Article 5.9

DESIGN YOUR SALES INCENTIVE PLAN TO REWARD PERFORMANCE

Like many managers today, you may be exploring new sales incentive plans to fire up the troops, to keep your best salespeople, and to add to your company's profitability. But be careful not to adopt a new plan that falls into the same traps as the old one.

Studies have shown that employees and management alike are dissatisfied with their compensation plans. Most employees see no connection between their performance and their pay. And many managers find that their plans fail to motivate their staffs and that they end up overpaying poor performers.

It seems to be getting more difficult to pay according to performance. It's especially tricky to reward individual successes because integrated team efforts have become more essential in meeting customers' needs. Many customers now make their buying decisions based on a vendor's overall capabilities, not because of a key individual's efforts.

As a result, the piece-rate approach to compensation, born in the era of mass-production and standard products and services, doesn't work today. Paying by the sale doesn't coincide with trying to meet customers' expectations regarding quality, variety, unusual requests, and a total package.

Traditional incentive plans also hinder pay-for-performance because they try to do something for everyone. They award across-the-board annual cost-of-living raises; they use performance appraisal systems that end up rating everyone a B+ or better; they apply a merit increase index with a narrow range such as 3% to 5%. These practices discourage high performance.

Sky's The Limit

In designing an incentive plan, don't place a limit on earnings. The increased profitability that comes from top sales performers will afford their extra pay. If results are so good that pay skyrockets, don't let managerial envy or greed interfere.

Don't substitute incentives for fair wages. Employees are most interested in a guaranteed income level. Whatever formulas you use, a salesperson's W2-form total must be in line with market rates.

Putting rookies on commission only is a mistake. Veteran high-performers can afford to be at risk for bonus compensation. But if you substitute risk and incentives for fair pay at the entry level, you'll only attract losers who can't command the market price.

Instead, pay new hires a competitive fixed wage for three to six months while you train them. Once they have taken over a territory, you can put them on a lower guaranteed draw with a "likely" monthly commission check that will put them a bit over their previous base wage. Then, the harder they work, the more they make.

When you review salaries each year, rank salespeople by how good a job they have done. Don't give automatic cost-of-living increases. Give achievers big raises. Weed out non-performers or cut their pay and tell them why.

Nurture New Business

Get rid of compensation formulas that support account custodians. Many salespeople earn good incomes harvesting loyal accounts that would keep buying no matter who, if anyone, called on them.

Instead, look for ways to compensate salespeople more for new business. For example, pay three or four times more for new growth results than for maintenance, have 10% to 20% of your force made up of people geared to new-growth results, and strip away mature accounts from salespeople who tend to harvest them.

Build in incentives for salespeople to hold firm on prices, special charges, and terms. Consider attaching a positive or negative incentive to every possible economic concession to customers. If salespeople lose money when they discount, they'll be less apt to do so just to make an easy sale.

Small-order accounts also can be unprofitable for the company, so it's a mistake to make them profitable for salespeople. Provide incentives to build average order size.

Pay Commission on Profit

One way is to replace sales-based commission with higher commission percent of a gross profit figure. But, first, subtract the incremental cost of filling an order, because that is what makes small orders less profitable. You can apply a flat charge, a percentage, or both.

To see how this works, let's take the example of a specialty hardware distributor that had been paying 5.5% of sales on any sale. The problem was that salespeople received commission on small orders that the company lost money one.

The company replaced that system with a new formula: 30% of the gross profit from an order, after reducing that profit by a 2% cost load and a flat $18 order-processing charge. Under this system an order with $18 in gross profit would turn into a loss after the reductions were made. The salesperson would actually be charged 30% of the loss- a strong incentive to give up small-order accounts.

Under the new plan, salespeople make a higher rate on any order larger than $50 gross profit, whereas they could lose money on smaller orders. The company's resulting average sales expense was 19% of its gross profit, which translated to 5% to 6% of sales- about the same total payout as before. But top performers now get a bigger price of that payout.

This type of plan will encourage salespeople to give up their small accounts either to telemarketing or to in-house order fulfillment. Don't let your plan equate outside selling with the inside sales desk; they are different jobs. Outside sales handles fewer, larger accounts, while inside small quickly disposes of many small orders with less expense to the firm.

Structure your plan to avoid competition between employees or departments, which would undermine their cooperative spirit. Make the external competition the source of motivation.

After you establish a new plan, sell it to salespeople one-on-one first and then follow up with a meeting. To help them understand it and plan new strategies, give everyone a report that ranks customers by gross profit per invoice dollar. Point out accounts with too many small orders and explain the importance of building order size. Then give them time before the new plan takes effect and weed out unprofitable accounts.

To get your salespeople to buy into the changes, sign up some of them to help gather, post, and explain the numbers. And remind everyone that nothing ever goes perfectly according to plan and that they must be open-minded and prepared for fine-tuning.

Exhibit I

Types of Variable Pay Plans

Gainsharing plans are operating-unit-wide bonus systems designed to create, measure and share improvements in productivity among everyone.

Group incentives are similar to gainsharing plans, except that bonuses are based on the performance of a small group rather than a larger unit. Formulas and amounts can vary from group to group within a unit, depending on performance and the nature of the work. Plans may be tied to an organization's strategic objectives or to its productivity measures.

Individual incentives tie all or part of an employee's pay to his own performance. This type of incentive typically is used where individual output is quantifiable.

Key contributor programs reward individuals or teams whose skills, abilities, or contributions make a significant impact on the company's products, services, technologies, or processes, thereby resulting in increased profitability, competitive advantage, or productivity.

Knowledge- or skill-based programs determine pay by the number of jobs an employee can do or by the level of skill used at a particular point in time.

Long-term programs, such as stock options, reward executives or other key employees for corporate or unit performance over a period of more than a year.

Lump-sum payments are usually implemented as a cost-containment measure. Eligible employees are awarded a one-time payment or bonus instead of all or part of a base salary increase. The payment does not become part of the base salary.

Profit sharing refers both to traditional supplemental retirement plans and to immediate cash bonuses, based on unit or corporate profit performance.

Two-tier structures pay new hires at a lower rate (as much as 50% less) than other employees in similar jobs.

Exhibit II

Test Questions for an Incentive Plan

If you're designing a new sales incentive plan, first weigh the pros and cons of your present plan. What job objectives does it overemphasize, meet adequately, and fall short on?

Generate alternate plans and test them by stimulation. Decide what percentages of compensation will be fixed and variable, and how the variable portion will be allocated. Be sure that your new plan will accommodate special conditions and meet the following criteria:

  1. Does the plan reflect your firm's strategic objectives?
  2. Is the structure and allocation of incentive pay for each job consistent with the priorities and sophistication of the people in those jobs?
  3. Will the plan reinforce what employees have already been trained and encouraged to do?
  4. Is incentive being paid for tasks that the individual can control and measure?
  5. Will the plan improve the quality of the overall job and the spirit of cooperation among employees?
  6. Does the plan respond to events out of the employee's control, such as bad economy or the loss of a key franchise?
  7. Will the program accommodate shared responsibilities or splitting commissions for special accounts or orders?
  8. Is the plan simple enough for the employee to understand it and keep his own score if he wants to?

 

© Merrifield Consulting Group, Inc., Article 5.9