Q. There has been a lot of conversation inside our company about our compensation plan. We haven’t changed it in 20 years. We pay a commission based on gross profit. Would you comment?
A. Absolutely. A well-designed compensation plan is one of the biggest pieces of your sales system, and a poorly designed compensation can be the biggest detriment to sales effectiveness.
So, let me start here: If you’re paying your sales reps straight commission, you’re using an obsolete formula.
If you’re paying your sales reps a straight salary, you’re also using an obsolete formula.
Both of those formulas are vestiges of an earlier, simpler time.
You may be like thousands of other companies who are using compensation plans that served them well in the past. In the last few years, however, a number of changes in the economic environment have combined to render some of those compensation plans ineffective.
There was a time when your market was growing relatively rapidly. You wanted your sales people to get as much of that business as they could, with little concern from where it came. For all but a few industries, that has changed. Even though the last couple of years have been good for many, most will admit to a general uneasiness about the demand for their products. Markets are leveling off, and customers are much more conservative than they used to be. Factor in changes in the dynamics of the marketplace caused by things like the growing power of the mass marketers, and you have several trends that translate to a perceived softness in the market.
At the same time, sales force software has grown incredibly sophisticated. Today’s CRM systems give you the ability to easily measure performance more precisely than ever before. For example, a few years ago you could probably easily measure sales and gross profits per territory. Anything much beyond that may have been very difficult to get.
Now, however, you probably have the ability to easily measure things like gross profits per line of billing, profitability per customer, profitability per product line, and sales costs as a percentage of gross profit per territory.
This increase in information sophistication should be viewed as an opportunity for increases in sales productivity. With this newly acquired ability to measure the results of sales behavior more finely comes the corresponding ability to reward sales behavior more precisely.
All of these relatively recent changes combine to create a climate where smart sales leaders should take a close look at their current compensation plan to decide if it really is meeting their needs.
There are a number of potential benefits to doing so.
1. Increase productivity — and therefore the bottom line.
Pressures on margins are not going to go away. It’s likely that you’ll be averaging a couple points less a few years from now than you do today. If you’re going to survive, much less prosper, in that kind of an environment, you’ll need to become more productive, to do more with less margin.
Until recently, you have probably reacted to the need to become more productive by concentrating on internal costs. You’ve reduced your inventory, streamlined the warehouse, and are probably on your third generation of computer software. But all this time that you’ve focused internally, you’ve kept hands off the sales force. It is, in all likelihood, costing you the same percentage of gross profit today that it did a few years ago.
Yet, the sales force is probably the single largest cost to your company. Look at your P&L statement. Isn’t sales force compensation the largest single line item? If you’re like most companies, your sales force costs range around 25 – 35% of gross profit. Doesn’t it make sense to at least investigate the potential of changing the compensation plan to make that group more productive?
A couple points change in the relative cost of your sales force, and therefore an improvement in its productivity, will drop directly to your bottom line.
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2. Implement corporate strategy.
As business becomes more complex and more competitive, the smartest companies are working harder at creating effective strategies. The days of “Go out and sell a lot” are over. Yet most sales compensation programs work against effective corporate strategy because they encourage the sales people to do what is easiest ( sell the easiest item to sell, to the people who most like them) rather than what is in the best interests of the company.
One of the most common complaints I hear is from frustrated CEOs and sales managers who want to build closer working relationships with certain manufacturers, but who can’t get their sales people to perform adequately on those lines.
It’s often a classic case of the sales people doing what the compensation program rewards them for (easiest sales) and not what is in the strategic plan.
Every sales compensation decision encourages and discourages certain behavior. For example, a straight commission plan encourages the quickest, easiest sales. But, it discourages strategic behavior that has a longer-term payoff — like acquiring new customers or emphasizing certain strategic product lines.
Straight salary, on the other hand, encourages loyalty, steadiness and attention to service. However, straight salary discourages individual initiative.
If you want to manage your company strategically, you’ll need to ask yourself if your compensation program directly supports your corporate strategy by encouraging the right kind of behavior. If not, it’s time to review it.
3. Free sales managers to become more effective.
Different sales force compensation plans require different types and amounts of attention from sales management. You need to make sure that your plan is using your sales management in its most effective way.
For example, commissioned reps not only require less management than salaried reps, they require a different kind of management. If your compensation program is primarily commission, you, or your sales manager(s) must be more adept at participative, “influencing” type of management. If your plan is heavily weighted in favor of salary, your sales management will spend considerably more time reading call reports, expense reports, and managing political maneuvering on the part of your reps. When your sales people know that their salary or bonus is dependent on management’s judgment, they’ll spend a significant portion of their time politically maneuvering for a more favorable evaluation.
The typical manager may be able to handle 6 – 8 reps who are salaried, and twice that many if they are commissioned.
So, one of the variables going into your compensation program has to do with your use of your sales management — whether that’s you or someone else. Since sales management is often one of the highest paid positions in your company, it’s a worthwhile exercise to ask yourself if you’re making effective use of that resource. Your sales force compensation plan can do more than any other decision to free your sales management up to be more effective.
4. Attract and retain the right kind of sales people.
One of the most powerful tools you have to attract and retain the right kind of sales people is your compensation program.
Potential sales people will measure themselves against the compensation formula, and make a decision as to whether or not they can perform adequately under it. Those who don’t think they can do it will take themselves out of consideration. Those who see themselves performing under your compensation plan will stay in the interview process. They, therefore, make your selection process easier by self-selecting themselves out.
I have found that, over time, sales people gravitate to that compensation situation in which they feel most comfortable. Your plan, then, becomes a tool to retain the kind of sales people you want.
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