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Contribution-based compensation is a time-tested approach to
sales force compensation that has been proven to offer significant benefits. At the foundation of this strategy is the belief that the best
way to set up compensation plans is to tie them directly to the costs of running
the company. Sales representatives contribute their share towards corporate
expenses and profit. After their contribution is paid, they keep most of the
rest of the money they bring into the company.
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Firms that have introduced this approach benefit in
several ways: |
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The opportunity to make an unlimited amount of money
provides a significant incentive to sales representatives. They
typically become more productive, so corporate revenue increases. |
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It becomes easier to recruit new sales associates,
particularly top producers. Improved recruitment translates into faster
growth and increased market share. |
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A pre-defined level of profit is built into the
plans, ensuring long-term profitability, which adds value to the
business and enhances the firm's financial stability. |
Here's how it works...
Cover corporate expenses
The first goal of any company should be to make sure it can pay its bills.
Expenses come in two types: fixed and variable. To simplify a
little, fixed costs are expenses that do not increase as business increases.
Examples include office space, utilities and salaries for support staff and
management.
Variable costs are expenses that vary with the amount of
business you do. Commissions, telephone charges and manufacturing costs are
variable expenses. Variable costs are tied to revenue—if you don't have any
sales, for the most part, you don't have those expenses. But whether or not you
bring in any money, you still have to cover your fixed expenses.
Fixed costs can be allocated equally among sales associates,
with each associate responsible for bringing enough revenue into the company to
cover his or her share.
Variable costs also need to be paid out of the revenue a sales
representative brings in. However, because those costs are tied to sales,
instead of allocating them equally, it makes more sense for each representative
to be responsible for the variable costs associated with his or her sales.
Build in profit
The second goal of any company should be to make a profit. The best way to
ensure profitability is to add the desired amount of profit into the expense
allocation.
Profit can be treated as either a fixed or a variable expense.
If it is designed as a fixed expense, that puts an upper cap on profit. So most
companies prefer to define it as a variable expense. This allows them to
continue to benefit as revenue grows.
This approach is an unusual one—most businesses define profit
as what is left over after expenses—but treating profit as an expense, and
planning for it, is the most effective way to make sure the company is
profitable.
Allocate expenses among sales associates
The next step is to allocate the expenses fairly among the sales
representatives. You need to make everyone responsible for contributing the same
amount. Anything else penalizes top producers and is a disincentive to selling
more. But, realistically, some people won't be able to bring in that much.
We use a concept called the "fully productive
equivalent," which counts newer sales associates or low producers as
partial representatives rather than whole ones. So, for example, at an office
with 16 sales representatives, the fully productive equivalent may be 13-1/4
representatives.
This method of accounting for the reduced contribution of low
producers brings a higher level of accuracy to the expense allocation.
Derive commission levels
The next step is to identify the correct placement of commission levels.
Divide total expenses by the fully productive equivalent number
of sales associates. This is the breakeven point, or the amount of money each
sales associate needs to bring in to cover corporate expenses and profit.
Then determine what percentage of each sale needs to be held
back to cover variable expenses. That provides the maximum a company can afford
to pay out once fixed expenses are covered.
Design plans
Once you have calculated the amount each representative must contribute for
corporate expenses and profit, along with the highest commission level the
company can afford to pay, you are ready to start designing compensation plans.
One way to structure plans is to have the representative's
commission level start out low, because the company is keeping enough money to
pay both fixed and variable expenses. Once the company has taken out enough
money to pay fixed expenses, that contribution stops. The money that was going
to the company to pay fixed expenses now goes directly to the sales
representative. The sales representative will now typically receive a
substantially higher commission.
However, that method may not be appropriate for your sales
force. Using CompensationMaster's software, you can design any type of
compensation plan you want: salary plus bonus, 100% commission, high split,
retroactive, etc. You can build in any type of perquisites, any type of
benefits.
The software will tell you whether each plan you create meets
your profitability goals or if it will put you in the red. This reduces the risk
of implementing new commission structures, and allows you to design compensation
plans with confidence.
Offer a choice
A crucial component of CompensationMaster's approach is to offer sales
representatives a choice of compensation plans. Experienced representatives who
are confident in their own abilities appreciate the option of maximizing income
with a 100% commission plan. New recruits or those who have high fixed expenses,
such as children in college, may prefer to trade some of their commission
potential for a higher level of guaranteed income.
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Offering a choice brings powerful benefits: |
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Improved motivation—when representatives choose the
compensation structure they find most appealing, it motivates them more
effectively and more permanently than any temporary incentive plan. |
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Easier recruiting—offering a choice of
compensation plans is an attractive benefit that provides a competitive
edge in recruiting. |
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Expanded labor force—there are many people for
whom your current style of compensation is not appropriate, yet who
would make excellent members of your sales force. By offering different
plans, you expand your potential pool of recruits. |
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Eases introduction of new plans—providing a choice of
compensation plans gives sales associates more control during a time of
change, increasing retention rates |
When commission structures are designed to meet the needs of
various types of employees, the company can also more accurately recoup its
costs. For example, an experienced representative who does her own lead
generation and requires little in the way of support services costs the company
much less than a newer associate who needs extensive training and support. On
the other hand, a top producer who requires a corner office, a late model
company car, and two assistants may be very expensive to support. By offering a
choice, the company can customize compensation plans so that all members of the
sales force receive—and pay for—the support and services they need, without
having to pay for things they don't want.
Although the logistics of offering a variety of plans might seem
intimidating, it's actually much simpler than might be expected. You can handle
compensation the same way you do health insurance: once a year, employees choose
their plan for the following year. Typically, there is an open season or
representatives make their choice on the anniversary of the first day they
started with the company.
The bottom line is that when sales representatives are able to
choose the type of compensation plan that best fits their needs, their tolerance
for risk, and their lifestyle, they are motivated far more effectively than with
any one-size-fits-all type of commission structure. The result is a more
productive and stable sales force.
To learn more, schedule a demonstration over the Internet.
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