hyperbolic discountingHave you ever heard of hyperbolic discounting? It’s the concept that people are willing to take smaller rewards sooner, rather than larger rewards later. For example, ask yourself the question, "Would you rather have $5 today or $10 in a month?" If you are like most people, you will take the $5 now—a response that has huge implications for compensation administration.

So what’s going on here? Although a rational person would wait for the greater reward, for some reason our brains discount the future value of things.  In 2011, Steven D. Levitt, well known author of Freakonomics, led a study published by the National Bureau of Economic Research. Researchers conducted experiments in various Illinois public schools where students periodically took a series of tests. The design of the study was to measure the impact of incentives, not necessarily the knowledge of the material. The incentives were a variety of cash rewards or trophies, and the incentives were given at different times—ahead of time, immediately, or a month afterward.

One of the study’s main findings is that rewards given a month after the tests had no incentive value. A number of other studies have similar outcomes and show that the longer people are asked or forced to wait for something, the less they value it.  

Think about that in terms of compensation for a second: The motivational value of a dollar declines over time and declines quickly. So what can we do from a compensation administration standpoint to maximize our compensation spend? Here are 10 things you can do to overcome the dreaded hyperbolic discounting.

Four must-do items:

  • Create optimized compensation plans that closely tie payout to desired behaviors.
  • Mandate daily activity reports.
  • Front-line sales managers should verbally and electronically reinforce positive behaviors as close as possible to the event.   
  • Keep the compensation administration process to under one week from close of period to payroll.

Six worth evaluating on a cost-benefit basis:

  • Integrate what-if compensation calculators with CRM. 
  • Require daily earned compensation statements.
  • Build what-if compensation calculators into CPQ (configure, price, quote) solutions.
  • Develop mobile apps with real-time notification of compensation amounts, updated leaderboards, etc. (Gamification)
  • Institute a same-day compensation administration process from close of period to payroll.    
  • Pay commissions in advance of the sale, at early stage of the sales process, and recover them if the sale doesn’t happen. 

Efficient compensation administration can help offset the effect of hyperbolic discounting. Automating sales compensation calculations is one common way companies seek to close this gap.

However, in general, the closer you can link payouts to the behaviors and actions that generated the performance and the smaller the gap period, the more impactful the incentives and rewards will be. I would be interested in hearing what else others have used to reduce this gap. 

 

Topics: incentives, sales compensation, sales commissions, hyperbolic discounting, Justin Lane