- Never cap “at-risk” compensation plans
- Decelerators after certain attainment levels and fairly written windfall clauses are better ways to ensure compensation plan equity
- Performance recognition gaps result in talent flight
Capping compensation bonuses places a fixed limit on incentives. While it’s prudent to use caps for no-risk compensation plans, you should never use them for sales plans or other at-risk plans. Let me tell you why.
At-risk plans reward participants based on their attainment of individualized goals (i.e. quotas), and are reserved for sales roles and others who participate directly in convincing customers to purchase. With at-risk plans, individuals agree to risk, or sacrifice, a percentage of their total compensation if they fail to reach their goals. As part of this agreement, they accept a lower base salary with the understanding that, in return, the company will offer upside potential for overachievement.
No-risk plans, on the other hand, offer incentives in addition to base salaries. Unlike at-risk plans, they reward participants based upon the collective achievement of more general, non-individualized goals – e.g. corporate revenue performance, bookings, margin. Because these bonuses are offered in addition to base salary, there’s no downside potential – so they’re capped. In other words, they offer rewards commensurate with the amount of risk their participants assume. Most organizations outside of sales are on no-risk plans.
So what’s the problem with capping sales plans or other at-risk compensation plans? The simple answer is that it violates the implicit covenant individuals make with the company when both parties agree that at-risk plans are prudent for the role. If a company violates that agreement, it’s not surprising that top performers and others leave – these individuals expect the balance between downside and upside potential to be honored. And they usually don’t go without informing their personal networks of their experience.
Thus, the short-term commissions expense savings that companies enjoy from caps get eaten up quickly in the form of missed revenue (due to understaffing), increased recruiting and training expenses, and difficulty finding high-quality replacements due to a tarnished reputation in the marketplace. In spite of these consequences, some companies continue to cap at-risk plans for the following reasons:
- They don’t understand the difference between the implicit terms of no-risk plans and those of at-risk plans.
- They get nervous about paying too much for the upside of at-risk plans and react by using caps instead of other more equitable methods – e.g. plan deceleration above a certain level of high achievement and the inclusion of windfall clauses.
- They are in financial distress and short-term commissions expense gains appear to outweigh longer-term implications.
- They rationalize. One of my favorite rationalizations is: “Our quotas are so high that they’ll never hit the cap anyway.” In those cases, the company has two problems. Unrealistic quotas and caps. Sales reps, when you hear that excuse, run!
It’s very rare to see a sales executive or sales operations leader be the first to suggest capping a plan. It normally gets “suggested” or imposed upon them. If you’re being asked to implement a cap, use the chart below to help illustrate why this is a bad idea. Sales force automation systems and other tools have democratized access to performance results, and it has never been easier for individuals to compare their contributions to those recognized by the company. Sales reps will be on guard to ensure that their performance is recognized (at least on par with corporate performance) and will be on the lookout for a recognition gap.
Getting compensation right is one of the greatest challenges for sales and sales operations leaders. At SiriusDecisions, we’ve recently launched our Chief Sales Officer Strategies (CSOS) service to help sales leaders navigate these problems, and we recently introduced our sales compensation model at the SiriusDecisions Summit 2016 in Nashville, TN.