Incentives Aren’t Everything

One day, a rabbit was grazing in a field when an eagle spotted it from high above. The eagle swooped in, and the rabbit took off only inches ahead. The rabbit ran as fast as it could, did its best dodging, but the eagle grasped it in its talons and prepared to enjoy a freshly caught meal. The last thing the rabbit said was an appeal that would go unacknowledged. “But my incentives were perfectly aligned!” it pleaded.

The importance of incentives receives, justifiably, a great deal of attention in economics and business literature. Economists write about how incentives in market dynamics encourage participants to act in certain ways. The profit incentive is the cornerstone of capitalism and market economics worldwide.

In the business world, incentive structures are important in designing organizations where everyone works in the best interest of the firm. This is to address the principal-agent problem, which arises whenever one entity must use another to attain certain goals. The principal-agent relationship may be manager-subordinate, chairperson-CEO, or even manufacturer-retailer, to name a few possibilities. By carefully designing incentives, relationships, and contracts, we can try to reduce the degree of this classic problem.

Within a company, designing the incentive structure to align employees’ compensation to the performance of the firm is an appealing way to ensure that one person’s success is tied to the extent to which they improve the company’s numbers as a whole. For example, CEOs may be compensated to a large degree with company stock. With their own money on the line, this incentivizes CEOs to increase the stock’s value.

But, of course, the value of a company’s stock is only a proxy for value created. If the incentive structure instead encourages the CEO to act in ways that increases the stock price in the short-term (long enough to reach retirement, for example) at the expense of its long-term success, the principal-agent problem has not been satisfactorily resolved. While deferring compensation can help to align the CEO’s time horizon with those of the company’s owners, the principal-agent problem is very hard (if not impossible) to eliminate completely.

Salespeople have traditionally been incentivized by tying their compensation to sales revenue or volume. While revenue and volume are important, it is not hard to see how such a structure might inadvertently enable sales to push for low-margin deals that look good according to their compensation metrics but do nothing for profitability. Generally speaking, and without too much qualification, salespeople should not be incentivized to give products away at a loss.

Therefore, it is important to design a sales incentive structure that puts heavy emphasis on company profit, if that is indeed what your company seeks. Your company probably does. Shifting a company from a revenue or volume sales mindset to a profit mindset can take a good deal of time and effort, but it is an important shift, and one that shows real results.

If your company is there already, congratulations! But this brings us back to our little story in the beginning. If you think your job is done once incentives are better aligned, you may be just as exposed as the rabbit.

Incentive structures garner much attention and are certainly important, but they cannot be the end of your company’s story. While a proper incentive structure can increase the probability of success for the salesforce and company as a whole, it cannot stand on its own.

People themselves matter. Peter Thiel places a large amount of importance on the specific members of a start-up’s founding team, and the same is true of a company at any stage. A company cannot afford to ignore the individuals who are its employees and count on an incentive structure alone bringing in the results it seeks. The wrong people with the right incentive structure are still the wrong people.

Even with the right people, they need to be trained, and not just once. Sales training is immensely important for getting the most out of a salesforce. A salesperson might see how a profit-based incentive structure works for them and have all of the best intentions of executing, but without the tools and skills required to do their best that salesperson will still underperform.

On top of it all, of course, your company needs a compelling value proposition in order for the sales team to be effective sellers. No amount of incentivizing can replace the fundamental importance of whether customers want your solution. Product and marketing are critical to defining the right product offerings, getting in front of potential customers, and otherwise supporting sales activities.

Improving incentive structures is very important for increasing a firm’s performance, but the best managers know that they cannot be a salesforce silver bullet. Companies must continuously seek out the right people and equip them with the right skills, also aligning not only incentives but the entire company strategy to fulfilling customer needs in a profitable manner.

Incentive structures are important, but they alone will not keep you from being someone else’s lunch.