Sales Performance Management Best Practices Blog

Loss Aversion and Sales Compensation Plan design

Posted by Jerry Hegarty on Fri, May 20, 2016 @ 13:05 PM

Are you someone who thinks that humans are rational? What about Sales reps? The fact is that not everything we do is either smart or rational. In fact, understanding the patterns behind why we often make irrational decisions sets the stage for deeper understanding of human decisions and can yield some very surprising results. 

Today we’re presenting some ideas that are not what we typically think of as mainstream when it comes to contemporary sales compensation plan design, but are interesting to contemplate all the same. The discussion below highlights the importance of ownership, value and its possible effects of "Loss Aversion" on motivation.

Key Takeaway: Should some of the core assumptions upon which we design sales compensation plans be reconsidered ?

Research and experimentation by Dan Ariely shed light on these topics and provide us with plenty to reflect upon and consider. Dan is a researcher at Duke University specializing in behavioral economics. He has done numerous "Ted" talks with over 8 million views. Much of Dan’s popularity stems from his Loss_Aversion.jpgunderstanding of human’s often irrational behavior. His insights are based on experimentation and
thorough academic analysis of data. They provide us with insights which, while focused on students in his economics classroom (see video below), have applicability to a much broader audience. For the sales compensation professional, is there a perspective here that may change the way we look at sales compensation plans and their basic structure? Are there methods here which we can apply to maximize the benefit of money invested in variable sales compensation?

My key take away from the video below is the fundamental role of ownership in any transaction. Those in an ownership of an item (game tickets) will value that item almost 10 times more than those who do not have ownership of the item. There are emotional cords struck by "owners" that simply is not felt by non-owners. The situation is not viewed from an entirely logical perspective in terms of what is given in what is received; but rather each party looks solely at what they would give up in a transaction.


So what is this mean for sales compensation? Here are a couple possibilities to consider.

Imagine you’re putting together the annual Presidents Club plan for your company. The two scenarios described below represent approaches that are the polar opposite of each other.

  • A more traditional plan design approach would stipulate that sales reps who perform at some predefined achievement level (i.e. top 10% ranking) make it into the club.
  • Or ... what if all sales reps start the year as members of the presidents club with the built in assumption that they perform at an outstanding level of achievement that will drive fantastic corporate financial performance (read: ownership), and then let sales performance determine who disqualifies themselves from membership over the course of the year only if they come up short of those lofty expectations..

If it is true that those who make presidents club contribute the most to the success of the business, the key question we have to ask ourselves is which approach should yield the highest level of motivation & achievement and contribute the most to improvement of the companies top & bottom line. Instead of the somewhat arbitrary approach taken in the first option, Would it be possible to define a level of value contribution as a threshold for president club membership and approach this in a manner consistent with the second option?

Just asking...

Let’s take a look at another situation, the structure of the commonly used quota based attainment rate tables in a sales comp plan.

  • A more traditional plan design approach would stipulate that sales reps progress through tiered achievement levels accumulated over the course of the performance period towards a targeted variable compensation level. As one’s performance improves so does the payout.
  • If we look at this same plan component to the 'Loss Aversion' lens, we may build a plan where each sales rep is paid out at a rate corresponding to 100% achievement of the target variable compensation, and then reduce payouts only if and when they disqualify themselves through lagging performance from performing at that level.

One could envision a similarly tiered rate table for this plan component with the assumption that for the first few months of the performance period, all producers are producing at 100% performance achievement levels and compensated as such and then have payouts and payout rates decreasing upon reconciliation for those with lagging performance. According to the logic presented by Dan Ariely, the reps who feel they have ownership of the higher payout rate will work harder to maintain that ownership than those who don’t have ownership and have to work their way towards that rate. 

If true, the impact on productivity could be profound. That said, how many have come across a comp plan structured in this manner? No matter which way you slice it, It's a very different context for thinking about sales incentives and compensation plan design.

For more on this topic, I strongly recommend Dan's book, Predictably Irrational.

 ROI Whitepaper CTA




Topics: plan design, CEO, Human Resources, Sales Operations