Article
Love, Jessica. (2016). “Finding the Right Performance Incentives to Motivate Employees.” Kellogg Insights.
Reviewer
Dr. Scott Downey, Associate Director and Professor
Summary
The author interviews three strategy researchers at the Kellogg School at Northwestern University and overviews their research. The research builds on contract theory, and takes a gaming approach to compensation. They looked at several ways of structuring monetary reward systems to determine behavior that best aligns with the company’s goals. They specifically looked at how a straight commission structure compares against a threshold performance requirement, or quota. They found that not having a downside risk put employees in a position to take more risk than they might otherwise, because the payoff potential exceeded the downside possibilities for them personally. A straight-line, simple, predictable reward system kept employees from gaming the system. Penalties for under performance or higher rewards for over performance were not as effective as straight-line systems.
What this means for food and agribusinesses
Compensation is always a challenge. Messing with compensation always creates problems. No matter what the system is that is put into place, there seems to be no reliable method that will make everyone happy, reward top performers, encourage under-performers, and be cost effective for the organization.
This research looked at both executive compensation and sales compensation. As consolidation creates larger firms in food and agribusiness companies, the risks and responsibilities for the people who lead those firms are greater and compensation seems to have risen as a result. The knowledge and demands needed to run a $5 billion company are much greater than what might have been needed for a $50 milion company. Competition for top talent to run these types of organizations, and absorption of talent from acquired companies leads to a lot of creative compensation packages that are relatively new for food and agribusiness firms and their boards of directors. Bringing in talent at the executive level from other industries also requires creative approaches to incentivizing performance that may be relatively new for boards. It is helpful to know that simpler is better in these situations.
That may be even more true for sales incentives. Program dollars from manufacturers and company-wide agreements that vary by product or category can create all kinds of systems that make compensation irregular and unpredictable for the company’s financial wizards and for the salespeople who are meant to be motivated by a convoluted system. If the employee can’t predict what the result will be, it is unlikely that having the reward will make much difference. That is not to say that people don’t figure out how best to be rewarded. I can recall several circumstances in agricultural retail where savvy salespeople figured out how to maximize their incentive payments (and trips) with a combination of product sales across several different lines of product, where they did just enough to reach a threshold and then put the rest of their effort toward some other incentive, or sandbagged sales to the next promotional period if they could.
We have created a system where maximizing benefits is a big part of what we do – for ourselves and for the end-users we serve, directly or indirectly. I often wonder how we got to the point where doing what is best for the company, the employee, and the end-customer was like solving simultaneous algebra equations: shift one variable and they all change. It makes doing what’s right difficult to figure out even with the best intentions.
One consequence pointed out by the authors is the “heck with it” phenomena (my language, not the authors’). That’s when an employee realizes they aren’t going to hit their target reward level for a specific period, so they (wisely) sandbag the current period and try to shift as much as they can into the next period. This actually reduces performance in the current period, which is the exact opposite of what the incentive system is designed to reward.
The authors are careful to point out that straight-line reward systems won’t work in every circumstance. There are times when the company wants to reward something in a non-linear way, such as over-incentivizing sales of a product that is soon facing expiration. But when gaming the system becomes more of a goal than the incentivized behavior, it is helpful to know that simple and easy to understand might be a better option.
