Success in selling requires self-discipline, persistence and enthusiasm in the face of daily rejection by customers and prospects and the pressure of direct and aggressive competition. Subsequently, for many business owners and managers sales force compensation is a vital element in managing and motivating their sales team to achieve their business goals.
As you review your compensation plan you will need to consider the total compensation package, i.e. base compensation, incentive pay and employee benefits. The base compensation is made up of salary and/or commission, incentive pay includes payments such as bonuses and awards, and employee benefits include such things as car allowance, child care options and superannuation.
A suitable compensation plan must be designed to attract and retain successful salespeople and must be appropriate to the nature of the products and services they will be selling. There is no such thing as the "perfect" compensation plan. Your goal should be to develop and implement a plan that is effective for your organisation.
Your sales compensation plan must strike a balance between salary and commission, and between base and incentive pay. If you pay too much, you cut into the revenues of the business. If you pay too little, you attract mediocre talent and risk losing your high producers and incurring the staggering cost of high staff turnover. In short, the amount you pay in salary, commission, incentives and benefits, should be appropriate in comparison to the revenue and gross profit being generated by your sales force.
There is no single way to find that balance. If we were to poll different businesses on how their salespeople are paid, their answers would vary significantly depending on the industry. e.g. the plumbing supply house might say, "small base salary, plus 15% commission", to drive daily orders. The mortgage broker might say, "45% commission, small draw for the first 60 days, bonuses for performance over quota", because of the few barriers to entry. The commercial real estate leasing manager might say, "straight commission on a sliding scale, from 45% up to 70%, based on production", to cover the spread between small and large leases. The software developer with high gross margin might say, "high base salary, with a yearly bonus based on performance", to account for the longer selling cycle.
Compensation drives behaviour
The number one principle to keep in mind when developing or restructuring a compensation plan is that "compensation drives behaviour". So ask this question: Is what I am paying my salespeople rewarding the performance we are trying to achieve?
Firstly, you want to reward salespeople so that their earnings relate directly to their contribution to the company. Secondly, since compensation drives behaviour, it should shape and focus the salesperson's efforts in the direction that best serves the profitability of the company.
For an example of this concept, let's consider the superstars of the sports world - for example, a world class team captain may earn a significant salary, plus possibly a signing bonus and further bonuses for guiding the team to a certain number of wins per season and for scoring a certain number of points per season. You may not be able to match the numbers, but you can copy the concept. Keep the person motivated all year long, despite a significant base income, by awarding bonuses consistent with the behaviour you want repeated.
Compensation and the business
As well as consideration to the above, your sales team compensation plans should support not only your sales objectives, but be in concert with your overall company objectives. Factors to consider include:
- Which type of accounts you are targeting i.e. major or small accounts, new or existing, broad based or product specific;
- Specific sales strategies i.e. growth, geographic penetration, product segmentation etc.;
- Improving margins;
- Co-ordinating with accounts and purchasing in terms of constraints that may be imposed on your goals;
- Controlling costs - use of technology, training etc.;
- Ensuring fairness among sales people;
- Providing income stability for the sales team;
- Keeping your plan simple;
- Attracting new salespeople while retaining your best people;
- Improving morale while establishing challenging but attainable goals.
Types of compensation plans
The three basic types of compensation plans are straight salary, commission and a combination of the two.
Straight salary
Under this plan, the salesperson receives a fixed rate of base compensation and may also receive additional incentives. This plan is effective when a lot of prospecting is involved or when the primary responsibility is servicing. This type of plan may also be appropriate in situations when it is difficult to determine who made the sale, in businesses that have cyclical sales patterns, or when you want to provide a consistent level of income instead of radical increases and decreases. This type of plan has the advantages of being easy to administer and allows for greater flexibility in assigning salespeople to territories or in establishing quotas. Also, salespeople drawing a straight salary consider support and administrative functions as part of the job.
The main disadvantages of straight salary plans to the business are:
- Salespeople tend to concentrate on the products or accounts that are easiest to sell;
- Incentive for increased performance is tied to performance goals, a less effective incentive than money;
- Requires continuous monitoring to ensure that costs compared to performance are at least no higher than in commission and combination plans;
- It is more difficult to assess the relative level of fair pay of more experienced as opposed to less experienced salespeople;
- The business is making a significant up-front investment in the sales department.
The main advantages of straight salary for the employee are that the pay is consistent and the plan is easy to understand. The disadvantage is that extraordinary effort is not rewarded.
Commission
Commission plans pay salespeople in direct proportion to their sales. Commission plans include straight commission and commission with a draw structure. Commission plans are most often used when companies are starting out, or in a growth stage, where there are wide possibilities or variations in the market, or when the size or scope of the market is difficult to determine.
From the company's perspective, the main advantages of commission plans are:
- A salesperson's pay is directly related to earnings;
- Provides the most financial motivation;
- Sales costs are proportional to sales, and gross margins become a more accurate tool in assessing the cost of sales;
- Up front costs are minimised;
- Can be easier to administer than combination plans, but usually more complex than straight salary plans.
The main disadvantages of commission plans are:
- Profitability may suffer if commission is based only on sales volume without regard to margins or other company strategic initiatives;
- Administrative, customer and other support activities may suffer if you don't establish some performance criteria beyond the commission structure while ensuring that salespeople get paid for them;
- Pay may fluctuate greatly due to seasonal variations for all salespeople or for selected salespeople if you segment selling by territory or product line. Fluctuations could result in high turnover during downturns;
- Salespeople could tend to focus on short term results to the detriment of long term customer relationships.
For the salesperson, the main advantage of a commission plan is that pay is directly tied to their sales performance, and therefore is theoretically limited only by their effort and by market limitations. The disadvantage is, of course, that pay can be negatively affected by those factors.
To offset the disadvantages of a commission plan and to help attract a strong sales force, a company should support new salespeople with interim compensation arrangements that may include a monthly minimum, generous draws, or a combination of sales and commission during a trial period.
Commission may be calculated by several methods:
- A flat rate on all sales;
- Different rates on different products or services eg. high commission on a new sale compared to a lower commission on a service contract with an existing customer;
- A percentage of gross profit;
- Weighted commission of different sales volumes or gross product levels.
Combination plans
This type of plan includes variations of salary plus some other financial incentive. The most common combination is base salary with commission on sales. Salaries may also be combined with quotas, contests and bonuses.
A combination plan provides more incentive for the employee than salary alone and more income stability than straight commission. It gives the company more flexibility in designing compensation packages that suit all salespeople, while also maximising benefit to the company.
These plans usually require more administration and paperwork. In the initial stages you may have to adjust the plan several times to find the right balance for both your employees and the company. Once established, however, a well designed combination plan will be almost as stable as a straight sales or commission plan. Nevertheless it will need periodic fine tuning as product mix, market conditions and internal profitability factors change.
A point to note is that combination plans allow you the flexibility to develop any combination of salary and incentives that you feel is appropriate. If you choose to invite the employee to participate in developing the plan you may add significant motivation to that employee to buy into the results, and that motivation will extend to making sales.
The advantages of combination plans may be summarised as follows:
- They can offer the best of salary and commission plans, providing security and a flexible earnings schedule for the employee;
- This type of plan often leads to consistent attention to the full range of selling functions;
- Employee motivation is usually optimised making your job as manager easier;
- They tend to generate more loyalty and commitment from both the company and the employee to each other.
Any disadvantages of combination plans usually centre on the complexity and cost of administration, so it is important to follow the K.I.S.S. principle when designing the plan.
As with any major decision involving employees, it is always advisable to consider their point of view and to get their feedback and support for this most sensitive aspect of their work.
Bonuses
Sales bonuses are best used to motivate performance to the achievement of a specific goal. These goals may be established and institutionalised over time (e.g. a $500 bonus to all salespeople who exceed their annual sales goal by 20%) and/or they may be introduced to effect certain strategies (e.g. rewarding new business activity). In both cases the bonuses are complimentary to the basic compensation system (straight salary, commission or combination).
In summary your goal should be to get the right sales compensation balance that is effective for your business situation utilising one or a combination of the methods discussed previously. Getting the right balance can make a significant difference to the future success of your business.