“Handing out bonuses to staff comes from good intentions but, unfortunately, if the incentive part of the wage is too small it will not have enough motivational power to get staff-members to change their behaviour […] On the other hand if the incentive part is greater than 30% it will be counter-productive since the remuneration will no longer be truly variable or conditional” Fabien Lucron, Primeum’s Development Manager and expert in incentive compensation, le-paradigme.com
Defining the correct ratio between the fixed salary and incentive compensation can be a real problem for employers. The correct balance between these two forms of compensation will depend largely on the employee’s motivation and company sales. In this article we will take a look at the various factors that have to be considered when calculating the incentive compensation share of a wage package.
Incentive compensation rewards individual performance. True incentive compensation must be 0 when the employee is a long way from the performances expected of them. If they achieve or surpass their objectives, then the incentive compensation must then reach the maximum amount. Incentive compensation can only come in addition to a fixed salary, within reason, since the risks can be very high.
The idea behind incentive compensation is to put a true value on an employee’s work without adding to payroll costs. It cannot be a substitute for a fixed salary. And high proportions, over 50%, are both unrealistic and completely off the subject.
Some companies propose very high proportions, as much as 60% or 70%. But what does that really mean, and what share of the remuneration is really incentive related?
The ratio between incentive compensation and fixed salary is the average amount of incentive compensation paid to the employee over the year. But in reality, different companies may use various interpretations of the term incentive compensation. Larger ratios often mean that a part of the compensation is considered as applied by default. By comparing the highest and lowest incentive compensation amounts paid to the sales operative, we gather that this payment is in fact considered a guaranteed income. Most of the time, this kind of incentive compensation proportion could actually be considered as a commission.
Commissions are often wrongly thought of as a form of incentive compensation. Whereas a commission involves paying the employee a percentage of the profit or turnover that they themselves have generated for the company. And a commission is very often applied from the first Euro generated.
There is a significant difference between these two forms of compensation: with incentive compensation, if the sales operative only achieves 50% of expected sales then they receive no compensation. Whereas with commissions, if the employee only makes 50% of expected sales they will still earn half of what they could have hoped for.
Another fundamental issue that needs to be considered is the client portfolio. If the sales operative receives a client portfolio on joining the company then the concept of incentive compensation becomes more complicated. In this case, unless they fail to take the slightest action to incite clients to renew their trust in the company, there is relatively little risk that the sales operative will fail to make any sales at all. So they are practically guaranteed to receive at least a part of the incentive compensation.
“An incentive compensation system is never fixed over time. It has to change with the company’s strategic orientations, even if that means changing in the middle of the year” Fabien Lucron, Primeum’s Development Manager and expert in incentive compensation, actionco.fr
Incentive compensation relies on employee motivation. This motivation will come from the potential of significant extra income balanced against the risk of losing everything. The aim of including an incentive-related share in a sales operative’s salary is to incite them to “surpass themselves” by achieving objectives based on both quality and quantity. The very singular nature of this remuneration makes defining the correct ratio between the fixed salary and incentive compensation especially complex.
There is no general rule to be applied when calculating this ratio. It all depends on the job’s specifics, the strategic issues involved in the set tasks, market developments as well as the sales operative’s actual profile and skills. The calculation of incentive compensation must consider all of these parameters in order to propose the most appropriate percentage for the employee and the performance period in question. A list of benchmark ratios per business sector should be applied to ensure that incentive compensation remains attractive to employees.
In reality, the only ratio that makes any sense is the one that applies to objective-related bonuses. This model provides the employee with the opportunity to earn an increasingly attractive percentage related to the extent to which they achieve, or surpass, their objectives. In this way, if they do not meet their objective the employee will only get a small bonus, but as soon as they go beyond the objective the bonus could be doubled or even tripled.
“Contrary to what most people think, these incentive-based systems can be applied to almost any type of job, provided that employee performance can be in come way measured or evaluated” Fabien Lucron, Primeum’s Development Manager and expert in incentive compensation, Le Monde
Incentive compensation must be attractive; it must be fair and reward the best employees, as well as being quantifiable wherever possible. It must also adapt to suit the specifics of different job descriptions.
In order to set an incentive compensation percentage for their employees, managers will need to establish suitable criteria at the start of the year. They will then need to ensure that they are met by the employees throughout the performance cycle.
The main difficulty with this calculation is the evaluation of the economic impact of different employment positions. Whilst the incentive compensation indicators applicable for sales operatives are easy to identify, this is not necessarily the case for other employees. In reality, individual performance for some jobs can be particularly difficult to evaluate in terms of the company’s sales.
By the very nature of their jobs, it is quite acceptable to say that as much as 30% of a sales operative’s wage could depend on their performance. The financial impact of their actions can be quantified directly. However we cannot apply such a large share for those in support roles such as back office or middle office operatives. In this case the compensation must not come to more than two months’ salary, no more than 15% of the total salary.
Whereas marketing is an obvious part of a company’s commercial success. But what could be the exact individual share? It is impossible to evaluate this precisely since the objectives are not the same as those set for sales operatives. This is very much the case for digital marketing. Marketing operatives can be at the origin of a profitable campaign that generates interesting leads. But these leads are not automatically converted into clients and it would not be fair to attribute that to the marketing department. To the contrary, it would also be very difficult to try to estimate the exact role played by the marketing operatives when such leads are actually converted into sales. In reality, sales and marketing cannot be disassociated effectively. So the ideal would be to propose bonuses that make sense.
“This type of compensation is suitable when staff work as a group, in a shop for example, where it is difficult to imagine all of the sales staff approaching a single customer to make the sale. It is more intelligent to recompense the group that operate the shop as a whole” Fabien Lucron, Primeum’s Development Manager and expert in incentive compensation, beaboss.fr
A company’s commercial success should be rewarded by a collective bonus. This should not be confused with profit-share schemes, which involve paying out a bonus, calculated as a proportion of company profits, to all of its employees.
A collective bonus based on the company’s commercial success rewards all of the staff that have contributed, directly or indirectly, to company sales. In this case the bonus cannot be applied to the product development department or any other positions not directly involved in company sales.
The collective bonus based on commercial success is especially relevant and, furthermore, it can be included equitably in the salaries of all of the sales operatives. Sales operatives are employees who prefer to work alone. So not all of their remuneration should be calculated on a collective basis. However, we can establish a fair and balanced ratio by proposing 80% of the remuneration as individual and the other 20% as collective.
For the collective bonus to be pertinent and motivating, for both sales and support operatives, it must also maintain the individual performance-related bonuses. Getting the right balance between collective and individual bonuses will ensure team commitment and individual motivation.
Finding the right ratio between incentive compensation and fixed salary can become an obsession and a source of worry for employers. However the ratio issue is not all that central when all of the different factors are brought into consideration. In reality, true incentive compensation must be both flexible and adaptable. The only pertinent ratio is therefore the one applied to objective-related bonuses.