Reprinted with the permission of CSCMP’s Supply Chain Quarterly, Quarter 1, 2011
by Beth Carroll
DESIGNING EFFECTIVE SALES COMPENSATION IS AN ART
When done well, it enables companies to develop the right mix of individual motivation and team-work while balancing the needs for both short-term financial gain and long-term strategic positioning. When done poorly, however, companies can end up creating at best a culture of complacency and entitlement, and at worst a culture where sales representatives are working to maximize their own incomes to the detriment of the company.
Many providers of supply chain services, such as transportation brokers, customs brokers, freight forwarders, warehouse operators, third-party logistics companies, and carriers, compensate their sales force using approaches that are more suited to start-ups than to mature, established businesses. By using the best practices outlined in this article, these types of companies can maximize the return on their sales investments and become stronger competitors.
Don’t pay more for less work
Providers of supply chain services tend to approach incentive compensation from a simplified, “cost of sales” viewpoint. After determining how much they think they can afford to pay for the sale of a particular product or a service, they establish a straight-line commission plan—for example, 5 percent of margin for truckload brokerage or 0.5 percent of revenue for third-party logistics (3PL) services. They then pay that percentage for as long as the salesperson and the customer remain with the company.
This approach may work for start-up companies, but it quickly falls apart for high-growth or mature organizations that invest large amounts of money in marketing, advertising, customer service and support, technology, training, and other programs that build brand awareness and help to attract and retain customers. That’s because the “cost of sales” approach fails to take into account the fact that these programs also have the effect of reducing the effort a sales representative must put forth to secure and retain customers. In fact, the contributions of other employees may have a greater impact on customer retention than those of the sales representative, who perhaps only gets involved with the customer when it’s time to renew the contract.
For example, if a company starts by paying its sales staff 10 percent of revenue and continues this approach as the company grows, it could end up paying more than the market rate for similar positions. Furthermore, it will be compensating sales representatives at the same level for what is likely to be less work. As a result, the company risks creating a complacent sales force that does not bring in enough new customers.
Three best practices
To avoid developing a complacent sales force, companies need to shift from the start-up “cost of sales” mentality to a more mature “cost of labor” approach. To accomplish this, it’s important to follow three best practices in sales compensation design:
▪Set the target total compensation (TTC) based on current market value
▪Match the pay mix to the sales role
▪Design pay elements to provide the right balance
To start then, companies need to determine the market value for each sales job. This ensures that they will be able to attract and retain top talent with-out overpaying or creating a disincentive for new-client acquisition. There are many market surveys available that can help you benchmark pay levels, but be sure to look at “actual total compensation” (or “tar-get total compensation” if actual is not available) and not just salary to get the full picture for a sales job. Total compensation is important because the salary may be only 50 percent of the compensation package, and the portion that comes from incentive compensation (commonly called “sales commissions”) can vary greatly from one company to another.
Similarly, benchmarking based on commission rates alone is a mistake. In the logistics industry, one company may pay a higher portion in salary and have a lower commission rate for a given product or service, while another company may offer a lower salary but a higher commission rate. Further, well-designed plans should have other variable elements besides commissions; for example, a commission rate based on margin may be offset by a bounty for new business acquisition.
Once you know the industry baseline, set the pay mix based on the nature of the selling role. “Pay mix” refers to the portion of target total compensation that comes from salary (fixed pay) versus incentives (variable pay). Not all selling roles in an organization should have the same pay mix. The more direct and personal control the sales representative has over the outcome of a sales call, the more compensation should come from variable pay (incentives) rather than from fixed pay (salary). When other factors, such as high brand awareness, low price, limited product availability from other sources, aggressive marketing promotions, or high switching costs weigh heavily in the customer’s decision to buy (or keep buying), the sales-person is less directly and personally responsible for the revenue from the customer, therefore less compensation should come from variable pay and more should come from fixed pay.
Generally speaking, “hunters,” or salespeople who focus on gaining new accounts, should have more variable pay than “farmers,” or account managers who focus on maintaining and growing existing accounts. Most customer support roles have the least amount of variable pay of all.
After determining the right mix of variable and fixed pay, companies need to make sure the elements that determine incentive pay provide a balance between financial and strategic objectives, individual and team effort, and short-and long-term focus. An element is the combination of:
▪performance measure (the metrics used to judge performance; for example, revenue, number of new customers, or percentage of margin);
▪scope (the level of aggregation at which performance is measured, such as individual, team, region, or company);
▪performance period (what time horizon determines the start and end for sales credit);
▪pay frequency (how often incentives will be paid); and
▪mechanics (what mathematical formulas will be used to calculate pay).
Well-designed incentive plans like the example in Figure 1 include more than one measure of performance. The best-designed plans have three elements, but a case can be made for using two or four elements in some circumstances. Going beyond four makes it difficult for the sales representative to give adequate attention to all parts of the plan, and he or she may decide to focus only on those elements that will make the most money and ignore the rest.
By following these three best practices in sales compensation design, companies can maximize the return on their investments in what is likely a very large part of their selling, general, and administrative (SG&A) budget. Additionally, the right design can help companies position themselves for increased growth and improved strategic position relative to their competitors, whether they are competing for customers or for top sales representatives, or both.
Editor’s Note: For more about formulas used for determining pay, see the online version of this article at For more about formulas used for determining pay, see the online version of this article at www.SupplyChainQuarterly.com/columns/scq201101careerladder/
Beth Carroll, CCP, GRP, CSCP, is a Principal with The Cygnal Group, a consulting firm that helps companies design, communicate, and manage their sales compensation plans. She can be reached at email@example.com.