Cybernetics Approach to Sales Incentive Compensation Management

Cybernetics Approach to Sales Incentive Compensation ManagementSales Incentive Compensation Management (ICM) is increasingly becoming the key decisive and motivating factor in influencing sales force execution to impact business performance.

The idea of the Sales ICM as a growing business approach that acclimatizes with changing trade scenarios is of crucial importance today. It has become imperative to recognize and appreciate, incorporate, and control various entities (both external and internal to the business) involved in influencing the Sales ICM function.

This white paper elaborates the cybernetics approach to understand Sales ICM, providing a 360 degree view of the same as a business system. It gives an insight into feedback loops that are crucial for the improvement, evolution and success of the Sales ICM system and provides a systematic approach to identify, comprehend, and examine them.

Cybernetics Approach to Sales Incentive Compensation Management TATA CONSULTANCY SERVICES1

About the Author

Rahul MehtaA consultant in the CRM domain for over 6 years, Rahul Mehta leads the CRM Sales CoE at TCS. He has been involved in multiple CRM Sales consulting assignments across industries. Rahul is a certified Siebel 7.7 Business Analyst and Six Sigma Green Belt. He holds a Masters degree in Management specializing in Systems and Bachelors degree in Electronics Engineering.

Cybernetics Approach to Sales Incentive Compensation Management TATA CONSULTANCY SERVICES

Table of Contents1. Introduction 3

2. The Cybernetics Approach to Sales ICM 4

3. Sales ICM CID 5

4. Feedback Loop Analysis 7

5. Conclusion 12

6. Reference 12

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IntroductionSales Incentive Compensation Management (ICM) is increasingly becoming the key decisive and motivating factor in influencing sales force execution to impact the business performance.

As sales models are being re-engineered to incorporate more market dynamics and adversities, sales compensation models are also becoming increasingly complex. In the global market where increasing customer reach is a major challenge, it has become essential to include dealers, partners, distributors, retailers, contractors, buying centers across various sales channels into the business’ Sales ICM model. Accurately measuring and rewarding the performance of the sales force (both internal and external to the business) has become the key to driving desired behavior in achieving the business objectives. Failure to understand Sales ICM as a key influencer for the sales force results in mal-aligned, error prone, labor intensive and time consuming compensation processes and a frustrated sales force.

It is important to visualize Sales ICM as a business system which evolves and adapts to changing business conditions, making it imperative to understand, incorporate and control various entities (both external and internal to the business) involved in influencing the Sales ICM.

This white paper describes the cybernetics approach to understand Sales ICM to provide a 360 degree visualization of Sales ICM as a business system. It will provide important insights into various feedback loops which are critical to the improvement and overall evolution of the Sales ICM system. It shall also provide a systematic approach in understanding and analyzing these feedback loops.

1.1 What is Sales ICM?Sales ICM establishes rewards schemes for the sales force based on quotas and achievements defined annually or defined adhoc during promotions or campaigns with respect to a base line sales plan. Sales ICM entails compensation plans, associated business rules, sales quotas, tracking and reporting performance-based results and payments.

Sales ICM provides guidelines, insights and versatility in designing compensation plans that effectively motivate the sales force and drive greater productivity. Sales ICM also provides inputs for sales performance that is specific to product lines and customer segments, customer purchasing patterns. These inputs are then used to enhance customer relationships and optimize effort.

Sales ICM aligns the sales force execution to meet the business objectives. Sales ICM helps the sales force to stay focused on key activities and delivering results that directly or indirectly impact the business. As more and more focus is on managing business growth, strengthening customer relationships, and building shareholder value, businesses are recognizing that Sales ICM is a strategic driver to success.

1.2 What is Cybernetics?Cybernetics is the study of communication and control, typically involving regulatory feedback, in living organisms, in machines and organizations and their combinations.

The term cybernetics stems from the Greek word ‘Κυβερνήτης’, which means (kybernetes, steersman, governor, pilot, or rudder — the same root as government). (Source: Wikepdia.com)


Organizations function and evolve. Organizational functions are interrelated and cannot work in isolation. It is important for each organizational function to coordinate, communicate and collaborate to contribute to the growth of the business. Business processes within the organization adapt and evolve to deliver desired results. Each business process has a defined process role to perform a defined task. So Organizations can be visualized as complex systems consisting of interconnecting sub-systems, which have the ability to adapt and evolve based on external or internal influences that impact the business. The Cybernetics approach will enable us to understand the business processes of such adapting and evolving ‘living’ systems.

The Cybernetics Approach to Sales ICMThe Cybernetics approach will provide an intellectual framework for analyzing the economic, social and operational components of the Sales ICM system and will form a basis for analyzing and delivering the desired behavior. This approach enables users in identifying sub systems, modeling their interactions, uncovering their internal structures, analyzing properties and designing them enable better decision making, designing better strategies , performing better and meeting the business objectives

For the purpose of applying cybernetics to the Sales ICM system, organizations can be defined as: “A mission driven cybernetics system with a number of information and communication linkages.”

Considering this definition, information system will have sub systems that can be broadly classified into the following:

1. Physiological Control Sub Systems: These kinds of systems look after the basic functioning of the organization. The physiological control sub system monitors effective and efficient running of the routine operations of the system. When the physiological control sub system is not functioning as expected, the organizations performance is drastically affected. In context with Sales ICM, the systems performing the functions of collating, calculating and distributing commissions can be categorized as physiological control sub system

2. Operational Control Sub SystemsThese kinds of systems govern the running of the physiological system. That is, these sub systems are concerned with decision making and managerial activities. Reviewing and designing operational control systems requires deep insights into the strategic environment encompassing economic, social, cultural and technological aspects that influence the organization; else it will eventually lead to the breakdown of the physiological system also.In context with the Sales ICM, the systems that are used for modeling commission plans, providing dispute resolution and analyzing revenue-Cost of Sales constitute operational control sub systems.

Information systems also consist of feedback loops. Feedback loops are mainly of two types:1. Positive (Self Reinforcing) Feedback Loop:

The self reinforcing feedback loop enables the system to evolve towards new behaviour or a new structure through amplification of influences. In context of the Sales ICM, incentive calculations feedback loop is a self reinforcing feedback loop (more the commissionable events, more the number of calculations and more the commissions)

2. Negative (Self Regulating) Feedback Loop:The self regulating feedback loop enables the system to stabilize after disturbance. These loops provide necessary control on keeping the system at the desired level.In context of the Sales ICM, Revenue and Cost-of Sales feedback loop is a self regulating feedback loop (more the commissions, more sales, more revenue, more cost of sales, less business performance)


Cybernetics Influence Diagram (CID)Feedback loops are the central concept behind cybernetics and analyzing the feedback loops will help us understand the dynamics of a system driven by these feedback loops. To analyze the feedback loops the Sales ICM System is represented in Cybernetics Influence diagram. The Cybernetics Influence Diagram (CID) is a visual representation of decision making. The CID diagram is characterized by concepts and influences. It encompasses the concept of systems with respect to connectivity, relationship and context. It provides a method for understanding the problem. It also helps to manage complexity by identifying the network of inter-related problems that make up the issue. It can be used to capture all internal understanding on policies, objectives, targets and overall effects.

The CID representation is a convenient way to outlay feedback loops and related relationships that are relevant to a particular problem situation, without distinguishing the natures of variables

Sales ICM CID

The Sales ICM CID represents various entities involved in the Sales ICM system. The following concepts are used to construct the Sales ICM CID:

From Sales ICM CID, there are two sub systems, which are the Incentive Calculation sub system (Physiological Control System) and the Incentive Planning sub system (Operational Control system).

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Fig 1: Sales ICM CID

Commission Payouts

Statements

Reports

DisputesCorrections

Commission Plans Training and

Communication of Plan

Sales Hierarchyand Territories

CommissionRules & Policies

BusinessPerformance

Motivation

AbandonedOrders

CommissionableEvents

Product Management

CorporateStrategy

CommissionModeling

Billing & Maintenance

Services

Cost of SalesAnalytics

SalesTargetBusiness

Drivers

Audit & Financial

Compliance

Customer Experience

Customer Interactions

ProductivitySales

OpportunitiesSelling

Orders

Revenue

IncentiveCalculations


The functions of the Incentive Calculation sub system can be summarized below:

Generating CommissioningThe events that take place are as follows:The sales force sells products and services to customers.The customer places orders.These orders are entered into the Order to Remittance (OTR) system.Also existing customers use these products and services and provide revenue in terms of billing and maintenance.If customers are satisfied by using these products and services there may be opportunities to cross sell and up sell. These cross sell and up sell opportunities result in more orders.Also, customers who are not satisfied with the products and services may opt to abandon the products and services resulting in clawback (negative commissionable events) and loss of revenue.Orders, clawback, billing and maintenance services together form the commissionable events.

Processing CommissionsOrders, clawbacks, billing and maintenance service entries may be generated in various business systems. A suitable interface is required to collate data from various systems as commissionable events to process commissions. The events that take place are as follows:

Commissionable events are reviewed by the sales ICM administrators before they are processed.Commissionable events are then processed to calculate commissions. These calculations are governed by compensation plans which are made up of rules and policies.The calculated commissions are reviewed by the sales ICM administrators before they are finally published to the accounting system.The calculated commissions are then accounted for in the accounting systems.The respective sales force receives the commission. Compensation payouts result in an increase in cost of sales which in turn impacts the actual profitability of the organization.Sales force can be provided with commission statements once the commissions are processed.Processed commissions, commission runs and payout details can be viewed through an end-to-end reporting tool.

The Incentive Planning sub system (Operational Control) is responsible for maintaining the incentive compensation operational sub system. The functions of the Incentive Planning sub system can be summarized below:

Developing Compensation PlanCompensation plans are developed after considering the following aspects:

Business drivers and performance indicators are key to developing the corporate strategy. Based on the corporate strategy, compensation models, sales hierarchies, rules and policies are defined.Inputs from production and marketing on product management influences considerably on the way compensation plan are built. Rules and policies also need to incorporate the feedback received from the sales force.Compensation models are tested by taking into account historical data and current business scenarios.Commissioning plans are developed based on models and these are then deployed for incentive calculations.


Dispute ManagementDispute management is important because it affects the motivation of the sales force. Compensation payouts may result in disputes if the sales force is not satisfied with the commission that been handed out to them. Disputes are generally resolved by the accounting and sales support functions and result in corrected commissions.

Sales force applies for corrections to the commission payouts to the sales support teamSales support team validates the correction that is claimed with the data on commissionable eventsIf validated, the correction is sent across to the accounting functionCorrections are adjusted in the next run of incentive calculations and are provided as payouts to the sales force.

Revenue and Cost of SalesMore revenue is generated when there are more orders. Also, if the sales force is motivated and performs beyond expectations, the rate of compensation payouts also increases. As the number of compensation payouts increases, cost of sales also rises. This acts as a self regulating feedback loop for business performance in the sales ICM system. Cost of Sales, Profit & Loss, General Ledger, accounts are required to be audited based on government regulations and other compliance such as SOX.

Feedback Loop AnalysisTo understand the behavior of the entities involved in the Sales ICM system, feedback loops are identified and analyzed with reference to the Sales ICM CID (Figure 1).

4.1 Feedback Loop – Commissions Calculations

The above figure illustrates the feedback loop from the Sales ICM CID for the standard operational commissioning process. This is the physiological control incentive calculation sub system within the Sales ICM system.

Fig 2: Feedback Loop for Commission Calculations

Statements

ReportsCommission

Plans

Billing & Maintenance

Services

Customer Experience

Orders

Customer Interactions Productivity

SalesOpportunities

Selling

Commission Payouts



Motivation


AnalysisConsider a scenario where the sales force has a identified a new sales opportunity. The following events occur:

1. The sales force interacts with the customer and closes the opportunity. 2. The customer places an order which results in a sale for the sales force. The sales force books the order in the OTR system. 3. This order entry is identified as a commissionable event. The commissionable event is processed for incentive calculation and is accounted for in the finance system. 4. This commission is paid out to the sales force and feedback is collected for the same. This results in increased motivation of the sales force and acts as a driver to enhance their productivity. This in turn will result in newer sales opportunities and more orders.

Commissions play a very important role in increasing motivation and driving productivity. This feedback loop can be summarized as:

More commissions translate to increased motivation, which in turn results in more opportunities, increased orders and higher commissions. This feedback loop demonstrates the characteristics of a Self Reinforcing feedback loop. The influences of the concepts in this feedback loop are that of positive amplification. Hence in such cases change in the behaviour of any of the concepts will result in the system producing an impact that is proportional to the change.

4.2 Feedback Loop - Clawback Calculations

The above feedback loop highlights the impact of clawbacks in the Sales ICM system. This feedback loop is a part of the physiological control incentive calculation Sub system.

AnalysisConsider a scenario in which a customer has bought products and services from an organization.

1. The customer uses this product/ service but is not satisfied with the performance2. This would result in a negative opinion about the product and eventually the customer may stop using the product/service3. This will result in deducting the commission that the sales force had claimed when the order was booked. This is known as a clawback4. Negative customer experience can have a severe cumulative effect on the business performance. It affects future opportunities to cross sell and up sell and results in low rate of repeat orders with the customer.

Fig 3: Feedback Loop for Clawback Calculations

Statements

ReportsCommission

Plans

Customer Experience

Customer Interactions

ProductivitySalesOpportunitiesSelling

Commission Payouts



Motivation

AbandonedOrders

Revenue

Orders


Clawbacks decrease the motivation of the sales force. This may result in the sales force pursuing lesser number of opportunities with the same or similar customers. This feedback loop demonstrates the characteristics of a Self Reinforcing feedback loop made up of negative influences. The business needs to maintain a high degree of control over the influences in such feedback loops

Organizations need to take care that clawback policies are not very rigid but at the same time it should also convey that customers are not satisfied with the product/service that has been sold to them. Clawback policies can be based on parameters like minimum usage a within time period and supported by a reason analysis.

4.3 Feedback Loop – Revenue and Cost of Sales

The above feedback loop highlights the impact of various entities on revenue and business performance. These feedback loops form a part of the operational control incentive planning sub system. There are two feedback loops in this system, namely, the Revenue feedback loop (Self Reinforcing) and the Cost of Sales feedback loop (Self Regulating).

AnalysisConsider a scenario in which the sales force identifies a new sales opportunity.

1. The sales force interacts with the customer and closes the opportunity. 2. The customer provides the order which results in a sale for the sales force. 3. The sales force books the order in the OTR system. 4. The booked orders results in revenue for the organization.

Fig 4: Feedback Loop for Revenue and Cost of Sales

SellingSales

OpportunitiesCustomer

Interactions Productivity

Motivation

CustomerPayouts

Statements

Reports

Cost ofSales

BusinessPerformance

Revenue

Analytics

BusinessDrivers

CorporateStrategy

CommissionRules & Policies

CommissionModeling

CommissionPlans


Sales Hierarchyand Territories

Training &Commission of Plan

CustomerExperience

AbandonedOrders

Billing &Maintenance

Services

Audit &Financial

Compliance

FEEDBACK LOOP 1

FEEDBACK LOOP 2

Others


Revenue is also generated when the customer uses the product/service and is billed for the same. Billing revenue is a good parameter for judging the usage of the product/service. Also, when the customer opts for maintenance services, revenue is generated. Revenue from maintenance services is an indication of customer satisfaction. The overall revenue earned (through orders, billing and maintenance services) will definitely be a Key Performance Indicator (KPI) for business performance.

Business performance (past and current) and business drivers need to be considered while developing a corporate strategy. Based on the corporate strategy the sales hierarchy, territories, rules and policies may be restructured with the sole objective of driving business performance through motivation and increasing productivity.

This feedback loop can be summarized as: More orders result in increased revenue and increased revenue is an indication of better business performance and a robust corporate strategy. This corporate strategy is directly responsible for creating an effective compensation plan which will motivate the sales force, resulting in more commissions and increased productivity. Finally, increased productivity is a factor that results in more selling opportunities, increase in orders and more revenue for the organization. This feedback loop demonstrates the characteristics of a Self Reinforcing feedback loop.

However, if we analyze the second feedback loop associated with revenue, we find that more revenue is generated when there are more orders and when the sales force is motivated, it also results in increasing the compensation payouts. As the number of compensation payouts increase the Cost of Sales also increases. This results in lowering the overall profitability which impacts business performance.

This acts as a Self regulating feedback loop for profitability in the Sales ICM system.It can be summarized as more commissions result in more compensation payouts, which increase the Cost of Sales. Increase in Cost of Sale can decrease profitability and the business performance.

Business performance is directly dependant on revenue from orders, billing or maintenance services. Hence, compensation plans should be built, taking into account the factors that will impact the business performance. It is important to align the compensation plan and its elements with the corporate strategy.

Also, it is necessary to minimize the impact of compensation payouts on Cost of Sales so that profitability is at par with increase in revenue. This can be done by simulating the compensation plans in various business scenarios before deploying them in the Sales ICM process.


4.4 Feedback Loop – Dispute Management

The above feedback loop highlights the impact of dispute management in the Sales ICM system.

AnalysisConsider a scenario where the sales force has received their compensation payouts and there is some discrepancy in the payouts that were handed out. This will result in the sales force complaining about the discrepancy. There needs to be a dispute resolution process that looks into such complaints. These complaints will be validated and then resolved. After resolving these complaints, commissions are re-calculated. Corrections may be applied immediately or may be applied in the next scheduled compensation calculation run. It is necessary to analyze and ensure that the dispute resolution process has provided the sales force with a satisfactory solution. This is important to ensure positive feedback on the Sales ICM process from the sales force. Based on the feedback of the sales force, commission, policies and rules may be re-organized to meet operational needs. This would result in a sales force that is more satisfied with the Sales ICM process.

This loop is a part of the operational incentive calculation sub system and is very significant in achieving the objective of accurate and timely compensation payouts. It can be summarized as follows:Fewer complaints result is fewer disputes and fewer corrections to the commission payout. Due to this, the sales force gives a positive feedback and more constructive compensation plans can be drafted. The sales force is more satisfied, due to which complaints and disputes are reduced. This feedback loop demonstrates the characteristics of a Self Reinforcing feedback loop made up of negative influences.

If there are regular disputes with certain compensation policies and rules then based on the feedback the management will re-construct the policies and rules. This feedback loop is a part of the managerial incentive planning sub system which enables the management to restructure compensation plans so as to incorporate business scenarios and generate compensation that satisfies the sales force.

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Fig 5: Feedback Loop for Dispute Management

Statements

Reports

Customer Interactions ProductivitySales

OpportunitiesSelling



Motivation

Revenue

Orders

Commission Payouts

DisputesCorrections

Cost of Sales

Audit & Financial

Compliance

BusinessPerformance


It is necessary to collect feedback from the sales force on the commissions and incorporate their suggestions in constructing rules and policies to ensure that sales force is satisfied with the overall Sales ICM process. It is also essential to include dispute management mechanism to ensure that the complaints are resolved on time in a satisfactory manner.

ConclusionThe Sales ICM system is a complex business system driven by external and internal influences that are not accurately quantifiable. While CID provides a means to represent and understand the Sales ICM system in terms of internal and external influences and analyze them with the help of feedback loops, it is important to consider the behavioural complexities existing in the Sales ICM system. It is necessary that Organizations do a thorough analysis of its business objectives, needs and operational readiness (people, process and technology) before deploying Sales ICM Systems.

Based on analysis presented in this whitepaper, following should be the desired characteristics of a Sales ICM system:

Sales ICM Operational Control Systems (Incentive Planning sub –systems)The system must meet the objectives of motivating the sales force, thereby increasing productivity and revenue.There needs to be a right mix of revenue and Cost of Sales to boost business performance.Sales hierarchies and territories need to be structured based on the corporate strategy.The compensation plan should be modeled on the underlying corporate strategy and built in consultation with the HR and FinanceCommissions and its relative impact on business performance have to be measured periodically.A feedback mechanism should be in place to ensure that the compensation process is able to positively stimulate the sales force and resolve any disputes.Motivation and productivity of the sales force must be measured and analyzed – this insight can be provided by means of Analytics

Sales ICM Physiological Systems (Incentive Calculation sub-system)The sales force should be aware of the compensation plans. Compensation payouts have legal implications. Commission payouts, statements and reports should be audited on a regular basis to ensure legal compliance.The organization should be able to respond to market dynamics to achieve customer satisfaction. .The core loop of this system, compensation calculations is a Self Reinforcing loop. This makes it necessary for the application required to support these components to have a scalable architecture that includes: An input interface to collate orders, billing and maintenance service data into commissionable events dataA robust calculation engine to enable accurate processing of commissionable events subject to complex compensation plansAn output interface to make the compensation calculations accountable and visible

Reference“System Practice in Consulting“ by Prof. P.N. Murthy, Business Systems and Cybernetics Center(BSCC), Tata Consultancy Services Ltd. , Hyderabad, India

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Cybernetics Approach to Sales Incentive Compensation Management

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