To Cap or Not to Cap Employee Incentives

Want to start a spirited debate about incentives? Asking whether a sales compensation plan should be capped is a surefire way to take the attention away from any other undesirable topic.

A cap is an upper limit on incentive earnings. If a cap is set at $500,000, for example, salespeople cannot earn any more, no matter how well they perform against their quota. Using a cap usually creates a perception of limitations from the salesperson’s perspective while mitigating risk for the company.

While in general most sales organizations argue against caps, there are some legitimate reasons a company may employ them, including protecting against unpredictable payouts resulting from major deals or bluebirds beyond the salesperson’s control, poorly set quotas, unreliable financial modeling or production-constrained environments where demand may outpace supply or the company’s ability to maintain quality levels.

Consider a telecommunications company whose sales organization had an incredible year. Specifically, one account team had almost every team member ending the year at about 400 percent of quota. While the sales team worked hard, the needs of one particular customer grew exponentially, and the sales team benefited. The company did not have any caps in place and had no way to foresee the unprecedented growth of that account. In this situation, a cap at earnings even 300 percent of quota could have rewarded the team and saved the company money.

In another example, say one salesperson brought a mega deal to his company with an incentive payment well over the $750,000 cap his company had in place. In fact, the payout was $6 million above the cap. The company is now in the difficult position of trying to fairly compensate the representative — and retain him — while respecting the cap and possibly avoiding a $6 million payout to a single person.

On the other hand, not using a cap creates a perception — and sometimes a reality — of unlimited earning opportunity. This is great for the morale of the sales organization, but potentially dangerous for the company. Uncapping the plan requires good historic data and financial modeling. An uncapped plan must also be consistent with the sales culture of the organization, especially if representatives may earn more than their managers or senior sales leaders in some cases.

Like many facets of sales compensation, caps are less about the math and more about the people, behaviors and psychology. The mere existence of a cap can create concern among reps that’s disproportionately larger than the reality.

For the company, the benefits of using a cap may be minor compared to the potentially negative message it sends to the sales organization. There are several alternatives to a cap that can still limit risk while allowing the company to communicate a positive and inspirational message about unlimited earnings opportunity.

These include:

• Effective modeling to know exactly what could happen under a range of performance scenarios. These may include a normal distribution of performance as well as random distributions and situations where a majority of reps exceed expectations. By looking at the range of possibilities, the organization can pressure test the plan and know the likely cost of sales under any situation.

• Policy approaches that might require management review of incentive payments above a certain percentage of target incentive — say, 300 percent. This allows the organization to make sure the rep had significant influence over the sale rather than being the beneficiary of a liberal crediting policy and being paid for “touch revenue” actually sold by his buddies.

• Regressive rates that gradually reduce the marginal incentive payout at each percentage of quota attainment above a certain level. This approach has the effect of reducing the slope of the payout curve while still continuing to pay additional incremental dollars for higher levels of achievement.

The debate over to cap or not will continue as long as salespeople are compensated with incentive pay. But having a solid plan in place for the many possible variations of a successful sale — even, and especially, those scenarios that seem unlikely to happen — is always a safe move.

Mark Donnolo is the managing partner of SalesGlobe and author of “What Your CEO Needs to Know About Sales Compensation.” He can be reached at editor@talentmgt.com.