How to develop an effective sales compensation program

September 1, 2010 | IHRM Journal

A sales compensation plan is a challenging topic for many people because they think in terms of absolutes. Most of the questions asked start with, “What is the standard (salary, commission, or both and at what percentage) for (industry, product or service)?”

Unfortunately there are no hard “standards” that apply to sales compensation. The variations in sales compensation plans are infinite and published research that provides compensation details (salary/draw plus commissions plus bonuses plus other incentives) by industry or geography is quite expensive. This makes sense when we think about it-if a company has managed to develop an effective sales compensation plan, what incentive do they have to share it with others? We should pay less attention to what other firms are paying and more attention to developing a sales compensation plan that:

1. Takes into account the profitability of our company’s various services, and also

2. One that motivates desired sales behaviors in a sales team members

With that said, there are some basic concepts that will help you develop an effective sales compensation plan.

Provide a Basic Salary first

Sales compensation plans that attract and motivate quality salesmanship usually include some type of “income floor”. This is a guaranteed minimum amount of compensation that the salesperson earns monthly; depending on his level of placement/seniority in a firm.

Salary: This is a fixed amount of money that is paid within a specified time period. Any commissions earned (if applicable) are paid in addition to the salary.

Commissions: This is earnings/ pay during a time period over and above the salary dependant on the volume of sales generated in a time period by a sales person.

Concern for Fairness: The fairness concern is that; can two salespeople earn different amounts of compensation for selling exactly the same amount? This can be addressed well if all sales people have same sales targets and have same basic salary and the commission rate is the same. Otherwise, it is possible for salesmen to earn different commissions for same volume of sales-which brings in a feeling of unfairness!

This fairness concern can be eliminated to have an acceptable compensation plan across the board.

Should commissions be based on Gross Sales Revenue or Gross Margin/Profit?

A common question is whether sales commissions should be calculated based upon revenue or gross margin. The answer depends upon a firm’s specific circumstances.

If the salespeople sell from a fixed price schedule, and they do not have much latitude to change prices without management approval, then it makes sense to calculate commissions as a percentage of revenue.

If the salespeople have considerable latitude when negotiating price, it is desirable to base commission calculations on gross margin. A common approach in this is to offer a “sliding scale” that increases and decreases the commission percentage based upon the gross margin produced.

Additional incentives

We also want to consider adding additional incentives to our sales compensation plan. One common incentive is offering fixed dollar bonuses to promote team selling, crossselling, sales of specific products, or increase in customer satisfaction.

This incentive 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 complex that salespeople cannot rapidly calculate how their performance will affect their compensation, it loses its motivational value.

Here are two real-life examples of highly effective incentives:

1. Quarterly & Annual Bonuses:

In one sales job, the compensation plan includes, say a USD 5000 bonus for achieving sales targets during one quarter and another USD 5000 bonus for achieving the annual sales target. As a result, salespeople could earn a total of USD 25,000 in bonuses (in addition to salary and commissions) if they achieved each of the four quarterly targets and the annual target! I personally advocate for the motivational value of this type of bonus program.

2. Reward Trips:

Another sales incentive that consistently catches one’s attention is an allexpenses- paid trip to an exotic location. A very small percentage of a company’s salespeople and sales managers win the trip each year, and the winners are joined at the exotic location by the company’s top executives.

This incentive is motivating for several reasons that include:

• Wanting to earn recognition as one of the top salespeople in a firm
• Wanting to “rub shoulders” with the firm’s top executives (which leads to future promotions if well handled!)
• A spouse or significant other half wanting to enjoy trips to exotic locations It is actually possible to motivate salespeople by offering incentives that go beyond salary and commission. But, we also note that sales incentives can also fail.

Why Incentives Fail

1. 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!
2. Performance Disincentives: The concept of a performance disincentive is best illustrated by the following illustration: When you think about it, capping a salesperson’s income just doesn’t make sense! If a salesperson sells more than the cap amount, are the sales in excess of the cap amount less valuable to the company than any other sales? Of course not! So why wouldn’t companies want to compensate the salesperson for those sales over and above targets? 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-exceeding targets!
3. 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 a firm’s salespeople.

To find out whether your firm’s sales contests may be perceived as being “stacked” against some people, we need to consider the following questions:

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

• Will some salespeople in your company service larger or more productive accounts? Does this give these salespeople an advantage during contests? Or, are the contests structured to enable all of your company’s salespeople to have a fair chance of winning?

• Is the contest designed to generate incremental sales, or is it simply rewarding salespeople twice for results they would have produced anyway? These sales incentives are special and you can use them to jump-start sales of new products and services or reinforcing desired changes in how your salespeople sell.

By Francis O. Ondieki Francis.ondieki@airtouch.co.ke