IT DOESN'T PAY

The danger of sales commission plans that work too well

Obsession
The Office
Obsession
The Office

As Wells Fargo CEO John Stumpf heads to Capitol Hill today (Sept. 20) for a grilling by the Senate Banking Committee, it’s being reported he will accept full responsibility for a scandal in which the bank’s employees opened millions of phony accounts on behalf of real customers. But let’s not forget to also blame the real culprit: the perverse system of sales incentives that tied pay to the act of opening a new account, rather than the income generated for the bank.

The problem wasn’t that the incentives didn’t work, but that they worked too well, says Dan Walter, CEO of Performensation, a consulting firm that helps companies design pay plans. “That program did exactly what it was designed to do: Getting people to open new accounts,” he said.

For as long as people have been given incentives to promote behaviors, there have been poorly designed systems that backfire. In a classic academic paper (pdf) from 1975, On the Folly of Rewarding A, While Hoping for B, Steven Kerr shows how life is replete with examples of poorly designed incentives, from schools that reward grades instead of learning, which leads to cheating, to sports contracts that pay for individual statistics instead of team performance, which encourages selfish play.

Employers like to pay sales people on commission because it means they don’t have to reward them for poor results, and it attracts confident and aggressive employees. But sales people have long found ways to game their commission systems. They’ll work with clients to moves sales from a quarter in which they’ve made their quota into the next one, or convince existing customers to switch among similar products, which can appear like a new sale without generating new revenue. (At Wells, customers didn’t have to be convinced to do anything—employees opened the sham accounts without their knowledge, leading to $185 million in fines and the firing of 5,300 bankers.)

A smart system would have layered in other incentives beyond commissions paid to the lowest-level employees, Walter said. If managers were paid based on how long the new accounts were kept open or for how much revenue they generated, for example, they would have been motivated to crack down on employee cheating.

Another problem is that the plan didn’t evolve, he says. After first establishing the goal of opening new accounts, the plan should have gradually switched to rewarding the quality of the accounts, to bring it more in line with the company’s actual goals, and to lessen the chance of employees gaming the system. “Incentive plans, if they are unmanaged, will give you unexpected results—more often that not, unexpected negative results,” he said.

Some companies are moving away from commissions altogether and looking for other ways to motivate sales people. In 2014, GlaxoSmithKline, the UK drug company, uncoupled compensation from sales targets after a US Justice Department probe into its marketing practices. (The company eventually paid $3 billion and agreed to reforms to settle claims its employees were selling drugs for unapproved uses.)

Glaxo now rewards employees on product knowledge and on how they’re viewed by doctors. The switch hasn’t been seamless—salespeople grumbled that the system was time-consuming and clunky, and investors questioned whether it was costing the slumping company revenue. But CEO Andrew Witty argued it was better to make the reforms voluntarily before they were forced onto the industry.

Wells Fargo is in a similar jam. It has pledged to end its commissions for new accounts and may need to do so voluntarily before it’s ordered to.

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