Business leaders and owners spend a lot of time crafting strategies and initiating change management projects. Yet, people have a tendency to fall back into old habits quite quickly. One reason to this that is often overlooked, is because the incentives you have in place beat your intentions. Simply because most people care more about themselves than the business.
The goal of any business owner or leader is to have a majority of people who care a lot about their business. It is a key to achieve extraordinary things; having people onboard who wants the company to succeed.
At the same time, it is foolish to believe that at the end of the day, they'll care more about the company than themselves. Perhaps you as a founder or owner do, but your employees won't. Which is why it's crucial to make sure that you reward a behavior that is good for your business.
When Sales Target and Good Business isn't Aligned
To highlight the issue with misalignment between incentives and wanted behavior, I'm going to deep dive into the career of a sales person I know. Let's call him Erik.
Erik has spent the last 10 years in sales. Both B2B and B2C. And there are two things that distinguish him from many other sales people I've met:
- He's crazy service minded. But only towards the customers where it really matters.
- He cares way more about the business than his own salary.
The latter is what makes him rather unique. Because he has time and time again acted for the better of the company, while personally taking the hit for it. Few people do and those who do eventually grow tired of it.
Case 1: the low margin product
At this company, Erik had a great relationship with his boss. But neither had a great one with their CEO. That CEO had, on behalf of the board, set a bonus based on target margin for the sales team.
One day said CEO went through the spreadsheet and stumbled upon one margin that stood out. The revenue was indeed massive, but the margin way off the target. Erik was the Key Account Manager, so the CEO confronted him. Believing he was negligent to allow for such a small margin.
With a heavy sigh, Erik explained the situation. Pointed out several other products with massive margins. Explained how the low margin product drove business that allowed for the high margin products. If the low margin one disappeared, so would all the other. It was their biggest customer and they were clear: we buy everything or nothing from you.
Erik then continued and explained the entire ecosystem. How he had source products at a much cheaper price thanks to the volume from the main customer. This allowed higher margins across all his customers, not just the one the CEO was looking at. And additionally, a production line at another company in their group was reliant on the business Erik was bringing in with the customer. Losing them would not only jeopardize their own company, but another one in their group, too.
A tad grumpy, the CEO walked away, mumbling about how he believed the margin could have been increased for that product. Erik had stood his ground. But it came at a personal cost because, despite delivering higher gross margins than everyone else, the percentage never reached the target. And no bonus was paid.
Case 2: the products running out of date
At the same company, Erik found that before he started, an incorrect purchase of dry goods had been made. And they were about to go out of date. Erik and his colleagues had tried to sell it, but they didn't succeed. The process was to destroy the products once they've gone out of date. Erik knew there had to be a better way. Reaching out to his manager, he asked if he could look into other alternatives.
The manager agreed. So Erik reached out to a company specialized in selling dry goods that are about to go out of date. The price was heavily subsidized. The margins negative. Yet, the bottom line much better than throwing the goods away.
Fast forward 3 weeks and the CEO yet again approaches Erik. He wasn't annoyed like last time. He was fuming.
"Why did you sell all those at negative margins?" He yelled. "It's going to be a massive blow to our entire margin this year. No one is going to get a bonus."
Erik had reached a point where he no longer weighed his words. "Because the alternative is 0 revenue. Which is a heck lot worse than a negative margin."
Erik left the company within 3 months.
Case 3: measuring more than you reward
His next position was in a new industry, where the sales organization was rather streamlined. Faster deals, processes that were to be followed meticulously, and a lot of KPIs. The three main ones were:
- Sales
- Customer rating
- Margin
These KPIs were discussed monthly and the sales people were measured against each other. But their provisions were only based on sales. Thus, the person who had the lowest margins and least satisfied customers (i.e. fewer returns) made the most money of them all. Simply because he decreased the prices in each sale. Those who had higher margins and more satisfied customers outperformed on the bottom-line, but their salaries didn't tell the same story.
This Isn't a Sob-story for Erik
It is a prime example of when incentives and intention don't go hand in hand. Because in neither case was the best behavior for the overall business rewarded. The incentive ultimately rewarded sub-optimization.
I've experienced this, too.
Having had a board and owner deciding that the long-term was more important than small, short-term success. Yet, every board meeting circulated around the sales pipeline. As did the bonus.
Not only does it send mixed signals. It makes it immensely hard focusing on the right things. Even if you prioritize the business, you always hesitate for a second. You question if this decision is worth the time it takes to justify it?
And so does the team. Consciously or subconsciously they hesitate. "Why should I follow the strategy when I'm clearly rewarded for something else?" Some do, others don't. Friction builds up. And one day someone wakes up, thinking that either the CEO or the board is lying. So, they choose their allegiance.
Creating the Right Incentive is Hard
You are not broken for not having figured it out. Setting incentives and KPIs is difficult. Those who make it seem like the easiest thing in the world are either lying or being delusional.
All incentives have trade-offs. Too many goals and measurements leads to admin from hell. Too few creates room for misalignment and friction, simply because the intention and incentives don't go hand in hand.
In the examples shown above, the incentive varied. The end result stayed the same. What was best for the business wasn't best for the individual.
But alignment of incentive and intention is not all. Hidden underneath, is the soft incentives that leadership imposes.
- What gets praised
- What gets ignored
- What gets challenged
Teams gather this information and treat it in its entirety. Erik did what was best for the company in case 1 and 2 because his manager encouraged him. Had he not, Erik might not have been as keen on challenging the CEO. In case 3, his manager often praises the customer satisfaction scores, creating incentives to be acknowledged beyond just the salary.
This, however, puts immense pressure on the leader. To ensure they're acknowledging the right behavior, even when the hard incentive does not. They need to sometimes take the fight with people above to justify good behavior. But may also face instances where a team member has been rewarded for behavior that wasn't in the best interest of the company.
So What Can You Do About it?
First thing: When you notice drift between strategy and output, take a long and hard look at both the incentives and what the leaders reward. Are they actually driving unwanted behavior? If yes, you need to make adjustments.
Second: When creating targets and goals, be transparent about the intention behind them. Talk about the actions you want it to inspire. Discuss if it's the right way or not. Highlight pitfalls. Be curious about alternative solutions. Look for ways to make sure the hard and soft incentives are aligned. Be open to when they are not.
Lastly: Choose the lesser of the evils. Because trade-offs are, as previously mentioned, almost always needed. And be willing to iterate when you get wiser.