It’s difficult to design an incentive compensation program that rewards employees for driving organizational success—rather than inspiring them to game the system. But for Erik Day, the dilemma is that much more challenging because of the topsy-turvy service business he’s in: auto sales. He’s faced with trying to calculate bonuses before he knows how much the company can spend on them.
Car dealers like the Miami-based Warren Henry Automotive Group, where Day serves as CFO, have had to keep up with each swerve of the industry. Car buyers, who used to depend on salespeople for advice, now conduct their pre-purchase research online, gathering information they can leverage once they cross the threshold of a dealership. If they need help deciding what their target price should be, they can turn to such information-providers as TrueCar.
The rebalance of power between dealers and buyers has resulted in slender—in some cases, emaciated— margins on transactions. Between 2003 and 2013, the average gross margin on a new car slid from 5.5% to 3.8%, according to the National Automobile Dealer Association. For a dealer, the average gross profit per new car amounts to about $1200. Offsetting that erosion requires more than just taking car-buyers on a friendly tour of the service area or pitching them on the value of extended warranties.
According to Day, this is where car makers—who have a stake in maintaining a robust distribution system—have filled a vacuum. “You might conduct transactions at a loss,” Day says, “then you hope for a bonus that will make up for that.” Dealerships rely on performance bonuses from car manufacturers—tied to everything from market share to Customer Satisfaction Index scores to service-customer retention—to boost their margins. Using third parties, the carmakers examine the dealer’s management of the brand to make sure that all advertising, from the language to the logo, is in compliance. Are the bathrooms clean? Just how calcified are the pastries in the waiting area? It all counts. “You are beholden to the franchisor,” says Day. “They exert a tremendous amount of influence through these particular performance bonus metrics to receive the payments that enable you to sustain profitability and receive the cash you need to support the liquidity of the operation.”
Those payments, however, are made on a quarterly basis—30 days after the end of each quarter, actually. “As a dealer, you go into the hole in the course of the quarter. The more business you do, the more liquidity issues you have as you are waiting for the manufacturer to complete their paperwork,” says Day.
In an industry that has traditionally doled out performance-based bonuses as a significant portion of compensation, coming up with a pay plan that offers employees enough stability to manage their personal finances is daunting.
Day tried switching to flat payments, extracting the performance-based component. “It takes out the motivational component, and you get complacency,” he says. “The plan drags down the better performers.” He also tried relying on historical performance as a baseline, using it to calculate bonuses until the actual figures came in. But when the time came to adjust the bonuses, it could turn out that he overpaid the employee. “It’s psychologically difficult to go to someone who is sales and performance-oriented and say, ‘You owe us $1000,’” says Day.
For now, Day is still open to experimenting. “How do you pay your people if you don’t know where you are going to stand until four months later?” he asks. “How can you attract qualified talent—with a pay plan that works for the employee and the dealership?” He’s well aware that compensation can be a key lever in driving organizational performance. “It’s important to come up with a pay plan that is aligned with this business model,” says Day.” I just wish the model itself would stop being such a moving target.”