Ask CFOs to draw a picture of themselves when they are calculating incentive compensation and they inevitably draw an angry, two-headed monster with red question marks shooting out of their mouths like flames.
Or offer words to that effect. Along with marketing spend, the payment of commissions and bonuses is the absolute bane of corporate finance chiefs. Typically, finance managers rely either on spreadsheets or jerry-built applications to oversee variable comp. It’s a tricky business. In a number of industries (such as publishing), a commission is sometimes paid on a sale before the income from the sale is actually booked. In others (software, for one) a commission is often parsed out based on the recognition of revenue — no small task if goods and services are bundled. No wonder analysts estimate that 4 to 6 percent of incentive comp doled out by businesses is wrong.
Mistakes can prove disastrous, too. Last year, software publisher CA was forced to restate 2006 earnings in part because of problems with its incentive-comp program. Apparently, management at CA spent $70 million more in commissions for its 2,500-person sales force than it had expected.
Stories like that — along with the internal-controls pressures wrought by Sarbanes-Oxley — have more CFOs checking out software aimed at automating the process. There’s no shortage of applications to choose from. Marquee players like Oracle and SAP sell incentive-comp management programs. So do smaller software vendors, including Callidus, Synygy, Xactly, Centive, Varicent, and Halogen. ICM programs vary by feature set and robustness, but all promise to streamline and simplify the administration of incentive-comp plans.
Michael Dunne, a Gartner Group research vice president, says some companies that have implemented ICM systems have reduced their error rates from 10 percent to less than 1 percent. And the adoption of these programs is just starting to pick up. Gartner reckons that 1 percent of large companies operated ICM software in 2001. By 2006, that figure had climbed to 5 percent. Analyst Denis Pombriant of Beagle Research believes that businesses are just beginning to look at how they administer their variable compensation plans. Says Pombriant: “We’re at the classic beginning of a market phase.”
Incents and Peppermints
Undoubtedly, some CFOs will be attracted by the notion of easing the scut work that incentive pay schemes generate. But some finance chiefs may see strategic value in the programs. According to a survey of companies conducted by Aberdeen Group, more than three-quarters of the respondents said incentive-comp plans are fueled by the need to align worker behavior and performance with business goals.
Achieving those goals can be elusive. One complication: scores of companies pay commissions to third parties such as product resellers and insurance agents. Calculating the complex variable payments on those sorts of out-of-house and team-based sales — which are usually tied to quota-, territory-, and product-driven commissions — can trigger an intervention by the MIT physics department.
Consider the case of Carl Zeiss MicroImaging Inc. The Thornwood, New York–based distributor sells a dizzying array of scientific instruments, ranging from $1,100 microscopes to $700,000 advanced imaging systems. The company maintains a worldwide sales, administrative, and services staff of 210. Up to 70 percent of the pay for the sales personnel is variable. What’s more, the company employs team-based sales, and some specialists work on several teams.