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How To Compensate Your Sales Force
We find that one of the most difficult challenges for many businesses is determining just how to compensate sales people. Developing an effective sales compensation plan is critical to your company's success and it is important that the plan that is developed make sense both for your business and your sales staff.
There seems to be a mindset among many sales people that they are entitled to a larger percentage of a given sale than they actually deserve. Unfortunately a number of businesses have made the critical mistake of overcompensating sales people in an effort to motivate them to higher levels of performance. When they discover that this rarely has the desired impact, they change the plan only leading to an alienation of the sales force.
Conversely, some businesses have taken a very conservative approach to compensating sales people and quickly discovered that underpaying sales people leads to high turnover, inadequate performance and low morale. Striking a balance between paying too much and too little is one of the challenges inherent in the process of developing of a sound sales compensation plan.
Business owners and managers must avoid "dabbling" in sales compensation if they are to arrive at a plan that works well for all involved. It takes a fair amount of thought and a lot of number crunching to arrive at a sales compensation plan that avoids as many pitfalls as possible and establishes internal equity within the sales force. In other words, the plan will end up being a true pay for performance plan that rewards sales staff for their productivity in terms of dollars generated.
There are many variations of sales compensation plans that will work well. Combinations of base salary, commission, and bonus usually work well as long as the numbers involved don't under or overcompensate the sales force. And the plan must be simple enough to both understand and administer.
As a manager of sales people, it is very important to understand that sales people will almost always tell you that they are motivated by a large sales commission and/or bonus percentage. In reality, most sales people will perform as well at reasonable numbers as they will at inflated numbers.
There are a few exceptions to this, but generally speaking, effort expended is not affected greatly by moving commissions or bonuses up unless those commissions and bonuses are too low to begin with. In fact, it can be argued that overpaying sales people actually causes a reduction in performance for many sales people because they don't have to work as hard to achieve strong compensation levels. In other words, they end up being compensated very well for underperforming. And that is the last thing that should result from your sales compensation plan.
The term "at risk compensation" is an important one in the context of sales compensation plans. "At risk compensation" is nothing more than that amount of potential compensation that is not guaranteed in any way, but is associated with the level of performance. Some portion of a sound sales compensation plan must be allocated to at risk compensation.
But why is this important? It is important because, very simply, you want to create a mentality among your sales force that they must work hard and perform at high levels each and every day in order to earn enough money to meet their immediate needs.
Some sales compensation plans have been developed around a salary only component. This type of plan is generally not recommended because there is nothing really at risk from a compensation standpoint. Sales people need to understand that in order to achieve sufficient compensation levels, they must generate acceptable sales numbers at a minimum. How you develop the "at risk" components of your plan is one of the questions that you will face.
Generally speaking, we recommend that between 17 and 26 percent of the gross profit generated by a sales person in any given sales year be paid to them. This range includes any base salary and all at risk compensation. For very high performers, the top end of this range can be expanded some, but it must be built into the plan initially. When businesses routinely give 30% or more of the gross profit generated from a sale back to the sales person, that leaves too little to contribute to other expenses of most businesses.
In developing a sales compensation plan, it is generally wise to think very carefully about what sales levels you expect from your sales force given their territory or market potentials. In other words, what are the sales objectives by representative? We strongly discourage basing any commissions or bonuses on the revenue levels generated by sales people.
Our preference, whenever possible, is to base sales compensation plans on the gross profit each representative will generate. Therefore, any specific commission and/or bonus plan will be based on gross profit levels for each person in your sales force rather than gross sales dollars generated.
Some businesses prefer a plan based on gross dollars generated. This can work, but it is critical that the sales force not be able to control pricing or discounts. When the incentive is based on gross dollars, any price or discount control allows too much room for negotiation to "get the deal". In that case, the sales person wins and the company loses. It must be a win-win situation.
A simple plan involves one commission and/or bonus rate across all gross profit levels. More complex plans use tiers for any of the at risk components. To illustrate, a simple plan might consist of a base salary of $25,000 per year plus 10% of the gross profit generated plus a year-end bonus of $5,000 if the representative generates at least $350,000 worth of gross profit in that sales year. Total compensation in this example would be $65,000 (assuming the representative hit exactly the $350,000 gross profit level). This amounts to 18.6 percent of the gross profit generated being paid out to the representative.
A more complex plan might look like this; a base salary of $25,000; a commission schedule of 8% for monthly gross profit up to $17,000, 10% for monthly gross profit between $17,001 and $25,000 and 14% for monthly gross profit in excess of $25,000; a bonus plan that would pay at year-end an additional 3% of gross profit if the representative hits a minimum of $400,000 in gross profit. For illustration purposes, let's assume that the sales rep hit exactly $30,000 in gross profit each month or $360,000 in total gross profit for the year. The calculation of the annual compensation would look like this:
Base salary: $25,000
Commission: ($204,000 x .10) + ($96000 x .12) + ($60,000 x .14) = $40,320
Bonus: $0 since the representative did not reach the $400,000 level
Total Compensation: $65,320 or 18.14% of gross profit generated
(In this example, we show an annual commission payout for illustration purposes only, but monthly commissions are almost always the rule. The sales commission number shown above would actually be paid out over the course of the sales year.)
These simple examples are provided only to illustrate possible approaches to sales compensation. There are a number of ways to develop a workable and effective sales compensation plan. The Sales Compensation Handbook is a widely used guide offered through mybusinessbooks.com. This handbook explains and illustrates various ways to create a sales compensation plan that helps increase sales and maximize productivity.
For additional information on sales compensation, click here to access another article on our sister site, Business Briefs.