Most sales forces link some portion of sales people’s pay to sales metrics. For example, they pay a commission on the revenues sales people generate or a bonus for achieving a territory sales quota. This proven ‘pay for performance’ approach motivates sales people to work hard and drive sales results.
Related: Creating inventive sales incentives
But today, companies increasingly expect sales people to deliver not just sales but profitable sales growth. Logically, it follows that a sales force can align sales people’s effort with company profitability goals by linking incentives to profit, rather than
sales metrics.
When an industrial lubricants distributor started paying commissions on gross margin rather than on sales, for example, the message to the sales force was clear and the impact immediate.
Sales people curtailed price discounts and focused their effort on more profitable product lines, leading to accelerating margin growth. However, when a medical device company started paying commissions on margins instead of sales, constant change in product costs, distribution costs, product rebates, and portfolio rebates made it a nightmare to determine territory-level margins. The plan was abandoned after just one quarter.
To help you determine whether paying sales people on profitability is something you should consider, start with two questions.
1. Is profitability strategic?
Companies sometimes sacrifice profitability for reasons such as building market share, blocking a competitor, or gaining entry into a market. Consider paying sales people for profitability only if profitability is a strategic goal.
2. Is profitability controllable by sales people?
Sales people who sell a single product at a set price have no impact on the gross margin of sales; the way they increase profits is by selling more volume. Thus, there is nothing to be gained by paying on profitability; the result will be the same as paying on sales. Sales people have the ability to impact gross margin when – 1) they can influence price and/or 2) they sell multiple products with varied margins. Paying sales people for profitability only makes sense if at least one of these conditions applies.
If profitability is both strategic and is within sales people’s control, then four additional questions can help you determine the best approach for using incentives to encourage more profitable selling.
3. Can you measure gross margin at the territory level?
The most straightforward way to encourage sales people to sell more profitably is to use the approach that worked for the industrial lubricants distributor – pay incentives on territory gross margin rather than sales. But as the medical device company discovered, measuring and reporting on territory gross margin in a timely and accurate fashion is sometimes more difficult than it seems.
Even when information systems allow measurement, complex calculations can make it challenging to gain sales force understanding and acceptance of gross margin metrics.
If you can measure and report on territory gross margin at reasonable cost, then pay on gross margin. But if the cost is too great, consider other options for using incentives to encourage more profitable selling (see questions 5 and 6).
4. Do you want to share profitability data with sales people?
If you can measure territory-level margins but want to protect the confidentiality of profit margins from customers and competitors, you may want to avoid sharing margin information with sales people.
Some companies have had success paying on margin proxies – artificially calculated margins that reflect the relative profitability of products, without revealing actual margins. Yet margin proxies still reveal a lot of information. If confidentiality is a big concern, consider other options for encouraging more profitable selling (see questions 5 and 6).
5. Do sales people influence price?
If the cost of measuring and sharing territory gross margin is too great, then linking incentives to average selling price is a good alternative for encouraging profitable selling when sales people influence price. For example, an office products supplier had a commission plan with a multiplier linked to average selling price performance.
Deals booked at more than 3% below list price earned the salesperson a base commission rate. For deals booked within plus or minus 3% of list price, sales people earned the base commission rate times a 1,1x multiplier.
For deals booked at more than 3% above list price, sales people got the base rate times a 1,25x multiplier. The multipliers discouraged sales people from conceding price in order to outperform on volume.
6. Do you want to drive sales of higher margin products?
If the cost of measuring and sharing territory gross margin is too great in a sales force that sells multiple products with different margins, then paying on sales by product grouping is a good alternative for encouraging sales people to spend time on more profitable or strategically important products.
For example, a technology company created an incentive plan with two product groupings: ‘strategic products’ (newer products with paramount strategic importance and an average 50% gross margin) and ‘core products’ (older products with an average 30% gross margin).
Related: Motivating Sales People – What Really Works
Sales people earned a 5% commission on sales of strategic products, but just 2,5% on sales of core products. The commission rate differential encouraged sales people to focus on higher margin products, thus boosting overall profitability.
© 2015 New York Times News Service.
