If the road to hell is paved with good intentions, then most incentive compensation systems are the equivalent of asphalt.
Anxious to cross-sell customers, bankers have hungrily copied cookie- cutter plans to give everyone who touches a customer a piece of the action.
The thinking is that people will do the right thing if you share the wealth. But the reality is often very different. "Inadvertently, banks have crafted incentive systems which encourage selling without regard to profitability," says Jim McCormick, president of First Manhattan Consulting Group (FMCG). "A consequence is that in many lines of business, 60 to 80 percent of new sales are unprofitable. Many of those are so unprofitable that we call them 'dead on arrival' because they can cost two to up to six times the revenue they bring in," he says.
So what's profitable
For many, the problem begins because companies do not know which customers or products are profitable. That isn't the case at Centura Banks, Inc. A progressive $7.8 billion-asset bank, the Rocky Mount, NC-based company began building a system to measure profitability four years ago.
More recently, the company has been using the system to track and reward about 400 key senior account managers for building profitable business. "We created a system years ago which just tracked the volume of what they did. Then we decided we wanted to track the value, not just the volume," says Bob James, group executive for market planning and customer development at Centura. "We said to (employees) that we want you to create more value than you cost the company, and we built a system around that. We view our incentive system as a strategic advantage."
That view is considered remarkable at a time when most banks still use old-line compensation systems more likely to be tied to titles than to results. Experts say that even though more banks are moving to commission- based comp systems in select lines of business, the pace of change has been glacial, and the impact has been difficult to measure.
Most institutions, it seems, are looking for a quick cure and either lack the data they need to redesign compensation plans, or the will to shake things up.
At Centura, the compensation system leverages piles of data already being analyzed by a customer profitability system originally built with the help of FMCG.
Using Customer Analytics software purchased from Denver-based Customer Insight (now a division of Experian), James created a specialized data mart that provides a monthly picture of the evolving profitability of every household.
Making use of data
The data mart captures balances on every account, analyzes the profitability of loans based on rates and risks, and analyzes critical data on channel usage and costs. James says the information on channel cost is the most important variable. A teller-led transaction, for example, costs $1.72 versus 34 cents for the same transaction at a Centura ATM.
Because of the extensive data, James knows who his profitable customers are and how it breaks out across five segments. Six percent of households account for 69 percent of all profits; another 14 percent of households account for 31 percent of profits; and 30 percent of households account for 19 percent of the profit.
In the fourth tier, 25 percent of households account for one percent of the profits, and the final 25 percent of households account for 20 percent of the losses. "There are some real eye-openers here. Before we had this, we relied on traditional wisdom," says James. "As Warren Buffet said, the problem with traditional wisdom is that it is long on tradition and short on wisdom."
As an example, James says that traditional wisdom held that customers with the largest deposit balances were the most profitable. In fact, those customers were rate-sensitive and aggressive negotiators who were not always profitable.
Weeding out the weak
By using that wealth of information, James can then create an individual profit and loss statement for each banker. This personal P&L will include the monthly costs of salary, benefits, administrative support and travel and entertainment for the banker. It then rewards each participant for both bringing in new business and for managing an existing portfolio of accounts.
The system gives credit to bankers for all referrals that close. The new business incentive calculation is based on the change of the current month portfolio value from the prior month, plus fees and referral credit for the current month. The portfolio incentive is based on the total portfolio value excluding fees and referrals. "We publish the results quarterly, and there is really no place to hide," James says.
Bonuses are paid quarterly, unless the banker is running a deficit in his personal P&L. The deficits-created by things ranging from loan losses to repricings of products-are carried until they are covered.
The process helps weed out underperformers, many of whom self-select out, and constantly raises the bar on peer performance. The 50 most profitable bankers are recognized as Peak Performers and accompany Centura's senior management on a trip to a resort destination such as Puerto Rico or Cancun. "The incentive system that is key to my individual bottom line will dominate my behavior. You are giving people an intelligence test, and the test is, 'How do I make my wallet fatter?"' says McCormick. "Centura jumps right to the end result."