Why companies should smile when they pay commissions

I’ve been doing a lot of thinking lately about compensation plans as I start to get ready for 2009.

As I’ve been planning all of this, I’ve been watching the chaos unfold on Wall Street and I’ve seen these articles blaming much of it on highly paid people in Wall Street firms.  Its always been my opinion that if a compensation package is designed correctly, then if the salespeople or executives are making a lot of money – well then the company must be doing well.  Simply saying that “compensation is top heavy” doesn’t always tell the whole story.   It is true that a poorly designed compensation plan can pay out too much money relative to effort, but I’ve been wondering if this was the case for many of the firms that have gone bust lately.

In my effort to find information on this, I came across a great post on LeapComp – a great blog on sales compensation.  In the post, the author, Julien Dionne, says:

Investment bankers earn a lot of money…  A lot of people in the financial sector receive (received?) huge bonuses.  But let’s take for example Lehman Brothers.  In 2006, along with many other investment banks, Lehman Brothers had a stellar year: it paid its average employee $335,441 and reported a fourth-quarter profit of 1 billion.   This is after of course, paying 8.87 billion in salary to its 26,000 employees.  Goldman Sachs has even more ridiculous figures; it paid its 26,400 staff an average of $622,000.  Two years later, Lehman files for bankruptcy.

So, how much can we blame “crazy” compensation versus bad risk management?  I’m not a financial analyst, and I’m not pretending to understand the entire issue…  However it seems logical that a firm such as Goldman Sachs, who paid almost twice as much in average compensation in 2006, should be hit equally hard by the credit crisis as another firm such as Lehman Brothers, if compensation was such a major factor.

Goldman Sachs Performance

Goldman Sachs Performance

It turns out that while Goldman Sachs was affected by the credit crisis, it is not in such a bad shape…  despite having paid its employees more.  And this proves that…  the credit crisis is a very complex problem, and that maybe, maybe compensation is not such a “significant” contributor to the credit crisis.

Despite paying out nearly DOUBLE to its employees, Goldman Sachs is of course better-off than the now dead Lehman.   I think the message here is that properly designed compensation packages work.  Obviously without knowing the details of the compensation packages, I can’t exactly make the assumption that the compensation plan was correct.  But what it does illustrate that the payouts in itself didn’t bring down the firms.  It shows that you cannot simply blame high compensation.

Bringing this back to sales:  When you design the right compensation plan, you can have top salespeople making a lot of money and the more they make, the BETTER it is for the firm.  In my first company, I ran a very sales driven company.  To that end, I was overjoyed when I had to pay a large commission check.  Why? because that means a BIG sale was made!  Big sales meant big money into the company – which benefited everyone related to the company – employees, investors, customers.

In my current assignment, I’m pretty proud of how the compensation packages are driving performance.  If you look at Q1-Q3 for 2007 and compare to Q1-Q3 of 2008, you can see that the improved compensation plan nearly TRIPLED the sale performance over that time.  The team performance is even better because I’ve  subtracted out the performance of an additional salesperson that started in 2008.  So, the same team did 3x what they did a year ago.  Sure, it cost the company more money, but you can’t argue with that kind of performance increase.

What makes this story even better is that I looked at the old compensation plan and calculated what the company would have paid out had the same performance been done, and the new plan actually pays out slightly less.  If you remove the challenge bonuses and monthly performance prizes, the new plan pays even less.

Designing a proper compensation package is quite challenging, but when you do, rejoice as you pay out big commission checks because it means the company is doing well!

  • Hi Mark,

    First, thank you for thinking leapcomp is “great” and for echoing the post here for your readers.

    Secondly, a point I didn't make in my post, is that not only is it important to reward with the right amount, it is also important to encourage the right behavior (obviously!). It's not surprising that in investment banking, some people make millions in bonus, but one has to wonder how much money they actually made the company to deserve that money.

    You say “When you design the right compensation plan, you can have top salespeople making a lot of money and the more they make, the BETTER it is for the firm.” Yes! The RIGHT compensation plan does!

    Going back to the market crisis and the sub-prime mortgage problem, when you look at banks incenting their reps for refinancing mortgages at a lower rate and after only a few months, often within the same institution, it is easy to realize there is a problem!

  • Mark I LaRosa

    Julien,

    Exactly correct! Upon a re-read I certainly didn't make it obvious that the reason the comp plan was designed correctly was because it DID infact inspire the correct behavior.

    I also focused heavily on the cost of the plan – not pointing out that the end-result was amazing for our company.

  • Hi Mark,

    First, thank you for thinking leapcomp is “great” and for echoing the post here for your readers.

    Secondly, a point I didn't make in my post, is that not only is it important to reward with the right amount, it is also important to encourage the right behavior (obviously!). It's not surprising that in investment banking, some people make millions in bonus, but one has to wonder how much money they actually made the company to deserve that money.

    You say “When you design the right compensation plan, you can have top salespeople making a lot of money and the more they make, the BETTER it is for the firm.” Yes! The RIGHT compensation plan does!

    Going back to the market crisis and the sub-prime mortgage problem, when you look at banks incenting their reps for refinancing mortgages at a lower rate and after only a few months, often within the same institution, it is easy to realize there is a problem!

  • Julien,

    Exactly correct! Upon a re-read I certainly didn't make it obvious that the reason the comp plan was designed correctly was because it DID infact inspire the correct behavior.

    I also focused heavily on the cost of the plan – not pointing out that the end-result was amazing for our company.

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  • Hii im jackson and you are right, i appreciate it.

  • Hii im jackson and you are right, i appreciate it.

  • Hii im jackson and you are right, i appreciate it.

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