At present there is a lot in the news about reward and compensation systems driving the wrong behaviour at banks and financial institutions. Luckily the ICT industry is not facing a Royal Commission, but there are certainly some badly designed incentives and discount structures delivering predictably poor outcomes, which we will explore in this month’s article.
There are two familiar adages worth thinking about in context together rather than separately. Firstly “you get what you pay for”, and secondly “what gets measured gets done”. When looked at together you have the makings of a reward and compensation system, or a channel program discount and incentive structure.
If badly designed however this sometimes creates what we call “unintended and reinforcing consequences”. Let me explain with an example of a client situation we are working on a channel structure review for.
Unintended and Reinforcing Consequences
They are a successful vendor in a very competitive, volume driven and price sensitive sector of the industry, with a mix of online e-tail, traditional retailers and resellers representing the vendor via a spread of distributors. The channel discount and pricing structure is what we would describe as a legacy structure and all internal metrics, external metrics and associated compensation is based on this. Therefore, changing would be challenging, especially mid financial year. In recognising some of the problems, they have tinkered with a few nuances over the years but there are still numerous flaws compared to what they could achieve through a complete redesign.
For example, they report sales as sell in to the distributors, not sell out, distributors are set rebates or incentives around quarterly volume targets and the channel does not have any significant program tier based pricing differences.
Consequently, you end up with both distributors and channel partners competing against each other on price, but often with different cost structures, and so different margin requirements. Secondly, the current distribution incentives such as “blitz days” where staff get spiffs or prizes and partners get discounted product, combined with volume based stretch targets (where additional rebates are provided), create the perfect storm of channel discounting. Distributors and channel partners know the vendor will regularly run these promotions, often at the end of the month or quarter so will hold off ordering until such time to get a better price and remain market competitive.
The net result is the current reward structure reinforces price/margin discounting as the most effective way to sell.
The consequence of this structure is some distributors and partners find it too hard to make money and are looking at alternative vendors as they can’t make consistent or sufficient profit selling this brand.
Additionally, the vendor is under margin pressure as they must continually discount to achieve their targets. These distributor volume based rebates and incentives are not only rewarding and reinforcing “business as usual”, but have another unintended consequence. The distributors often end up with too much stock of a certain product because of buying aligned incentives. This means they now have to discount these items further to clear the stock, so they can order more of something else to meet their operating targets! No wonder they have a channel pricing problem.
KPIs & Incentives Drive Behaviour
The example above is not unique to this vendor, nor the ICT industry. There has been plenty written lately about the banking and finance sector, not only in Australia but also the US. Wells Fargo bank in the US was fined $185m and ended up firing 5,300 employees for inappropriate sales conduct primarily for opening unauthorised customer accounts. The CEO admitted this behaviour was driven by the employees need to meet sales quotas and earn incentives. Read the HBR article Wells Fargo and the Slippery Slope of Sales Incentives.
Therefore, when thinking about “what gets measured gets done”, our advice is to think through the unintended consequences of not only the measure itself but the “height” of the measure. If the measure seems unattainable to the people it is being applied against, then you will either have people not try to achieve it as it is out of reach, or worse people “game” the system to achieve it.
Gaming the system to achieve targets at its worst can cause illegal or corrupt actions, as has been uncovered in the Royal Commission. At the very least it has the potential to create a less than ideal company culture leading to longer term poor financial results and customer outcomes. The telco industry has in the past been guilty of this with mobile plan SIM splitting and other activities such as where customers were churned and resigned to meet sales targets or improve commission outcomes. One thing my experience working in telco taught me was to recognise that not all revenue is “good revenue”, and you really do or can get what you reward.
A fair general assumption would be employees or channel partners are not inherently unethical. But in the competitive, fast paced and evolving digital business environment we are in today, there are significant pressures around job security, the desire to be seen to be successful, and of course containing business costs. Therefore, target and KPI setting needs to focus on measuring and rewarding behaviours that lead to desirable outcomes, not just the outcome itself.
Read Sydney Morning Herald Losing our way: How the cult of the KPI has damaged our moral compass
Reward The Predictor, Not The Outcome
Nearly all ICT vendor sales orientated staff are measured and rewarded on revenue as the primary KPI, while distributor and partner staff are more likely rewarded on margin, which is the first channel disconnect. However, revenue (and margin) is an outcome of a range of activities that occurred well before the customer signed the purchase order with their selected partner. Who in turn would have received a quote from a distributor employee trained, managed, and supported by a range of vendor channel staff. I.e. a sale or revenue just does not happen in isolation.
A well designed channel program and supporting compensation system, while still recognising revenue, should also reward sustainable and cumulatively enhancing customer satisfaction activities or behaviours. For example, think about linked productivity measures such as:
• Quote turn around (bad in isolation as could lead to poor quality)
• Quote to close ratio &/or quote to close time (in conjunction with above)
• Number of staff trained/certified (easy to game)
• Quote/BoM/order accuracy (in conjunction with above)
These are just two examples of KPIs now thought through with potential unintended consequences eliminated. What initially might have appeared to be a good measure of success, when re-designed will provide far better customer and company outcomes.
For those interested in this subject in more detail here is an old but in depth MIT Sloan Management Review article Designing A Sales Compensation Plan but this will require a log in to view the full article.
The same applies to channel rebates. In the earlier example we highlighted the vendor providing additional rebates for achieving volume targets, which in our opinion is a margin dilutive practice for “business as usual”.
Rebates Compensate For Additional Effort
When we design a partner program including rebates of any kind, the first thing we look to avoid is paying rebates for what should be done in the first place i.e. business as usual.
Rebate systems when well designed are there to compensate for the additional time, effort and associated cost of doing something above and beyond business as usual.
Therefore, achieving a sales number where sufficient margin is provided should not necessarily be additionally rewarded. There are caveats however.
For instance, if the sales number rebate is provided for a new product requiring additional skills, more complex quoting, investment in specialist inventory, market mapping, reporting etc, this is a good thing.
Rebates offered for a specific and usually transitional period make complete sense, as you are looking to compensate the partner for the over and above investment until this becomes business as usual, then it should be withdrawn. Otherwise the rebate effectively becomes operating margin for the partner or a permanent cost for the vendor, and this can of course have unintended consequences for market or channel parity pricing.
If you want to understand people’s behaviour start with my adage of “follow the money trail” by understanding what they are measured on and how they are compensated. It will go a long way to demystifying what can sometimes seem as unusual or unexpected behaviour.
Changing external channel programs with the associated rules, requirements, discounts, and rebates must be done at the same time there is re-alignment with the internal reward and recognition system. Additionally, plenty of thought needs to go into the design to ensure there are as few as possible unintended consequences or holes where the system can be gamed, and so you really do get exactly what you pay for.