Sales Commission: Sales Compensation Q&A

by Alan Rigg

This article addresses three frequently asked questions related to sales compensation plans.

Question #1

In trying to create a fair breakout of the cost of sales, I came up with the following components:

1. Lead Management: Includes cold calls, lead followup, and prospect followup
   
   
2. Demonstration/Design: Includes demonstrating the products and designing the solution
   
   
3. Proposal Generation: Create/present the proposal

I was thinking that they are roughly equally important so I was going to apply a commission scale as follows:

• 10% of net profit for Lead Management
  
  
• 10% of net profit for Demonstration/Design
  
  
• 10% of net profit for Proposal Generation

Some of my other thoughts are that a salesperson could demonstrate the products for simple demos, which would give them more opportunity for increased commission.

Answer #1

I think consistency is critical to building an effective sales culture, for two reasons. First, you want to set very clear expectations for your salespeople, i.e., "this is how we manage the sales process here at (company name)". Second, you want to provide a predictable, repeatable customer experience.

While some salespeople probably will have the talents required to learn how to do Demo and Design effectively, other's won't. If a salesperson doesn't deliver an effective demo or design a good solution, it will negatively impact your chances for winning deals.

I recommend that salespeople focus their time on finding and qualifying new opportunities, writing proposals, and closing sales. That doesn't mean they should be "banned" from attending demos. If they do attend a demo, they shouldn't DELIVER the demo. (Let a real expert in whatever is being demonstrated do that.) The salesperson's role should be to keep the demo focused on how your solution solves the prospect's identified business problems, and making sure the prospect's questions are interpreted correctly.

I would be hesitant about offering salespeople the opportunity to choose which parts of the sales process they participate in. It's just human nature that most of us would prefer to spend time working on identified opportunities rather than finding new ones. Working on identified opportunities makes us feel productively busy, and we get to interact with "friendlies", which is more comfortable than dealing with strangers.

In my opinion, the key to scaling your business as rapidly as possible will be to make your salespeople into PROSPECTING and QUALIFYING machines. Expertise in these areas will also help them collect the data required to write effective selling proposals. Also, doing an effective job of quantifying the impact of a prospect's business problems and focusing demos and proposals on how your solution solves the prospect's specific business problems will maximize close rates.

In this scenario, everybody wins - the prospect, who receives the critical information required to make a valid purchasing decision and solve damaging business problems; your salespeople, who maximize commissions earned; and your company, which maximizes profitability and customer satisfaction.

Question #2

Are most plans based on a percentage of gross profit or total revenue? Which one is preferred? We have a concern about having our profit margins being known in our industry.

Answer #2

The decision as to whether to base a sales compensation plan upon revenue or gross profit is determined by company-specific factors.

If your salespeople sell from a fixed price schedule and do not have much latitude to change prices without management approval, then determining compensation as a percentage of revenue makes sense. You could even establish different commission percentages based upon different price bands (with the commission percentages declining as the profitability of the price bands declines). This would give your salespeople some pricing latitude, yet still incent them to secure the highest possible margins. Plus, it would protect the confidentiality of your profit margin information.

If you want to motivate salespeople to produce the highest possible gross profit, then it is desirable to base compensation plans on gross profit. A common approach is to offer a "sliding scale" that increases and decreases the compensation percentage based upon the profitability of each transaction.

For the sake of discussion, let's say your target gross profit percentage is 20%, and the target compensation is 10% of gross profit. In a sliding scale model, the compensation percentage would be adjusted upward if the gross profit is higher than the target percentage, and downward if the gross profit is lower than the target percentage. For example:

You can have as many or as few steps as you wish in the sliding scale, and you have complete flexibility when determining how much each step increases or decreases the compensation percentage. Usually it is wise to cap the compensation percentage on both the plus side and the minus side.

Question #3

I have a friend that has started a company. He has been successful with the sale of his product in this first year. However, he is asking some of his friends that need work to sell his product for him. It seems to me if he wants to have a viable sales force he needs to make it possible for us to actually make an income from our sales. So I guess what I'm asking is, on commission sales, what should the salesperson's commission be as a percentage of net profit?

Answer #3

Your question is a tough one, as there is no hard and fast rule on what percentage of revenue or profit a company should pay in commissions. A company needs to look at ALL of its costs of operations and determine how much profit it needs to retain to pay all of its bills (fixed costs as well as variable costs), and make a desired level of profit.

By the same token, your point is absolutely correct - if he wants to have a viable sales force, it must be possible for the salespeople to make the living they want to make from their efforts.

The end result is it all boils down to a negotiation that addresses the following questions:

• What do you need to earn to make selling your friend's product worth your time?
  
  
• How will increased sales impact the overall profitability of his business?
  
  
• Are there any economies of scale that can be enjoyed as a result of higher sales?
  
  
• Can he afford a dedicated, full-time sales staff, or does he need to consider part-timers, or working with manufacturer's representatives that sell a portfolio of offerings?
  
  
• Who would you be selling to? Is it individuals, resellers, or some of both?
  
  
• How many of the product can you reasonably expect to sell in any specified time period? (That quantity will be a key factor in determining the commission rate you need to earn per product sold to make it worth your while.)

One thing your friend needs to keep in mind is that any salespeople he engages should bring INCREMENTAL business to the table. Incremental business is like "found money". Your friend should consider:

• How much of that "found money" does he need to put in HIS pocket to make it worth his while to fulfill the orders?
  
  
• What is it worth to him to get that incremental business and not have to invest the time and effort required to make the sales himself?
  
  
• What other activities can he apply that time (and incremental profit) to that will accelerate the growth of his business?

©2005-2008 Alan Rigg

About the Author

Sales performance expert Alan Rigg is the author of How to Beat the 80/20 Rule in Sales Team Performance: A Step-By-Step Guide to Building and Managing Top-Performing Sales Teams, and the companion book, How to Beat the 80/20 Rule in Selling: A Step-By-Step Guide to Achieving Top Sales Performance. His 80/20 Selling System™ helps business owners, executives, and managers end the frustration of 80/20 sales team performance, where 20% of salespeople produce 80% of sales. For more information and more FREE sales and sales management tips, visit http://www.8020salesperformance.com.

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