The majority of business owners prefer linking pay to employee performance. The sales role in most businesses is the easiest and most obvious place to begin. Yet owners struggle with compensating salespeople in a manner that is affordable while still driving sustained performance.
Building a sales commission plan requires a balance between security (some form of base compensation) and incentives for performance. In addition, there are three factors that are considerations in the structure; Service levels, price flexibility and the length of the company’s sales cycle.
- Service Levels: These are (or should be) described in the salesperson’s job description. How many tasks are required that aren’t, strictly speaking, sales? Duties may require in-servicing or training clients on new products, straightening customer inventory, troubleshooting shipping and production issues, or other ongoing responsibilities that fall more under the category of customer service than new business development. Base pay should reflect the percentage of working time that is expected for these tasks. Ignore the cost to the salesperson of these requirements, and they are likely to be neglected.
- Price Flexibility: This is a pretty straightforward part of compensation structuring. If prices are fixed, and the salesperson has no control over them, then commissions can be tied to gross sales. If the salesperson can offer customers different percentages off a book price, estimates, volume discounts or has any other control over the selling price, commissions should be based on gross margins.
- Sales Cycle: Simply put, how long does it usually take to land a customer? I worked with a CPA firm that wanted to hire a salesperson on commission only. When asked about the typical time between introduction to a prospect, and a decision to move compliance business to the firm, they answered “Two or three years.” They had no idea how the salesperson was supposed to survive long enough to see the fruits of his or her efforts. Pure commission structures are more appropriate in one-stop sales situations.
Base compensation covers two scenarios. One is the non-sales work as described above. The other is to provide a level of security while the employee is learning the business or building a customer base. There are three types of base pay.
- Draw is an advance on commissions not yet earned. If the salesperson is starting with no customer base, draw arrangements frequently fall into the trap of a disincentive. Negative balances that have to be made up before the employee can earn more are discouraging. If there is a draw arrangement, it should logically be accompanied by a starting active customer base or recurring revenue that at least comes close to covering it.
- Guarantees are similar to draw, but with no downside or deficit balance for falling short of goal. They function like salary, except that they are directly tied to sales production from the first dollar.
- Salary is appropriate for new people starting out, or for positions that have a high service requirement. If the salary is to be permanent, then it should be about half the eventual expected income.
Salaries don’t have to be permanent. I knew one very successful organization that started all new sales employees on straight salary. Commissions were tracked, but none were paid while the employee was getting a salary. It lasted for six months, after which the employee automatically converted to straight commission.
If commissions were running at a rate less than the salary after six months, the salesperson was welcome to continue working for less compensation. The company also offered an interesting feature. The salesperson could elect at any time prior to the six month cutoff to move to straight commission. Of course, there was no going back.
This type of plan illustrates the final critical factor in any sales incentive plan. The salesperson should know, from the first day of employment, the level at which he or she is expected to perform, and the time allowed to reach that goal. Except for service compensation, any guaranteed base ceases at that point. A chart of this concept, dubbed “The Francis Curve” after the friend who first drew it for me, is on page 66 of my book Hunting in a Farmer’s World.
In the straight-salary-to straight-commission model above, salespeople knew from the first day when their commissions were expected to exceed their guaranty. Of course, many pleaded for an extension, claiming to be “real close” to making it. They were invited to invest in their own success by toughing it out until they succeeded.
In reality, most who were underperforming chose self-termination well in advance of the deadline. A properly structured compensation plan means that you never have to fire a salesperson. They either leave voluntarily, or lower their cost to match their performance.