Linking Compensation and Metrics to
Corporate Objectives

Problem

A mid-size company with over 300 salespeople and managers in 70+ branch offices had experienced a 58% year-on-year decline in profits, despite the fact that revenues had increased during that period. With a corporate objective of maximizing profitability, senior management was concerned that the performance metrics and employee compensation systems were driving activity that ran counter to the company’s goals.

Action

The company’s senior management called in Go To Market Partners to assess the situation. A thorough review of the business’s economics, compensation system, and performance metrics determined that management’s suspicions were correct. Three interrelated issues had caused this dramatic decline in corporate profits:

1. The company’s business model required each customer transaction to be profitable and always cover all costs associated with doing business. In other words, there were no real economies of scale, so the notion of selling at a low margin and hoping to ‘make it up in volume’ was not feasible.
2. A new compensation system, which the firm had implemented two years prior, was focused on many metrics, including: return on assets, operating profit, net income, inventory turns, and revenue. Given this multitude of metrics, many salespeople and managers did not know how to positively affect their compensation packages. As a result, these employees focused on the one metric they most easily understood (and which comprised the largest percent of their compensation package)—topline sales growth. A corporate system of ranking and rewarding branch offices based on revenue growth further strengthened this revenue-driven selling approach.
3. To continue topline growth, salespeople and managers would frequently cut prices to ‘get the business’. Because many hidden costs to serve, including delivery and service, were incurred serving their customers, some transactions that appeared profitable were in fact unprofitable once all transaction costs were factored in.

To stem this tide of money-losing transactions, GTM Partners helped senior management develop performance metrics and a compensation system that was more tightly aligned with the company’s economic structure.

Go To Market Partners began by developing a new performance metric that measured the “direct customer profitability” of each customer. Using activity-based costing methodologies, expenses that affected profits were allocated to each customer to reveal their true profitability. This metric was further refined to provide salespeople each customer’s profitability on a transaction-by-transaction basis, as well as on monthly and year-to-date bases. This data was also aggregated to give managers insight into customers’ profitability at branch, regional, and corporate levels.

Next, GTM Partners developed a compensation system that rewarded “direct customer profitability”. The number of compensation metrics was reduced from 5 to 1, with only direct customer profitability being measured. Employees were rewarded primarily for the portion of the business they had the most control over, but were also rewarded for profits generated by their regions and the company as a whole. As a further incentive, rewards also increased the more that budget was exceeded.

Finally, Go To Market Partners provided salespeople and managers with tools and training to help reinforce these changes. Employees were trained on how to make customer relationships more profitable and how this profitablity would impact their incomes. Direct Customer Profitability calculators were distributed to help salespeople determine the profitability of each deal as they transacted with customers. Also, all employees were given compensation calculators, which enabled them to determine what incentives they would receive if they performed at various levels of profitability.

Result

The company’s turnaround was wildly successful. The simplicity and transparency of the new metrics and compensation system enabled employees to understand exactly what behaviors were expected of them, and how to maximize the company profitability while also maximizing their own incomes. In the following year, net profits for the company exceeded budget by 41%, marking the most profitable year in the company’s history.