Q: I sell advertising for a local newspaper. In our sales compensation plan, we compete with our revenue numbers from the previous year, and approximately 6% is added to the previous year’s revenue number. That becomes your goal for that particular month. We get a salary plus commission and have a stair-step commission that starts at 80% of our goal.
The problem is there is no motivation between the salespeople due to the fact that we are competing with numbers from the year before. When we have talked to management about it, they say that if we changed the pay plan, we would have to lower salaries. In most months our company keeps approximately 92% to 96% of the total revenue I bring in. I’d like to know your thoughts on this kind of sales compensation plan.
A: I suspect that this kind of question lurks in the back of the minds of many salespeople — “Is my sales compensation plan fair?”
Seeing Both Sides of Compensation
I’ve been on both sides of this issue. As a salesperson, I’ve worked under a number of different compensation plans. In every sales position I had, my compensation plan was changed at least once.
As a consultant, helping companies refine their compensation plan is a regular part of my practice. Almost never does a week go by that I’m not involved in a compensation plan project somewhere.
Criteria for Evaluation
Over the years, I’ve developed some criteria for evaluating a compensation plan. Here’s one of them: A good compensation plan should be a win-win plan. That means, good for the salesperson and good for the company.
From the salesperson’s perspective, that means that the compensation plan should be competitive with others in the market, that it should fairly compensate them, and that it should financially reward exceptional performance.
From the company’s point of view, it means the same things, with one provision: A good compensation plan should cost the company an appropriate amount of the gross profit generated by the sales force.
There is, unfortunately, a good deal of misunderstanding on the part of salespeople on the economics of the business. Your statement that the company “keeps 92-96% of the revenue you generate” is an indication of that misunderstanding. You are implying that the money is yours, totally due to your efforts. I can empathize with this feeling because, for years, I shared it.
However, a more reasoned investigation into the issue will reveal that you are just one part of the company. The people who reliably turn out every edition of your newspaper — who distribute it, who pay the bills, and run the presses – are just as much a part of the reason your advertisers choose to spend their money with your paper. To say that the company keeps the money you generate is to over-inflate your contribution.
Secondly, you are implying that something is wrong with that percentage. I don’t think so. If the company pays you 6% to 8% of the revenue from your accounts, that seems to me to be in the range of what they can afford to pay and still be profitable.
Costs to Understand
In any well-run company, out of every dollar of revenue, the company must pay all of its costs. Sales costs are just one such category of cost. On top of that comes, of course, the cost of goods sold, the rent or building costs, executive and administrative costs, other marketing costs, all of the other workers in the company, costs of maintaining accounts receivable, costs of borrowing money, etc. When all of these costs are in line, the company may make a profit, typically between 1% to 5% of the total revenue. If any of these costs get out of line, it hurts the company, in many cases causing it to be unprofitable.
Keep in mind that your cost to the company is far greater than the take-home pay you receive. Add in the costs to train you, the fringe benefits the company provides, the taxes they pay on your behalf, and the expenses they pay on your behalf – like cell phones and car allowances, etc. As a rough general rule, take your total gross income, and add about 30% to get a better idea of what you actually cost the company. So, in other words, if you grossed $50,000 last year, add 30%, or an additional $15,000 and that will approximate what you actually cost the company. Probably closer to $65,000.
Now, the company is paying you 8 – 12% of the gross income it receives. For a service company like yours, I don’t think this is out of line. Other kinds of companies, like distributors and retailers, would go out of business paying sales costs that high.
Looking at the Numbers
Let’s assume, for purposes of the illustration, that the products and services you sell have a 40% gross profit. In other words, for every $100 in income, it actually costs your company $60.00 to deliver that product/service. If we work the numbers out, 8 – 12% of gross revenue, at a gross profit of 40%, equals sales costs of 20 – 32% of gross profit. In other words, you are costing the company somewhere between 1/5 to 1/3 of all the money that is available to the company to pay all its expenses and make a profit.
Depending on some other factors, this is in the range of what I would expect it to be. If you work for a distributor or retailer, this is too high. If you work for a manufacturer or service provider, you are in the range.
Any company that pays more than 35% of its gross profit in sales costs is in danger of being unprofitable.
So, while this little analysis is based on averages and rules-of-thumb and not your company’s numbers, it does indicate that you are probably not being underpaid relative to your contribution.
Salary Plus Incentive
So, the question really has to do with the format of the compensation plan. Is salary plus incentive a more effective, win/win approach than 100% commission?
Without knowing your circumstances, I really can’t speculate. But, let me say that in mature markets, I favor the salary plus incentive format over the 100% commission plan for a number of reasons.
All of that said, at least on the surface of things, I can not find fault with your company’s compensation plan. The real issue here is this: What do you do about a compensation plan that you feel is not effective?
If you believe that your plan is not fair or effective, then you have some decisions to make. I think you have only two options: 1) Express your opinions to the company’s management. Back up your case with some substance. Try to sell them in your opinion in the same way that you’d try to sell a customer on the value of your products or services. Keep in mind, however, that you are just one part of the company, and that there is a limited amount of the whole pie that the company can afford in sales costs and still remain a viable, growing company.
If you are successful in getting them to revise your sale compensation plan, congratulations.
If you are not, then you need to pursue the second option: 2) Decide if you can live with this plan or not. If not, then look for another position. If so, then chalk it up to experience, be thankful for the position you have, and continue on.
I don’t think you ever have the option of fomenting rancor and discontent. Be black or white on this issue. If you can’t embrace the opportunity you have and whole-heartedly pursue it, then you owe it to yourself and your company to find something else. What is not an option is continuing in your current position and spending time and energy complaining about your compensation plan.
What we make definitely sparks a lot of emotions, especially when the feeling of being unfairly compensated starts to take hold. I really liked your response to this question, as you take the emotion out of the equation and look at it logically. The Win/Win approach to finding compensation that a salesperson finds lucrative and the company gets value is such a sensible approach.
Thank you for the answer to the question above. I thought it was a great answer and completely agree with your recommendations. I am in the process of developing a compensation plan for my boss. However, I prefer to call it an Incentive Plan, or even better a Sales Incentive Plan. As a Distributor/Wholesaler, our company is basically the 2nd Step in a classic 3 Step Distribution Cycle. We also sell direct to consumer both online and counter sales. My charge is to develop an Incentive program that identifies truly incremental sales and rewards them a % of GP on those sales. We can’t afford to compensate (past base salary) on organic inbound counter or e-commerce sales, but we still need our people focused on those areas as well.
I wonder it I/we might be better served developing a Team Bonus program which would allow us the flexibility to reward the whole Team for their collective efforts. My fear here is that it is putting one person’s destiny (incentive) in the hands of another.
Very curious to hear your thoughts. I have written and/or co-written several Incentive/Compensation plans in the past but I have not been in such a hybrid position before.
Thanks again for your article. You have already been helpful.
John, Thanks for your comment.
By the way, distribution sales is my specialty. I have written four books for wholesale distributors and most of my practice involves the distribution channel.
Having said that, I generally don’t favor team bonuses as they have a tendency to discourage the high performers. If your situations meets a couple of criteria, it is relatively easy to incent incremental sales. If your salespeople have assigned accounts, and if you can track the number of skus purchased per account, you incent the increase in the number of skus per account. There’s a lot of rational behind that, as well as some major training modules for the sales people.