves (and from time to time it will), it will be necessary to reconfigure your compensation program. You will inevitably find yourself having to explain to team members at the prior constraint that they must now satisfy themselves with a lower rate of pay (this is particularly challenging when the team members involved are salespeople!). The second assumption is that it is beneficial for team members at the constraint to strive for maximum output. The reality is that what you want is not maximum output but maximum sustainable output. While it sounds like a heroic endeavour, the pursuit of ’stretch goals’ increases volatility and decreases average output.* It’s time now to unveil performance pay’s mostinsidious flaw: the assumption that pay drives performance.
Fatal flaw two: pay does not drive performance
At first glance, the assumption that people will work harder in the pursuit of a greater income looks innocent enough. After all, a donkey will chase a carrot, won’t he? Well he will, until he’s replete! From that point on, the donkey has no interest in the carrot whatsoever. In our experience, team members’ desire for additional money subsides rapidly once they are earning what they believe to be a fair market rate (assuming, of course, that their basic needs are met by that level of income). Furthermore, team members value the security of a fixed income more than they value the possibility of a higher (variable) income. But — and I’m asked this question often — don’t we want our employees to be entrepreneurial? The answer is ’no’. We don’t. As suggested previously, we will destroy our organisations if we turn them into a loose cooperative of contractors — all taking risks in the pursuit of a profit (this is, after all, the definition of ’entrepreneur’). We want our organisations to be tightly synchronised, highly efficient and totally predictable. The donkey-and-carrot method of compensation is totally at odds with this objective.
Market rate plus some
Now I’m not suggesting that the elimination of commissions should result in a drop in your team members’ average rates of pay. In fact, I would expect the opposite to occur in many cases. But I am prepared to suggest that, along with performance pay, we should eliminate the notion that performance and pay should be directly linked. A better method to apply to the calculation of salary is to estimate the replacement cost of an employee. This replacement cost should consist of the market rate for a person of comparable capability, plus a premium for the inevitable switching cost you would incur if you were to lose that team member. You’ll find that this method provides a simpler and more rational basis for setting and renegotiating salaries. Obviously this method will result in an indirect link between productivity and salary (more productive employees will have a higher replacement cost). You’ll also find that the offer of a good fixed salary (in place of the promise of untold riches) will result in a greater number of better quality respondents to your employment advertisements; particularly when you are recruiting salespeople!
It’s important to highlight that the elimination of performance pay is contingent upon the successful reengineering of the sales process. If your sales process (or any other process) is intelligently designed and objectively managed, the retirement of performance pay is likely to be a logical and painless eventuality. An attempt to reengineer a traditional sales process that begins with the heavy-handed suspension of performance pay is likely to have unpleasant consequences.