Finding Just The Right Formula: The American Salesman

-Payment of an organization''s salespeople has long been an issue marked by trial and error.
Payment of an organization´s salespeople has long been an issue marked by trial and error. Many companies have struggled for years to discover just the right formula or approach for compensating salespeople, typically using some form of combination of base pay and performance incentive.

Theorists are wont to point out sales compensation is an ideal forum for using incentives because of four factors: (1) most salespeople are not subject, as are production workers, to close supervision because salespeople may spend most of their time away from the organization; (2) salespeople often see themselves as independent employees who view incentives as recognition for their efforts; (3) commissions are one of the most direct ways of relating performance to reward; and (4) because sales tasks consist of several activities an organization can choose to reward the behavior it wants to reward.

In reality, there are four basic sales personnel compensation arrangements: (1) straight salary, (2) straight commission, (3) salary plus commission and (4) salary plus performance bonus.

Straight Salary

A straight salary compensation plan does not involve any form, obviously, of incentive payment. Salespeople are simply paid a flat hourly, weekly or monthly rate. This approach is often used when salespeople are essentially order takers, sales are the result of a group effort or customer service is critical.

Advantages

Straight salary offers a number of advantages: (1) sales personnel have a steady and predetermined income level, (2) sales personnel can be more easily directed to perform nonsales tasks without loss of income, (3) teamwork is more likely to occur among sales personnel, (4) customer service is more likely to be encouraged and (5) inequities in time required to make a sale are likely to be reduced.

Disadvantages

Several disadvantages are associated with straight salary plans: (1) sales personnel may exert little or no extra effort in making sales, (2) the proper mix of products may not be marketed because salespeople may focus on types of sales, (3) straight salary may impede an organization''s ability to attract top-notch sales people and (4) a straight salary plan may negatively affect motivation inasmuch as everyone makes the same relative salary.

Straight Commission

A straight commission compensation plan rewards sales personnel on the basis of how much they sell of an organization''s products or services. The commission is usually stipulated as a percentage of the person''s total sales for the period specified. Organizations using such compensation arrangements typically allow sales personnel to draw against future sales commissions. The theory behind draws against future commissions is sales are often seasonal or cyclical and salespeople should not be punished by wide swings in earnings. A draw thus enables a sales person to smooth out his or her income so it is more consistent from period to period.

Advantages

Straight commission compensation plans offer some significant advantages: (1) an organization is likely to attract results-oriented sales personnel who value a high earnings potential and the freedom of action that may come with it, (2) an organization is able to share its risks and rewards with its salespeople, (3) straight commission plans tend to quickly eliminate incompetent sales personnel and (4) commission plans encourage aggressive selling which may be needed in highly competitive industries.

Disadvantages

The disadvantages of a commission-only approach to sales compensation include the following: (1) a commission-only approach encourages salespeople to think of themselves as free agents rather than company employees thereby creating a greater than usual sense of disloyalty to the organization, (2) dramatic overpayments or underpayments to sales personnel unless the commission percentage is determined with great accuracy - something that may be difficult to do, (3) salespeople may experience severe fluctuations in earnings from period to period due to variations in sales volumes, (4) salespeople may be tempted to seek out easy sales rather than cultivate more potentially profitable longrun customers and (5) it may be difficult to open up new territories because of the reluctance of salespersons to perform the necessary missionary sales work.

Salary Plus Commission

A salary plus commission plan provides a salesperson with a guaranteed level of income plus an opportunity to exceed this income level by either selling in excess of a specified sales volume or receiving a commission on all sales. The typical salary plus commission plan allocates 60 percent to 80 percent of pay to salary.

Advantages

Salary plus commission provides the following advantages as an approach to sale compensation: (1) it assures sales personnel a guaranteed income, (2) an opportunity is offered to make additional compensation, (3) it establishes a relationship between performance and reward, (4) a salesperson''s income does not fluctuate as drastically as it does under a straight commission plan and (5) it allows an organization to attract more salespeople than is usually possible under a straight commission plan.

Disadvantages

Disadvantages of salary plus commission are: (1) salespeople may not be as aggressive in making sales as they would under a straight commission approach, (2) mediocre salespeople are not as quickly eliminated as they would be under a straight commission plan, (3) it is sometimes difficult to establish the points at which commissions kick in and (4) determining the salary rate requires a knowledge of what competing labor market organizations are paying similar salespeople.

Salary Plus Performance Bonus

Under this sales compensation arrangement a salesperson is paid a specified salary and then at the end of the sales period - a month, a quarter or a year - is paid an additional amount for achieving specified goals. These goals can include anything the organization wishes to emphasize: number of sales calls made, training of new salespeople, account servicing, quality of sales made, for example. Often, the performance bonus is in addition to commission. In other instances it may replace commission. Bonus plans are common in technical sales where a salesperson may spend a large amount of time on nonselling activities or in situations where a great deal of time and effort is expended in consummating a sale.

Advantages

Among the advantages claimed for this approach are: (1) the organization can emphasize what it deems important in the sales area, (2) sales emphases can be changed from year to year, (3) sales personnel are encouraged to pay attention to both selling and non-selling activities, (4) rewards are based on accomplishment of objectives and (5) greater teamwork is encouraged between sales and service personnel.

Disadvantages The performance bonus approach has the following disadvantages: (1) bonus objectives may be expressed in subjective terms, (2) there may be no clear-cut formula for calculating bonus achievement, (3) sales personnel must fully support the established objectives or they may not exert additional effort to accomplish these goals and (4) when used in combination with salary and commission it may be difficult to integrate effectively all three compensation components.

Factors Affecting Sales Compensation Approach

Selection of a particular methodology for compensating sales personnel is influenced by three major factors: (1) the organization´s strategy, (2) compensation practices of competitors and (3) products or services being sold by the organization.

Organizational Strategy

It is imperative that any sales compensation system that is adopted directly support the strategic thrusts of the organization. For example, where increasing sales volumes are the organization''s goals some form of sales commission plan should be utilized. On the other hand, where there is an emphasis on customer service some form of salary payment plan should be used. An organization''s strategy indicates the types of behavior the organization is seeking; therefore, its sales compensation scheme must reward these behaviors. Failure to do so will only result in counterproductive behavior by the sales force.

Practices of Competitors

A major factor shaping, or in some cases dictating, the form of sales compensation used is the type of plan used by competing organizations. By the nature of the profession, salespeople frequently cross the paths of each other and are thereby afforded the opportunity to discuss pay plans of their organizations. An organization whose pay system is out of sync with the market may find turnover of its sales force is unreasonably high. Competing organizations are, consequently, forced to use compensation systems similar to their direct competitors.

Products or Services Sold

Some products or services require a great deal of time and effort before a sale can be consummated - large-scale computer systems, commercial aircraft or commercial real estate, for example. Other products or services - used automobiles, lawn mowers and nails - require shorter selling periods. In the former case, straight salary or salary plus a small commission are typically required. In the latter case, a small salary plus a larger commission or a straight commission plan may be needed. Where products tend to sell themselves different compensation approaches are called for than in situations where technical expertise and extensive salesmanship are necessary to sell a product or service.

Other Considerations in Sales Compensation

Compensation experts often recommend consideration of a three-step plan for designing a sales compensation plan. First, the design process should be broadened to focus on all elements of sales compensation: payout mechanics, pay levels, payout frequency, performance measures and weights, pay mix (percent fixed versus variable, and incentive form (commission versus bonus).

Second, organizational strategy, job roles and competitive pay levels should be used to drive the design process. An organization must consider more than the affordability and business economics of the plan.

Third, sales rewards must be tied to organizational goal setting. Linking rewards to goals communicates how the salespeople will be paid and, more importantly, what they are expected to achieve.

It is important to bear in mind that compensation is only one part of an effective sales management foundation. No matter how good the compensation plan is, it will not make up for organizational deficiencies in definition of the sales role, communication efforts, training and development opportunities, sales staff selection processes or other areas.

Essentially, compensation should always be a by-product of a company''s sales strategy. The specific approach used should be defined by such things as variances in local markets, product strengths or weaknesses and the competitive posture of the organization''s products and services.

There are some definite cautions in designing sales compensation plans. First, compensation plans cannot be expected to take the place of effectively managing a sales team. Commissions can easily be overrated as motivational tools. Moreover, motivation is often over-rated in comparison to competence. Good management of the sales representatives should improve both competence and motivation of sales personnel. Good management is often considerably more important than compensation.

No compensation plan can make, or should be expected to make, salespeople more competent. Managers often make the incorrect assumption salespeople know what to do and simply need some type of incentive to do more of it. Motivation without competence is, however, nothing more than good intentions.

A manager''s job is to work with the sales team. Managers must evaluate and teach. A manager who does not invest a majority of his or her time with the salespeople is not an effective sales manager.

Second, where there is a traditional sales route, sales commission should not be the driving force behind the route structure. Frequently managers are interested in being fair with all salespeople and attempt to provide all sales personnel with equal earnings opportunities. Consequently, managers often adjust sales routes for income purposes, failing thereby to consider the impact of this adjustment on the effectiveness of salespeople.

Routes that are designed around compensation or earning potential may overlook key issues as travel time, overlapping territories, the number of stops, skill fit for the account and time required to do an effective job. Operational inefficiencies may result from such actions: excessive deliveries one day, too few the next day or overlapping deliveries due to overlapping territories.

Third, compensation and job requirements must not be misaligned - for example, paying commissions on sales when the sales job is basically inventory replenishment or merchandise restocking. The pay system must fit the sales job or the sales team may begin to feel they are being treated unfairly. This may have an adverse impact on motivation and productivity levels.

Fourth, any compensation plan that is implemented should be one that can be managed effectively and as easily as possible. Sales compensation plans require time and precise performance tracking. If supporting internal systems are weak administration of the plan will take excessive time and effort to manage effectively.

One way of determining if a plan is too complicated is to ask sales personnel to provide feedback concerning the plan. Management should listen carefully to this feedback and make adjustments as required. If sales personnel have difficulty explaining or understanding the plan, it is obvious adjustments must be made.

Some sales compensation plans place emphasis on payment for goal attainment. These plans can be very effective if they remain simple and communication is sufficiently explained to those affected. However, such plans can do more harm than good if managers are not skilled in setting goals and measuring results. Poor goal setting can result in goals too high to be attained; if so, de-motivation may occur. Goals set too low may result in such unfortunate organizational results as higher costs, poor productivity levels and failure to achieve overall sales objectives.

Fifth, commissions should not be relied upon to drive long-term market share development. While commissions can be effective they may also provide little incentive for development of new markets or the introduction of new products. A new product, for example, generally requires a high level of intense up-front sales time. As a result, the new product is often not afforded the requisite sales effort because the sales time required is too excessive for the amount of compensation received. It is easy and convenient for sales personnel to continue spending their time selling established product lines and earning sufficient income levels.

Any sales compensation plan must clearly specify all payment options such as whether full or partial payment is contingent on the customer''s paying in full. Or, how will the organization handle future commissions in the event of a termination of sales person -are commissions contingent on continued employment? all payment details must be specified in advance and put in writing to make sure all possibilities are covered.

Draws against commissions sound simple but in reality they can be confusing. In most states, unless there is a written agreement stating otherwise, a draw is considered a salary.

How draws or advances are to be handled must be clearly specified in the sales compensation plan.

Experienced sales managers know the highest-earning salesperson is not always the best employee.

The compensation plan must specify that what a salesperson earns is not necessarily related to overall job performance.

Clarifying this issue up front helps protect an organization. Otherwise it may be difficult to terminate for poor performance, such as inappropriate behavior toward customers or co-workers, a salesperson who is highly paid.

(C) 2004 The American Salesman. via ProQuest Information and Learning Company; All Rights Reserved.

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