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Effective Sales Compensation Plans: A Primer

carrotsKeys to attract and motivate quality salespeople

Should sales commissions be calculated based upon revenue or gross margin? The answer depends upon your company’s specific circumstances.

If your salespeople sell from a fixed price schedule and do not have much latitude to change prices without management approval, then it makes sense to calculate commissions as a percentage of revenue. You could even consider offering different commission percentages for different price bands, with the commission percentages declining as the profitability of the price bands declines. This would give your salespeople some pricing latitude, yet still motivate them to secure the highest possible price. It would also protect the confidentiality of your company’s profit margins. If your salespeople have considerable latitude when negotiating price, it is desirable to base commission calculations on gross margin. A common approach is to offer a “sliding scale” that increases and decreases the commission percentage based upon the gross margin produced.

For the sake of discussion, let’s say your company’s target gross margin percentage is 30 percent and the target sales commission percentage is 10 percent of gross margin. In a sliding scale model, the commission percentage would be adjusted upward if the gross margin for a transaction is higher than 30 percent and downward if the gross margin is lower than 30 percent. An example is provided in Table 1.

You can have as many or as few steps as you wish in a sliding scale. You also have complete flexibility when determining how much the commission percentage increases or decreases between steps. Usually, it is wise to cap the commission percentage on both ends of the sliding scale.

You may also want to consider adding other incentives to your sales compensation plan. Common incentives include offering fixed dollar bonuses or multiplier “kickers” to promote the pursuit of new business, team selling, cross-selling, sales of specific products or increases in customer satisfaction.

These incentives can motivate desirable behavior in some circumstances, but this motivation comes at the price of adding complexity to the sales compensation plan. When a sales compensation plan becomes so complex that salespeople cannot rapidly calculate how their performance will impact their compensation, the plan loses much of its motivational value. Below are two real-life examples of highly effective incentives.

Table 1: Sliding Scale Commission Example
  Base    Net 
Margin Commission Multiplier Commission
40% 10% 1.50 15.0%
35% 10% 1.25 12.5%
30% 10% 1.00 10.0%
25% 10% 0.75  7.5%
20% 10% 0.50  5.0%

Quarterly and Annual Bonuses. In one of my sales jobs, the compensation plan included a $500 bonus for achieving budget during a quarter and another $500 bonus for achieving the annual budget. As a result, salespeople could earn a total of $2,500 in bonuses (in addition to salary and commissions) if they achieved each of the four quarterly budgets and the annual budget.

I can vouch for the motivational value of this type of bonus program. One year, I earned the first three quarterly bonuses and sold enough during those three quarters to also earn the annual bonus. Yet, there was still one quarter to go. My pipeline was tapped out, but I really wanted to go five-for-five and earn the final bonus. I ramped up my prospecting activities and ended up selling more in the final quarter than I had sold during the previous three quarters combined! Needless to say, I earned the final quarterly bonus—plus some very fat commission checks. I’m sure my employer had no problem writing those checks—they earned a lot more from my sales than I did!

Reward Trips. Another sales incentive that consistently caught my attention was an all-expenses-paid trip to an exotic location. A very small percentage of the company’s salespeople and sales managers could win the trip each year, and the winners were joined at the exotic location by the company’s top executives. This promotion was motivating for several reasons, including wanting to earn recognition as one of the company’s top salespeople, wanting to rub shoulders with the company’s top executives (which could lead to future promotions), and having a spouse or significant other who wants to enjoy trips to exotic locations. (Never discount the power of this type of “indirect” motivation!)

Clearly, it is possible to motivate salespeople by offering incentives that go beyond salary and commission. However, sales incentives can also fail.

Why Incentives Fail
Here are three common reasons why sales incentives fail:

Lack of Talents Required for Sales Success. Many salespeople lack key talents required for sales success. When salespeople lack these talents, no amount of incentives will cause them to suddenly sell more effectively. A more likely outcome is they will start to press harder to close sales and suffer a decline in sales performance.

Performance Disincentives. Some years ago I had a friend whose husband worked for a large textile manufacturer. This textile manufacturer had a policy that capped salesperson earnings at 200 percent of their annual target. My friend’s husband was an exceptional salesperson, and in the second month of the fiscal year he closed the largest order in the company’s history. One undesirable outcome of this achievement was that he had maximized his earning potential for the year with ten months remaining! He didn’t know what to do. Clearly he had little incentive to sell for those ten months. He went to his manager, and together they tried to convince the company to make an exception to the policy, but to no avail. This very successful salesperson ended up leaving the textile manufacturer for a sales job that did not cap his compensation potential.

When you think about it, capping a salesperson’s income doesn’t make sense. Are sales in excess of the cap amount less valuable to your company than any other sales? Of course not! So why wouldn’t you want to compensate the salesperson for those sales? If anything, it would make more sense to pay some kind of bonus in addition to the salesperson’s normal commissions to reward them for extraordinary performance.

Stacked Contests. Sometimes sales contests are perceived to be “stacked” in favor of certain salespeople. This destroys the motivational value of the contests for most of the company’s salespeople. To find out whether your company’s sales contests may be perceived as being “stacked,” consider the following questions:

• Do the same salespeople consistently win all of your company’s contests and incentives?

• Do some salespeople in your company service larger or more productive accounts? Does this give these salespeople an advantage during contests?

• Are the contests structured so that all salespeople have a fair chance to win?

• Is the contest designed to generate incremental sales, or is it simply rewarding salespeople twice for results they would have produced anyway?

Be careful about making excessive use of sales incentives and contests. Rather than constantly running new sales incentives and contests, save them for special situations such as jump-starting sales of new products and services or reinforcing desired changes in how your salespeople sell. Your company’s sales compensation plan should be designed to motivate desired daily behaviors, such as new business generation, maximum account penetration, team selling and cross-selling. Top sales performers are usually internally motivated, success-oriented and outcome-focused. If you hire the right kind of salespeople and provide them with a compensation plan that rewards the right activities and results, you won’t need to offer frequent sales incentives!

Material Handling Equipment Distributors Association
Alan Rigg Meet the Author
Alan Rigg is president of 80/20 Sales Performance, located in Scottsdale, Arizona, and on the Web at www.8020sales.com. He will present “How to Develop a Truly Effective Sales Compensation Plan” at the 2011 MHEDA Convention on Tuesday, May 3, at 10:45 a.m. 

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