Do I believe in bonuses for procurement professionals? Why wouldn’t I? And it’s not just because we don’t want to be singled out as the only profession not getting any, it’s more toward the pay-by-performance concept that I believe in. Otherwise, it’s human nature to be complacent.
Yet there are still many opinions within my profession who opt against the idea because of integrity, measurement and benchmarking concerns. I acknowledge those concerns, but I think they are addressable through rigorous control mechanisms rather than taking away the incentives for precision, innovation, effectiveness and efficiency.
The issue is well addressed in the following article by Rima Evans, projects editor for CPO Agenda. The pros and cons of bonus schemes are covered, together with an implementation checklist. For those organizations who are not convinced of rewarding their champions of change, I hereby recommend this article to them.
“Because You’re Worth It
By Rima Evans
Amid the current period of fragile and uncertain recovery, now is not a great moment for pay rises – in fact, the latest CPO Agenda economic survey showed a considerable drop in the number of companies approving pay increases (from 25 per cent in May 2010 to 9 per cent in November 2010.) But bonuses may be an option for CPOs currently wanting to redefine or improve the way their teams are rewarded while having to adhere to strict mandates to keep salary bills under control.
Although bonuses are not uncommon in procurement (sector and level of seniority are obviously big influencing factors), there is still some way to go in terms of catching up with other professions.
Andrew Coulcher, director of business solutions at CIPS, says its annual salary survey with Croner Reward in 2010 showed about a third of procurement and supply professionals received a bonus.
Most FTSE organisations offer bonuses ranging between 10 and 30 per cent as the average value, although these figures don’t just apply to procurement staff.
Mark Childs, director at Total Reward Group, points out that the higher the salary, the higher the bonus procurement can command. “If you are earning £60,000 you might expect a 15 per cent bonus, but on £100,000 you might be offered a 50 per cent bonus,” he says.
This type of financial incentive has its obvious advantages – it promotes improved performance and results by being tied to personal objectives.
Jonathan Bean, managing consultant at Purcon, an executive recruitment company specialising in procurement and supply chain management, says: “Do bonus schemes work? Ordinarily they do.
Procurement professionals are tasked with delivering results – not always savings, but often performance that is quantifiable – and a bonus is a great way to acknowledge performance.”
He adds: “The size of the achievement does not always correlate to the size of the bonus and as long as the mechanisms for bonus entitlement encourage sustainable solutions rather than short-term actions, there is no reason why bonuses should not motivate over-achievement.”
Childs agrees. “Bonuses work – partly because people believe they work. In procurement if the lifecycle of the thing or service that is being procured can be measured over time then bonuses are worth looking at.”
A recruitment tool
There are added benefits, Childs explains. Not only can they increase the retention value of reward packages – which is an advantage for CPOs trying to keep talent from walking out the door – they can also be used as a recruitment tool to differentiate your organisation from the competition.
For employers, bonuses are an effective way of keeping a proportion of employment costs variable, which offers flexibility when employment costs need to be reduced quickly, for example, during a downturn.
At an individual level, “providing a line of sight between their activity and earnings promotes a healthy psychological contract”, Childs also explains. “Often the consequences of not providing a bonus are more detrimental than the positive effects.”
Not all procurement leaders, however, are convinced by their worth and they remain a contentious issue for some practitioners.
CIPS also warns that while bonuses do have their merits, it is a particularly sensitive issue given the austere economic cutbacks being implemented in many countries, and employers should tread carefully.
Coulcher says: “In times of recession and economic turbulence, retaining good staff and keeping them motivated can sometimes be a challenge. Of course procurement and supply management professionals should be offered incentives in the way other professions are and it’s just one way of keeping the high performers. Yet, with all the controversy around bank bonuses, naturally there is a degree of uncertainty on how this should be approached, and with public sector cuts even more sensitivity is needed.”
Martin Blake, head of corporate procurement at London Probation Trust, a UK public sector organisation, admits to much deeper concerns about the principle of bonuses, describing them as incompatible with the aims, integrity and effectiveness of procurement.
“They can create a negative effect for an organisation, especially when buying services. Reducing cost and making savings is easy – but at what cost to quality? Procurement professionals must act with integrity and in the interests of the greater good of the organisation rather than merely looking after their own interests. A salary should be sufficient.”
However, Blake concedes that the effectiveness of a bonus depends on the nature of what is being purchased. “If you are buying commodities or products that are very discrete, bonuses may not be so detrimental. But in services it’s a different kettle of fish. How do you put a bonus on such intangible aspects as creating robust contract terms to protect the business, or important factors such as flexibility? Procurement adds a lot more value to the organisation, for example risk management, but how do you measure that for a bonus?”
Motive to influence
By contrast, Dirk Zemke, director of strategic procurement, ESAAP, at Sensus, thinks if other departments such as sales are offered bonuses, procurement should be included in the deal too. “Purchasing has to convince other departments to change so why not motivate them with a bonus to change the thinking of others? As service levels are defined and agreed with other departments I do not think a bonus creates negative effects for an organisation.”
Zemke says there is a bonus scheme in place at his company, offering 10 per cent. “It does work. It helps to define the priorities clearly and helps people focus on these priorities. I think it’s important with a scheme such as ours offering 10 per cent to keep people focused on two or three projects a year. With a team of five that is at least 10 major projects or activities you can achieve per year.”
So what elements make bonus schemes work, how can they be structured and what criteria should CPOs set down for the individuals’ and organisation’s benefit?
First of all arrangements will differ according to role and job. Childs explains there is a key distinction between a bonus, and commission or incentive plan. A procurement manager is likely be on a more general bonus plan, driven by the profitability and results of the company, as well as having to meet personal objectives. Whereas more junior staff carrying out transactional work might more commonly be on a commission-based arrangement, directly linked to individual results.
“For junior staff, where there is a more direct relationship between what they do and results achieved in the short term, they tend to want to see the reward more quickly. So they might earn £20,000 basic but be able to increase that to £500-£1,000 more per quarter in commission,” says Childs.
Broadly speaking, there are a number of criteria or KPIs that may be common to procurement bonus plans:
On the face of it, this is a logical way for procurement’s performance to be measured, but there are challenges. According to Bean: “As savings can be captured in a variety of ways, such as negotiations, cost avoidances or specification changes to reduce costs, it is not always a clear-cut issue. One problem often experienced within procurement is of course the validity of savings and how they are measured or recognised within the business. If you change the specification of a material used in production, is that a saving that can be banked against procurement for identifying an alternate grade, or against finance as the cost of manufacturing the product is reduced?”
Bean also warns that the contribution by procurement can also be muddied if savings are reinvested but overall budgets stay the same.
Childs says procurement enjoying a share of the savings they make is not as common as one might expect. “It’s more likely to happen among outsourcing procurement providers, where their revenue is tied in with savings achieved. Where procurement is not the core activity of the business they are more likely to be on a conventional management scheme.”
2. Contract compliance
Candidates are often measured on this, says Bean, as well as spend coverage managed or influenced by procurement. “It can be quantifiably measured while at the same time showing how much leakage there is in contracts set up with suppliers.” It’s not completely watertight however. Procurement can often bank a saving based on anticipated budget. But the savings might not be fully realised as compliance or buy-in to a deal is poor.
3. Customer or internal stakeholder feedback
This can often be used to validate activities and satisfaction levels and can be used as a KPI, especially if the business is encouraging experts in their field and wanting customers to have full confidence in procurement, says Bean.
4. Compliance to follow the sourcing process
A measurement that can be adopted especially within organisations keen to make sure their interaction with suppliers is fair, auditable and transparent.
5. Quality and outcomes
Offering bonuses that hold individuals to account for outcomes is an area of opportunity for innovation, explains Childs, particularly in long-term, major contracts or purchases of large capital items.
“An element of the bonus could be deferred and remain at risk subject to long-term outcomes. So if a person cuts a deal and claims a certain amount of success, but 18 months later there were outcomes or quality issues that were not so great, that person can be held to account. So a person can’t just walk away after a deal has been cut.”
Childs adds: “This is much like what is going on in the financial services. I haven’t come across a scheme like this in procurement yet.”
The value of bonuses is hugely variable – some meritocratic organisations offer up to 98 per cent bonuses, according to Bean, but he adds that it is not usual for companies to directly relate the bonus value to value of savings delivered. “Ordinarily it is a combination of company, function and individual performance,” says Bean.
Coulcher thinks the split should be about 75 per cent/25 per cent with reward linked to overall company performance and supply chain performance.
However, Bean also advises: “A typical CPO will have a pot of money that will need to be sliced and diced for team members and the exact value an employee receives is affected by whether they have hit or exceeded expectations. There is no guarantee that a higher performer will always get a generous bonus, especially if peers are also performing well and the pots needs to be divided equally.”
Ensuring an effective bonus scheme requires there to be clarity about its purpose and reason. Being clear to staff on what the bonus represents – reward for contribution over and above a job or role and how it differs from salary, which is an employers’ contribution for doing a job, is paramount to avoid confusion. Its benefits should also be clearly spelled out.
They also have to be part of a long-term strategic approach rather than about encouraging short-term wins, says Coulcher. “Otherwise it may not encourage the right behaviour in staff. There may be consequences with supplier relationships if any incentives are based on cost savings.”
Childs warns that many managers place too much faith in bonus plans and are over-reliant on them as a tool for management control. “It’s the combination of the bonus plan and management support that makes a difference to performance. You can have the most generous bonus in the world but if you don’t enjoy working at an organisation it won’t make any difference,” he says.
He also advises that plans be designed so targets can be easily modified when necessary, which will also avoid allowing schemes to get stale.
Can bonuses be taken away? Usually they are discretionary, but not always. However employment contracts rarely refer to bonuses being guaranteed, says Bean.
They are usually cut when people are more concerned about job security than they are about earnings. “It’s very difficult to take bonuses away in boom times,” Childs warns.
Five tips for implementing a bonus scheme
☛ Align performance measures to your procurement function needs for both now and the medium term.
☛ Keep bonus schemes fresh. Periodically change performance measures and be prepared to revise targets to reflect changing circumstances.
☛ Align payment frequency to the procurement cycle. If you are letting long-term contracts then consider deferring some element of the bonus to be able to measure on outcomes and quality. If you are trying to incentivise short-term, tactical, small-scale results, consider monthly or quarterly payments.
☛ Think about the total reward package on offer to staff. It’s not just about earnings from a bonus. Personal development is also important, so too are opportunities to climb the career ladder, and the culture of the business plays an important part in motivating teams.
☛ Be situational. Don’t look for best practice or compare with another organisation’s bonus plan. Have the confidence to do what’s best for your own business.”