In defence of bonuses

I was having yet another discussion about bonuses this week and boy, are we fed up with that discussion. Or maybe not.

The reason for the maybe not is that we were talking about whether bankers being on salaried versus commission structures is better or worse as a business model, following the survey last week that I mentioned showing most investment banks are moving to higher basics and lower bonuses.

There are several issues in motion here.

The first is how can you regulate one industry’s remuneration policy one way and not reflect this to all industries?

Banks defend their bonus culture on the basis of pay-for-performance. They want their best performers to have the best incentives to win business. They therefore aim to ensure that their salaries do not cover their needs, and that bonuses drive behaviours towards profitability, revenues and sales.

That is no different to any other sales culture.

The only difference in banking is that the bonuses and salaries are of scale and magnitude far greater than many other industries and maybe it is this area where the concern lies.

After all, a sales person for an IT firm might earn £50k basic and £150k in commission; a sales person for bank, otherwise known as a broker-dealer, earns £250k basic and £750k+ in commission, otherwise known as a bonus.

So it’s this disproportionate rewarding and reward levels that is the issue, rather than bonuses themselves.

Second, from a business viewpoint, a high salary and low bonus is surely not a good thing for two reasons.

One, people on a comfortable salary are just that: comfortable. What you want in a sales person, a broker-dealer, is hunger. You want them to really need to sell and create business. That’s the whole point of a bonus reward system: you are rewarding people for bringing home the bacon.

Now maybe that’s the problem that occurred in recent years: they brought home rotten ham, but that’s because the management gave the sales force the wrong targets.

From a business viewpoint, you want your hunters to kill good bacon and hunters need good incentives to go hunting in the first place. So bonuses are a necessary evil.

Two, if you have lots of people on high salaries and small bonuses, surely the overall remuneration pot is far higher than if you have people on low salaries and a few rewarded with big bonuses. It’s a no-brainer fixed versus variable cost structure, with salaried staff being in a far more high cost structure than incentives-based staff.

Finally, and it relates to the first of the two reasons above, I always remember working for a firm that a high bonus structure.

As a result, sales were really hungry and were always out knocking on doors drumming up business.

We competed with a firm that paid their sales force a pure salary without commission and, as a result, we beat those guys every time.

It was easy.

For example, in our case, if we were asked by a prospect: “can you do a deal?”, we would answer: “what sort of deal do you want?” and, in most cases, could give them the discounts they were seeking.

This was not the case with our salaried bozo counterparts, who would respond: “I’ll have to check with the management?”

They had no autonomy, no wheeler-dealer capability, no cohonez ... those guys were just mincemeat.

Unfortunately so were we.

Our problem was that the big swinging dick sales mentality of my firm resulted in several clients being stitched up with poor deals, because it gave the sales person the sale.

By way of example, I walked into one account as their new ‘relationship manager’ and found the customer really unhappy.

My predecessor had done a deal with them where he sold them a pup.

The system configuration was half of the system required to do the job in their invitation to tender, and they were seriously unhappy.

They had given my firm the deal because the price was the lowest for the job ... but it was the lowest berceuse they only got half the system they needed.

Now the good news for me is that I sold a system.

The bad news is that the customer had now paid double what they expected for the system they should have been sold in the first place.

In other words, the commission culture created bad practices of stitching up clients, taking risks and delivering inappropriate solutions

This is where the real heart of the bonus versus non-bonus debate should focus: what’s the appropriate level of incentives to allow that ensure correct behaviours to prevail.

That’s a far more constructive discussion than just saying bonuses are bad and to eradicate such practices completely.

 

Comments

[Sean]

My thoughts on the subject from May 09 fwiw: http://www.parkparadigm.com/2009/05/23/on-compensation-and-outcomes/

[Jonathan Charley]

Totally agree that the incentives are key to driving the right behaviours. Get it wrong and you end up with misselling, get it right and you have a vibrant and successful business.

The challenge for retail banking is keeping the incentives scheme simple and meaningful. Branch staff can be overwhelmed by the number of incentives that are thrown at them by different product teams, often in conflict/competition with each other causing confusion,leading to mistakes and churning of customers.

[shellyk]

The bonuses surely helps to motivate the employees to perform well but on the other hand they may feel the pressure to fulfill the targets too.
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[Fritz Thomas Klein]

Part of why the debate does not go away: As stated above, management gave thze sales force the wrong targets. And for this achievement, management took home even larger bonuses than the sales force!

[Steve]

Like most everything in the business world, financial rewards/bonuses focus on short-term financial results, with no thought of long term consequences. And, with folks more routinely changing jobs every couple of years, those making very risky bets with corporate resouces can do lots of unknown damage and be long gone before anyone finds out. Either bonuses need to be based and paid-out on long-term results, or bonuses should not be paid all at once, but some held back as a continuing incentive. A deal goes bad, then the bonus expires.