Thursday, July 30, 2009

Economic Fundamentals: The Role of Incentives

“What gets rewarded gets done.”

That’s what business professor Michael LeBoeuf calls the greatest management principle.

Simple, isn’t it? Incentives work. It’s why the vast majority of sales professionals are paid partial to full commission. Every sales manager knows that a 100% salaried sales force is a lazy sales force.

Not Everyone Is Money Motivated

Of course, there are some people who are not money motivated. Incentives don’t work well for these individuals, even though managers try to impose them.

Some technicians, for example, fail to respond to contractor spiffs and incentives. All the tech has to do to earn extra money is offer homeowners a service agreement or place a few door hangers, but the tech resists.

What drives these guys? Some are craftsman who derive internal satisfaction from the quality of their work. Others are subject to the negative peer pressure of other technicians. Some receive enough money from wages and are not hungry enough to step outside of the comfort zone.

Creating incentives for employees who are not money motivated can be a challenge for owners and managers, in part because many managers do not understand people who will not respond to monetary incentives. If the manager is money motivated, he figures everyone else should be.

The challenge for the manager is to step outside his experience and find what the employee values and use that as a reward. It might be extra time off, flexibility on the job, a fishing or golf outing, and so on.

Money Motivated People Seek Incentives

So, we acknowledge that there are some people who are not money motivated while others are. While, people who are not money motivated gravitate towards occupations where incentives are not a factor in compensation, people who are money motivated tend to gravitate towards occupations where incentives exist, like sales.

For people who are incentive driven, the design of an incentive program is critical. Done well, it leads to greater exertion and effort. Salespeople, for example, sell more and earn more.

In some companies, superstar salespeople earn a lot. They may earn more than the boss and some bosses, especially bosses without sales experience, have a hard time handling it. They shouldn’t. When the salesperson makes more, the company makes more, and ultimately, the boss makes more.

Yet, ego sometimes trumps common sense and the boss decides to cap sales compensation. What a blunder!

“Caps have some considerable disadvantages,” writes Andris Zoltners, Prabhakant Sinha, and Sally Lorimer in The Complete Guide to Sales Force Incentive Compensation. “They can dampen the motivation of top performers. Salespeople stop working hard if they know they will not earn any incremental income from their efforts. Caps often encourage salespeople to hold sales over to the next period, when those sales can help them earn incremental income.”

I’m shocked, shocked that salespeople would hold sales over to the next period. I’m not, of course. Salespeople are especially prone to working the system to their advantage. Anyone who has sold or has managed salespeople should agree.

The mistake managers make capping sales income is no different than the mistake managers make when they insist on monetary incentives for employees not money motivated (or even negatively motivated due to negative peer pressure).

Three Truths About Sales Incentives

Here are three truths about incentive compensation for salespeople…

1. Since salespeople will work any compensation system to their advantage, it’s good management practice to keep the system simple and straightforward.

2. Since salespeople shut down when incentive compensation is curtailed or capped and this reduces company sales, salesperson earnings should be unlimited.

3. Since salespeople respond to incentive compensation, raising the commission tends to result in greater effort on the part of salespeople.

Tax Incentives

I ask why anyone should expect the tax code to work different as a disincentive?

By and large, high income earners are money motivated. They respond like salespeople. Increase the top marginal tax rate and they are less motivated to perform. They’ll spend their time working the system, looking for legal ways to avoid paying taxes. And given the inordinate complexity of the tax code, there are lots of ways to work the system. The net of this activity is efficient for the individuals, but not society.

If we want more economic activity as a society, we should reduce the disincentives (i.e., taxes), not increase them. This is all so blatantly obvious to me that I struggle to understand why everyone can’t see it. Then, I remember that the people who seek government jobs are not money motivated. If they were, they wouldn’t be in government. They don’t get it.

© 2009 Matt Michel

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