Poisoned Carrots
Or Variable Pay?
The Enron scandal showed the industry world how bonuses for senior executives can turn into poisonous “carrots” that end up degenerating behavior across an entire management team and causing economic catastrophes. However, any worker with variable salary, bonuses, or commissions, is a miniature incubated version of the Enron case for the company they’re in.
The first reason a company may decide to establish a variable pay plan is a fervent desire to incentivize its employees to work in the right direction, and so they hope to positively reinforce this behavior with money.
Another possibility is, if their base income is already at market rate, the administrators may want to share with their team the wealth generated in the process.
Or lastly, if an employee’s base income does not correspond to the market salary, the shareholder is simply sharing their own risk with the employee by assigning a market salary with variations according to performance.
Throughout this article, we will show how the noble intentions of the first two reasons doesn’t make them any less useless. We won’t discuss the third reason, because if you decide to stay in that job, maybe your market salary is not what you think it is.
When you start these kinds of policies, just like with teleworking, people receive it happily. Especially because in the initial stages of implementation the variable is an additional salary component that they didn’t have before, and it brings with it the possibility of getting more income, regardless of the difficulty this may imply. At worst, they’ll say: 'I didn’t have it anyway, so if I don’t earn it, it’s not like I lost anything'.
In short, variable pay will always be accepted at the beginning, unless the variable is implemented as a measure of salary reduction, which is another topic that we won’t discuss here. If you sign on to something like that it’s because there was no other option, and most likely the total benefits you were already receiving were above the market.
The first of the big dilemmas that appears with the definition of variable pay is about what kind of goals will be rewarded.
On the deepest philosophical level, an organization is a team, and in this sense, compensation should be associated with the team’s overall performance (as in winning the tournament, in a football context). So bonuses, etc., should only be given if the company surpasses its profit goals. Granting incentives simply to meet the profit goal will increase spending, undermine profit, and put the company at risk.
However, compensating based on overall company performance creates new problems:
Profit is measured annually, therefore it must be paid annually. So the carrot is so far away that it doesn’t incentivize, overriding the original intention.
Will anyone be truly incentivized to pursue the overarching goal of company performance when they know that their individual actions will have a minimal impact? The success of the company as a whole is the most logical goal to reward, and yet it ends up being a minimal motivator.
So if aiming for overall group goals doesn’t seem to work, we can look for an easier incentive: individual goals. They’re a “carrot” that is easier to identify and determine. And since they correspond to just one part of the company’s process (sales, expense reduction, etc.), they can be awarded over shorter timespans (quarterly, monthly).
Individual goals are a powerful carrot, for better or for worse. In football it’s the equivalent of giving bonuses to the one who scores the most goals. This does not necessarily honor the collective game or passing the ball to a teammate who can score the goal, as we will see below.
The most common variable pay scenario is payment by commission: if you sell more, you earn more, if you sell less, you earn less. It seems logical, but is utterly foolish, especially when it comes to intangibles.
When you incentivize this behavior, a salesperson seeks to sell at all costs. They’ll sell to anybody, whether they’re a good customer or not. They’ll convince the customer to buy things they don’t really need. Or they’ll sell at a loss and not care, because they’re going to change companies soon anyway. Budgeting goals are no different: is buying cheaper buying better? Does buying less generate profit, or does it generate supply problems?
Some expert in compensation models will say: "That’s why you need to have variable pay proportions for group goals and individual goals."
That doesn’t solve the problem, in fact it just changes its magnitude. From a human standpoint you’ll still think: "On group goals my influence is minimal, so I’ll seek to achieve individual goals regardless of the immediate and future impacts I have on the company". It’s understandable, in the end: if all you measure and reward is sales, humans will behave accordingly.
Additional questions that arise regarding variable pay are:
Does money actually incentivize quality, or even incentivize at all?
Can people live decently on their base income and use compensation only as a surplus, or would the absence of these bonuses gravely impact their livelihood?
Is it easier to overcome an economic crisis with a team who had no additional compensation to begin with, or with a team who systematically loses the compensation they’d come to expect?
Variable pay is meant to incentivize, but in the long run does the novelty wear off? In the end does it actually do the opposite and cause discouragement when the incentive is not achieved?
Does a manager really know the secret formula of balancing individual and group goals so as to lead to the fulfillment of the global strategy?
How do exceptional employees feel when they start getting paid extra for doing what they normally would already do?
The message that gets conveyed by rewarding achievements with money is that things must be done for money and not because they’re the right thing to do.
In short, I believe that the relationship of an employee with the organization for which they work must be marked by a prior agreement in which there is a fixed salary according to the market rate as an exchange for the time that this person dedicates to the organization.
Paying based on the results of the company technically means transferring some of the risk to the employee. If transferred for profit, it should be transferred for loss as well.
Incorporating variable payment models stimulates selfishness in individuals. On a group level, variable pay increases the cost of the company without motivating the majority, and demotivating when it’s not won. People need to be incentivized by the task itself. They should receive motivation from a fair environment that favors their development, and want to do things well because they understand their importance.
We need salespeople who can understand the customer and be able to say: "You don't need what I have, you don't have to buy from me.” We must have staff who love what they do, and who do things right because that’s the way to do them. In order to do this, our expectations have to be focused on doing things right, not just on making more money.
In the end, Enron collapsed for wanting to meet the goal and earn the bonus, and for this purpose companies were created to hide losses. How does this differ from what your purchasing staff may be doing with your suppliers today, or what your sellers may be doing with customers in order to earn the bonus?
As in the Enron case, you will notice too late. If there’s a bonus to be paid, it should be given years after the actions taken, since the full and true impact of actions can only be seen with the passage of time.