Fuller Brush salesman Fred Wetstine making call on housewife. Photo: Alfred Eisenstaedt, Google LIFE photo archive © 1946 Time Inc.
A motivated sales force is the heart of any business, but the law of unintended consequences can derail your enterprise if the commission incentive drives the wrong behavior. You don’t want to misalign the sales force with the interests of your company.
Some common pitfalls are:
- Plans that lead to excessive discounting
- Plans that cause a misallocation of the reps time across your product line
- Too high or too low a quota
- Too high or too low a commission percentage
- Plans that have no flexible commission on loss leaders.
Let’s look at some examples and solutions.
Products with different gross margins
Widgets and Thrum-mats have similar list prices, but the cost of making Widgets is much lower than the cost of making Thrum-mats. A revenue-based plan leads to a lost opportunity because the reps have no incentive to focus on high margin Widgets.
Solution: Pay commissions as a percentage of gross margin (= revenue – cost of goods) instead of a percentage of revenue. An approximate cost of goods is fine, perhaps expressed as an amount per unit sold. Increase the commission percentage so that the overall amount of commissions is about the same. The reps will spend more effort trying to sell Widgets than Thrum-mats, aligning their interest with those of the company.
Products with different warranty costs
Now imagine Widgets and Thrum-mats have similar list prices and gross margins, but Widgets incurs much lower warranty costs than Thrum-mats. The problem is similar to the example above, except that now the cost difference is in operating expense instead of cost of goods.
Solution: Pay commissions as a percentage of revenue (or gross margin) less an operating expense charge for warranty maintenance that is smaller for Widgets than for Thrum-mats. Again, the goal is alignment of interests.
In this scenarios, Widgets and Thrum-mats have similar list prices and costs, but Widgets are highly differentiated and Thrum-mats more of a commodity. Thus, Thrum-mats are often thrown in as a loss leader in bundled deals. Sales reps and managers who are assigned to Thrum-mats feel cheated out of a potential list price sale when this happens.
Solution: Pay part of the commissions on Thrum-mats as a flat amount per unit sold.
Impact of commission changes
You want to to change your commission plan with the goal of increasing the sales of high margin Widgets relative to low margin Thrum-mats. How do you measure success?
Solution: Compare planned results for sales and commissions with actual results. You might have one spreadsheet to compute planned sales and commissions, and a second that computes actual results in the same format so it is easy to compare them.
You can set up sales commission plans like these very easily with the right custom spreadsheet. You can experiment, track the outcome, and adjust. For example, we’ve just released one that does all this and more. Click on the link for a free trail of our custom sales commission spreadsheet.