By Shari Dunn, Compensation Consulting, Arthur J. Gallagher & Co.
As we’ve worked with clients over the years to develop new sales compensation plans, we’ve noticed that there is a tendency to start the design process by assuming that the plan will be focused on commissions. A commission is a variable pay component that is typically expressed as a percentage of sales revenues. It can be 100% of the pay, or it can be combined with a base salary. Sounds simple, right? Well, perhaps, in some cases. We’d suggest, however, delving more deeply into the situation before making that decision.
We have found that there are a number of alternative approaches that have the potential to be better choices than pure commission plans. One especially effective approach is to base the variable portion of sales compensation on systematic measures of goal achievement that have been tailored to each sales job. Another possibility is to pay sales teams, if such teams exist, based on aggregate performance.
As with most endeavors, planning can be critical to success. When planning a new or modified sales compensation plan, here are the sequential steps we recommend:
Define the sales process. This is the essential starting point. During this step, determine the answers to these questions:
What is sold? (products, services, commodity, custom, how many types)
How do sales occur? (channels, length of sales cycle)
Who are the customers? (B2B, B2C, transient or long-term, direct or through distributors, high or low volume, distant or local)
How are the sales jobs defined? (functions, expected results, supervision of others, degree of decision-making authority, including pricing, limitations)
What are the desired performance results? (volume, profitability, repeat business, up-selling, forecasting accuracy, customer service, expense control, etc.)
Establish the FLSA status (exemption) of each job. Although viewed as a minor detail to some, California in particular has stringent rules that define whether employers must pay overtime to sales people, especially if they are “inside” sales representatives. Special rules may apply, but the job needs to be properly classified before plan design can be done.
Determine desired plan features and provisions. Some of the key decisions that need to be considered are:
Eligibility and eligibility waiting periods
Ratio of target fixed to target variable pay
Frequency and timing of performance measurement
Frequency and timing of variable pay payouts
Results to be targeted and measured
Linkage of results produced to pay consequences (formulae, commission, conditions, etc.)
Responsibility for computation and communications
Duration of payouts for long-term results
Consequences of such occurrences as returns, re-work, disputes relative to territories, ownership of customers, etc.
Effects of terminations, transfers and disability and/or death on plan payouts
Obtain and analyze competitive data. Establish market rates of pay on a job-by-job basis as a means of determining job values and target variable pay.
Develop data on past practices and payouts. This needs to be used to compare prior pay levels to potential new levels, a critical step in making sure the new plan will be motivational.
Develop product-specific cost-of sales data. This is a critical analysis to assure that the compensation costs associated with sales results are reasonable and consistent with the company’s business plan.
Develop desired target performance results for each job. Considering the sales process and the job descriptions, define actual targeted performance outcomes on a job-by-job basis, first by category of result, and then in measurable quantitative terms.
Model plan costs and payouts under assumed alternative scenarios. This is an essential process of forecasting the degree to which the plan will produce the desired results, both from the company’s and the employees’ point of view.
Create final formulas and plan documentation, including communications materials. This will be the final step and will be based on all of the prior steps.
Simple, on the back-of-a-napkin, sales compensation plans have a tendency to backfire. They are likely to generate ill will among the sales staff, and also cost the company more than necessary to achieve the desired results. Remember, as Yogi Berra once said, “If you don’t know where you are going, you might wind up someplace else.”
About the Author
Shari Dunn is a Managing Director of the Compensation Consulting Practice for the Human Resources & Compensation Consulting team of Arthur J. Gallagher & Co. Her practice helps organizations strengthen the performance of their organization with sustainable solutions for compensation, program design, employee engagement, executive compensation, HR audits, surveys, training and development, recruiting solutions and more.
Managing Director, National Practice Leader
Human Resources & Compensation Consulting
Consulting and insurance brokerage services to be provided by Gallagher Benefit Services, Inc. and/or its affiliate Gallagher Benefit Services (Canada) Group Inc. Gallagher Benefit Services, Inc. is a licensed insurance agency that does business in California as “Gallagher Benefit Services of California Insurance Services” and in Massachusetts as “Gallagher Benefit Insurance Services.” Neither Arthur J. Gallagher & Co., nor its affiliates provide accounting, legal, or tax advice.