The Effective Use of “Non-Financial” Goals in Annual Incentive Plans
We are used to seeing executives and sales representatives annually rewarded for meeting their direct sales or profit goals. They are often rewarded with an incentive or bonus determined by performance versus management or ownership’s expectations. While these direct incentives and rewards are obvious there are also an entire series of incentives that can be also employed to these executives and employees that are based upon less direct measures of performance.
These components (in terms of goals or metrics) are often used with and as a complement to direct sales or profit incentives in order to let the company also focus upon (and pay for) the “building blocks” of sales and profit success in this and future years.
What are examples of these types of indirect goals or metrics? Sales success building blocks include:
- Focusing sales force time and attention on those customers with the highest potential;
- Convincing current customers to buy and use more of your most profitable and important products;
- Assuring that the company’s share of market is constantly growing or in line with strategic objectives;
- Closing ratios for deals (e.g.: 50% of proposals written); and
- Getting the highest price possible on each and every transaction (e.g.: gross profit of the revenue stream).
Similarly, executive (or business-unit) success building blocks include—
- Getting your sales force to get the highest price possible on each and every transaction (e.g.: gross profit of revenue stream);
- Productivity of capital employed;
- Aggressive product development and introduction (keep the product pipeline full);
- Control of overhead and cost;
- Improving productivity in all aspects of business operations; and
- Managing exposure to product, process and people risk and obsolescence.
While you are regularly paying executives for sales and profit success, you are generally also asking them to do the above tasks every day—so why not include some of them in the annual incentive plan, if you do not already do so?
This suggests that a company should rewards its leaders and operators both for those things that happen and can be measured this year (financial quantity and quality), and those things that are building the foundation for this and next year’s success (sustainability).
One way to do this is with a mix of pure financial (direct) along with indirect goals and metrics in the annual incentive plan. This trend in incentive design has increasingly gained traction over the last decade. The following are real examples of two such plans:
In the sales force—The sales representative is paid an incentive of $0 to $60,000 per year for the growth of their book of accounts versus management’s pre-established expectations for success. If the annual goal is achieved, $30,000 is earned. In addition, the sales representative can earn another $0 to $40,000 in the year if they—
- Sell over $500,000 of the company’s newest and most-profitable product to the sales rep’s top 6 volume accounts.
- Increase the gross margin of their account portfolio by 2% (nominally), or increase total account profit contribution by $200,000, or more.
In the executive suite—The top divisional executive is paid an annual bonus of $0 to $90,000 based upon the pre-tax profit of the business unit. An amount of $45,000 is earned if $1,000,000 in pre-tax profit is achieved. 2% of pre-tax profit is added to the executive’s bonus for all pre-tax profit over $2,000,000. In addition, the executive can earn another $0 to $60,000 in the year if they—
- Reduce company general and administrative overhead from 15% of sales to 12% of sales by year’s end.
- Complete implementation of a new direct sales channel that accounts for (as a running rate) of no less than 10% of company volume by year end.
- Introduce a new specific technologically-based product by mid-year and achieve $1,000,000 in sales orders by year’s end through all sales channels.
These incentives are sometimes called “non-financial.” We prefer to use the term “indirect,” because the metrics are generally both financially-based and readily measurable by normal accounting practices and systems. You are simply measuring sales and profit success in a different and more elemental way.
The use of these types of indirect incentives can be controversial. Three basic objections are most often heard.
“These are really discretionary bonuses.” Clearly, the examples above are all designed to be quite objective and clear in terms of expectations and reward. Further, simple pay and performance tables can be developed for clarity of communication and ultimate year-end bonus calculation. However, we have seen indirect incentives that do fit the description discretionary. In our world, more objective and measurable metrics are better for everybody.
“They are just too complicated.“ Well, guilty on that charge! They are clearly more complicated than calculating a percent of sales or percent of pre-tax profit each month. But, your business is surely also much more complicated than the above-stated calculations. In my experience, we have found that we can describe an indirect executive or sales incentive plan on a single (and one-sided) page with accompanying payout rules. I generally also throw in a second page with an example or two, as needed. It just isn’t that complicated once you take the plunge.
“Management and ownership will need to spend all of their time on plan administration.” It’s true only if they like doing plan administration—and some do. The payout tables and rules I described above (combined with a little common sense) make incentive plan administration no more time consuming than a traditional commission plan, and likely less time consuming in the end.
So how do you put these ideas into action for 2012? Try this.
Consider both your sales force and your key executives. Choose three annual goals or metrics for each, (other than enterprise, unit or portfolio sales or profit) for 2012. A hint—start by focusing on improving margin, product mix, quality, or productivity. Tell the sales rep or executive where you will be looking this year and explain your expectations. Then measure and talk about your expectations every month. In our experience, you do not even need to attach money to get results and their attention.
Then, select the same or new indirect goals or metrics for 2013 and do it all over again. But now, make it part of their existing bonus plan, with dollars attached.
Remember, in the end, you are building annual incentives to focus your operators on three imperatives—quantity, quality and sustainability. If you ignore any one of the three you will eventually get into trouble.
If you have questions or seek other examples regarding reliable-indirect incentive structures or techniques, call me at (847) 823-5090.