Often times their is some connection between budgets and performance evaluation.

Question

Often times their is some connection between budgets and performance evaluation. The budget tends to set a benchmark for expectations. Many compensation schemes tie some type of bonus to reaching and exceeding this benchmark. This linkage results in some interesting behavioral implications. Here is one example:

Bartlett Drugs makes generic prescription drugs. It relies on its sales personnel to market and sell its prodcuts widely to pharmacies, doctors and hospitals. While Bartlett has always been profitable, revenues have been stagnant over the last five years. In contrast, other generic companies have recorded significant revenue growth.

After careful investigation, Bartlett's CEO, Leslie Howard, concludes that an important reason for the lack of revenue growth is the way the incentive system is set up for the company's sales personnel, coupled with the role sales personnel play in the annual budgeting process. Currently, an average sales person receives a fixed annual salary of $40,000, and a bonus of $20,000 for meeting or exceeding an annual sales target of $400,000. A look at the records was enough for Leslie to realize that hardly any member of the sales team exceeded the target of $400,000 by much and many of them were just about meeting this target. The sales target was set each year in consultation with the sales team, and the target had not moved in the last five years.

It was clear to Leslie that the sales team was "low-balling" the target to be able to comfortable meet and qualify for the bonus. They also seemed to stop once the target was met. However, Leslie realized the sales personnel were in the best position to assess market trends and to help set realistic goals for the company. After consulting with experts on sales force compensation, Leslie has come up with the following four options:

Option 1: Remove the bonus for meeting the target and increase annual salary to $60,000.

Option 2: Set the target at a level that is 10 percent higher than what the sales team recommends. Implement a sales commission system whereby a salesperson earns 5 percent of the amount by which actual sales exceed 90% of the target.

Option 3: Set the target based on industry growth and keep the existing bonus system.

Option 4: Implement a tournament scheme wherein sales personnel are ranked into five performance-based groups, and vary the bonus across the groups.

Discuss the relative mertis and drawbacks of each scheme from the company's point of view. Which scheme is likely to put the company on a path of sales growth?

Explanation / Answer

Answer :

Option 1 : under this option if we convert the bonus amount given on meeting the targets to fixed salary than this would not be a step in the benefit of the company as the sales person would be free from the responsibility of meeting the targets and would not put any effort to reach that mark. The bonus amount is currently acting as an motivator to the sales person and os maintaing the current state of revenues. Converting the bonus into fixed salary would only have adverse effect.

Option 2 : Setting targets higher than what has been recomended by the sales team and linking the bonus scheme to the sales revenue will be a strong motivator for the sales team as their incentives will be directly based on the revenue growth they are achieving. this would result in good growth for the company in terms of revenue.

The same could also prove unproductive as increasing the sales budget recomended by sales team with 10% without researching the market regarding the same could set unrealistic targets and demotivate the sales team to work hard as the target would be quite difficut to achieve.

Option 3: Setting target as per the industry growth is a good option to overcome the demerit faced by option 2 but again this would not cover the individual strenghts of the company which could be a mojir revenue driver for eg : Sales growth of a company that is poineer in R&D would be expecting much more sales growth than a saturted Company which has not made any new discoveries in near time.

Option 4 : this option would categorise sales team into various bands according to their performance and bonus would vary as per the band allocated, this could be a great step to motivate the employees .The employees who are not taking their work seriously and just meeting the targets would become active as their binus would be reduced if they dont make it to an approp group,while the employees who are currently working efficietly would be motivated to mintain their place

We believe option 4 is a better option and would put company on the path of sales growth

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