Aligning Incentives With Variable Compensation To Propel Projects Forward
Many professions, particularly sales, use variable compensation (or performance-related pay) to align employee incentives with business goals, leading to positive outcomes for both parties — when the business makes more money, the contributor makes more money. This model rewards results instead of time worked, giving contributors a direct stake in the outcome of their efforts as well as autonomy over their work. The one who generates great results with little effort will earn the same as one who toils for hours for equivalent results.
Variable compensation is implemented in a variety of forms:
These compensation models ultimately link performance to strategic goals and the recognition of different levels of achievement. In practice at DAOs, we already exchange “equity” (in the form of governance tokens) to fund projects, so in this article, we’ll explore the two other models that DAOs might find particularly useful: commission and bonuses.
Differences between Bonuses and Commission. Source: Xactly
Commission and Bonuses
With commission, contributors receive additional compensation in direct proportion to the revenue (or profit) that they generate. This compensation structure works particularly well with revenue-generating projects and is the typical compensation model for customer acquisition jobs (salespersons). Commission is flexible because the percentage can be adjusted to reward the sale of particular products. Given a product that’s not doing well in the short term but is important for the long-term roadmap, a good commission structure can incentivize salespeople to change priorities.
Bonuses are similar to commission, but the additional compensation that contributors receive is usually fixed and based on meeting a particular milestone or achievement during a set period. Both of these compensation models (commission and bonuses) can encourage DAO contributors to create projects that generate income since they will have control over how much they make or don’t make.
These compensation structures align incentives to the individual with that of the organization. The more revenue the individual makes, the more the DAO makes. This creates a situation where each contributor has direct control over how much they are paid — they get what they put in. This increases the autonomy of contributors and turns “generating revenue” into a game that can be optimized. We can make work more like a game and less like “work” as long as we have systems in place that allow people to plug in easily and see how others are doing.
Humans want to be valued, and compensation structures like these make value explicit through the receipt of direct and specific rewards. If implemented well, this could lead to a culture of high performance within DAOs. Smart contracts have created the opportunity to design our own incentive structures, and variable compensation is another tool that we can experiment with.
We can make work more like a game and less like “work” as long as we have systems in place that allow people to plug in easily and see how others are doing.
Compensation Design Challenges
While these compensation models seem efficient and productive, they also come with certain downsides, including:
Variable compensation turns project leaders into founders and if the project doesn’t work out, they may get little for their efforts. This is why most variable pay plans include a base salary. Native DAO tokens can be used as base compensation, but it should be made clear that project contributors will be rewarded for the value they bring, whether it’s revenue or some kind of internal value.
There are places where variable compensation simply doesn’t make sense. One instance is cost cutting. If contributors are rewarded based on how much they cut costs, this can lead to a downward spiral where growth is reduced through cost reduction. These are often competing goals.
If two separate work streams of a project (or the DAO) implement incentive structures that run counter to each other, it could neutralize the benefits of both. And if the goals, KPIs, or quotas are unattainable, people will end up burning out and rage quitting. Poorly designed compensation can lead to worse overall outcomes.
Compensation structures shouldn’t be overly complex. If the structure is too complex, it will reduce overall effectiveness because it would be hard to see how results drive compensation. Therefore, it should be made clear how the compensation plan affects the overall project, why certain compensation design choices were made, and how contributors are rewarded for their efforts.
If people feel like they’re not measuring up to their peers or they feel like they aren’t bringing value to the projects they’re participating in, their vibes will be low. We all want to create a fun place where we get paid to do the things we love to do, but we all do things differently and will most likely produce different results. This could lead to increased competition in stressful ways.
One study from 2021 stated:
"The results of four empirical studies, including more than 1,400 salespeople, suggest that an increasing variable compensation share (i.e., greater pay-for-performance component in salespeople’s compensation plans) increases salespeople’s stress, resulting in emotional exhaustion and more sick days. These outcomes are more likely for salespeople with lower personal ability and fewer social resources."
Variable Compensation Optimization
Based on the above concerns, variable compensation doesn’t seem appropriate for all occasions. However, it could always be implemented if we choose effective parameters and design in the open. Here are ways this can be achieved:
Set Your Own Goals
Variable compensation is particularly effective if DAOs let people set their own goals across all positions (even functions that are not revenue-driving). By giving members ownership of their objectives, we give them autonomy over their work. This is really useful for roles that don’t directly tie to the bottom line and roles that are more difficult to quantify. For instance, while activities such as answering support questions or onboarding contributors don’t create direct revenue, they’re still very valuable.
One study from 2007 supports the idea that goal setting and planning are linked to subjective well being:
"Structural equation modeling with a sample of 210 British athletes showed that autonomous goal motives positively predicted effort, which, in turn, predicted goal attainment. Goal attainment was positively linked to need satisfaction, which, in turn, predicted psychological well-being. Effort and need satisfaction were found to mediate the associations between autonomous motives and goal attainment and between attainment and well-being, respectively.”
Allowing contributors to set their own goals frames the question of success within the scope of the project and gives each person a stake in delivering something that matters.
Avoiding Bad Goals
Wouldn’t people just game the system and set bad goals? Yes, there’s always that possibility, but when people must state their goals publicly, there is social pressure to not undershoot.
The DAO treasury and project leads can work together to figure out what the goals are and to keep team leaders accountable. All variable compensation and goals are reported to the funding entity. When contributors know that their team, project lead, and funder can see what their goals are, they’re more likely to set better ones.
Everyone intuitively knows what good goals look like. These goals should be quantifiable and assessed/evaluated regularly (a good place to start is monthly).
“What gets measured gets managed.”
— PETER DRUCKER
We can also implement a base pay and a threshold that unlocks a portion of the commission/bonus. This can be considered “partial credit” for the work done to achieve the intended outcome. A 50–50 split for base to variable compensation with half the variable compensation allocated after hitting a predefined mark is one idea. This is only an example; the specific numbers can be adjusted by each team.
Definition and explanation of SMART goals. (Source: Silvia Pencak)
The bonus or commission can be taken in the DAO’s token or the asset that is paid as revenue. The key is to get members to think like owners and to give key players equity in proportion to the contribution that they provide. This will increase talent retention and reduce churn because the best people want a stake. Winners win, and they want to participate in the upside.
The End Goal
This mechanism allows contributors to see and monitor their growth within the DAO. Churn should go down because people see that they are making progress and challenging themselves. This is a key factor in creating feelings of fulfillment in life. And while we can’t make people feel fulfilled, we should endeavor to create an environment where people can make good money and strive towards shared success.
Towards an Efficient DAO Compensation Structure
The goal of variable compensation is to incentivize everyone to think and act like owners. While holding tokens gives people ownership, we can enhance this by implementing systems that get everyone aligned around a common goal. An ideal scenario is a place where we create a game-like environment where people can play and experience flow states. A place where the more money you make for your community, the more money you make for yourself. A place where helping to make the pie bigger also earns you a bigger slice. All in all, this kind of compensation structure would go a long way in making DAO operations more efficient.
Flow state graph. Source: ResearchGate
A version of this article initially appeared in BanklessDAO’s State of the DAOs newsletter on August 10, 2022.
Jake and Stake is a writer and editor at BanklessDAO. He is the former Writers Guild’s Governance Coordinator and runs the DeFi Download newsletter, with a background in software engineering and cybersecurity.
Kornekt is a writer and editor with strong conviction in the world Web3 creates.
Dippudo is a pseudonymous individual who spends most of his time in front of a computer and has a natural interest in finance. He started contributing to Bankless DAO after falling down the crypto rabbit hole in the middle of 2021. Dippudo subsequently won the Fight Club NFT Competition and is now working on numerous other projects within the DAO and The Rug News as a designer. He is now spending time diving deeper into the worlds of economics, computer science, and finance.
BanklessDAO is an education and media engine dedicated to helping individuals achieve financial independence.
This post does not contain financial advice, only educational information. By reading this article, you agree and affirm the above, as well as that you are not being solicited to make a financial decision, and that you in no way are receiving any fiduciary projection, promise, or tacit inference of your ability to achieve financial gains.
More Like This
Updating the DAO Operating System by siddhearta
Analyzing DAO Treasuries by Jake and Stake
The Digital Gold Rush by Dimitri Litvin