June 24, 2012

How to get bean counters and managers on the same side of the table

by Joy Parr Drach, Entira

How does your company determine individual compensation? Most businesses base it on performance relative to budget with big bonuses tied to making the budget. But this system can limit -- and even erode -- long-term growth and profitability. How? By creating the opportunity for lowballing and gaming the numbers.

Striking out with lowballs

Typically, lowballing starts during the budget process. To ensure they'll get their bonus, employees underestimate their potential. While they may know they can deliver $50 million in sales, they'll say, "It's going to be a stretch, but I think I can do $45 million." The reasoning is: "If I say 45, we'll agree on 48, which will trigger my bonus, and I know I can do more than that." They can make a nice bonus without extra effort.

At the same time employees lowball their sales projections, they overestimate their expense budget. That way, they reason, they can get what they really need to get the job done. And if they don't spend all they've been allocated, they'll look like heroes a second time.

Let the (number) games begin

After getting their target as low as possible and the funds they want, employees begin gaming for numbers. This is especially true around year's end. That's when they often take a "make-the-numbers-at-all-costs" approach. Logic and good business practices fly out the window as they focus on just one thing -- get that bonus.

During the fourth quarter, anyone who hasn't made target has the potential for selling into inventory. In a panic, managers offer sweetheart deals. They tell customers they can return the product later. They cut prices to make a big sale. Or extend terms.

Before Sarbanes-Oxley, we'd even seen products sent from one part of a company to another when rep numbers are based solely on product shipped. Then, it was shipped right back again.

But all of these practices can hurt your company's profits in the long-term. Selling product just to have it returned again amounts to a waste of freight costs, not to mention the warehouse hours and labor to generate paperwork. Cutting prices to make big sales results in losses, too, because the discounts are often offered to customers sure to say "yes" -- those who would have bought the product the next year at the non-discount price.

Hit one out of the ballpark

By breaking the link between compensation and your budgetary process, you can prevent many of these practices. Plus, the budgeting process can become a useful tool, one that can help increase your bottom line and spur your company forward.

Performance-based pay is an important motivator; we just advocate changing the performance metrics. The behavior you want to create is that which contributes to long-term profitability. But the link between budgets and bonus undermines that. For the best results, first determine key drivers of your profitability (see last month's article, How's Your Company's Report Card?). Then create the incentives that will promote those drivers.

For example, if an animal health and nutrition company depends on the sales of new, high-margin products to make its numbers, the sales reps' bonus might be paid based on the number of trial purchases initially and then a combination of trial and repeat purchases. This would minimize lowballing during the budgeting process and gaming afterward while still rewarding reps for the behavior that can drive long-term profitability for the company.

By removing the link between the bonus and the budget, you can make the budgetary process something dynamic -- an opportunity for discussing how to move your company forward and what it will take to get there. That's because employees will feel free to mention things that can improve company performance and profitability -- without jeopardizing the size of their bonus.

For instance, a rep might believe a specific program could drive sales in his area. Because he thinks it is expensive to implement, he never mentioned it before. But if a bonus isn't tied to the budget, it won't take money out of his or her pocket to get the program going.

Breaking the link between bonuses and budgets gets employees charged up and more involved. Lowballing and gaming for numbers can become things of the past while your profits improve. And your bean counters and managers will finally be on the same side of the table.

Entira has experience helping companies succeed by focusing on the drivers of profitability and creating the right incentives. To discuss how they can help you, contact Entira at info@entira.net.


This article appeared in the July 2006 issue of Strategic Agribusiness Review.