David Cichelli of the Alexander Group shares advice on how to structure your sales compensation plans for a new sales force in start-up companies.
Hi, this is David Cichelli, senior vice president of the Alexander Group, thanks for joining us today. We’re going to be talking about sales compensation programs for start-up companies. And the reason this topic is of recent interest to me was I was chatting with a client. Now this particular client has a really large company and they have lots of sales entities and it’s an insurance company and they have classic insurance type compensation programs. However, they were starting up a software business and I was talking with the manager and he was saying, “This is a brand new business for us and we really got to get into the marketplace and it’s important for us to gain market share because we have a very shallow window. This is a government-mandated software application. We have lots of competitors and we need to really quickly get into the market and grow our revenue.” Well, that’s actually something that occurs pretty often with other startup companies. And the idea is is we need to hire somebody who really knows what they’re talking about and we need to bring them on quickly. And frankly, we need to pay them a lot of money. So this presents a challenge in how to compensate these types of people. And of course, the manager already had a thought in his head about how he was going to do it. His solution was to provide a base salary and a commission program on all products sold. And that’s actually a good idea for a start-up because you can actually see that the more they sell, the more they’re going to produce. Having a base salary is going to actually provide some stability. However, what that solution does may in fact create a problem in the future. And that problem could be in the reality that at some point we may not be paying enough to these salespeople, or we may be paying too much to them.
So a base salary plus a commission is known as a hybrid design. It’s really two different types of compensation systems. The base salary comes from what’s known as a sales representative model, and the sales rep model has a base salary and a target incentive amount that you earn your incentive based upon your quota performance. And a producer model, that’s the commission side, is usually set aside for those who produce revenue, and these would be people like real estate agents and bond traders and stockbrokers. Producers get no base salary and they get a percentage of everything they sell. So the idea that these sales representatives or producers is probably not what they really are in the future, but the manager wants them to think that way, wants them to get out and generate as much business as possible. So we generally call this population of sellers, market makers and really what they are is the precursor of a sales representative model. However, they have the sort of characteristics of a producer model – go out and sell as much as you possibly can as quickly as you can.
Now a sales representative model has a base salary and a target incentive and a goal. However, in a start-up situation, the goal is not that clear. You really don’t know what level of production they’re going to produce. So the idea of a flat commission program is actually pretty appealing, and that’s one of the advantages of paying these types of people that way because you can get into the market quickly and you can produce a lot of volume and produce a lot of outcome. However, if we think about it, that could be a liability in the future. What if the volume took off in a dramatic fashion or what if prices collapsed? Our sales representatives would be suffering from having been locked into a commission program, and that’s OK for producers, but that’s not OK for sales representatives or people that we actually invest in, and they become an important component of our go-to-customer strategy. They’re not fungible. In other words, they’re not they don’t come and go like a real estate agent or mortgage origination person would be. The alternative is to give them a base salary in this bonus formula. However, not really clear what they can produce. So that kind of puts us in the middle.
The recommended solution and something to think about is potentially what we would call a market maker incentive program. A market maker incentive program kind of looks like a producer model. It’s that hybrid appearance. It has a base salary and a commission. But instead of paying a commission that doesn’t change, we call it an ICR, an individual commission rate. Now what’s an individual commission rate? An individual commission rate is actually taking the expected volume and applying some type of payout formula to that against a target instead amount. So the formula would be you take how much you would like them to earn and divide it by the volume you expect them to produce. And the idea about the ICR is is that you can recalculate it. You can recalculate it annually or you can recalculate it quarterly. It allows management to make adjustments so that in fact, we are paying at target incentive for the production that we’re expecting. But we can adjust the commission rate based upon the production that is anticipated at that time. Even in some cases where production is growing very quickly but prices are declining, which is pretty common in the software sector, we might need to improve that commission rate as the prices decline. In other situations, we might find that the volume took off unexpectedly, and we’re paying a lot more than we would ever had hoped to pay, and any retrenchment off of a commission rate at that time is usually viewed pretty negatively. So once we put the employee population into place and we let them know that we’re going to be using an ICR and that we’re going to be taking a look at our commission programs on a regular basis, it seems to find the good balance between the producer model and the sales representative model. Future salespeople that we hire, account managers and other types of global account managers and maybe territory reps, they would probably be on that sales representative model with a targeted set amount and a quota. But our early market producers, market makers, we want to make sure that they have a sense of open road, but we don’t have permanently guaranteed commission rates. We have commission rates that they know that we’re going to be adjusting to reflect a very handsome earning opportunities for them. And just one additional note market makers are expensive. They usually come with a lot of experience in the market segment and consequently can really get us into the market quickly. So it’s not as if we’re trying to save money here, but we do want to be able to manage our commission program going forward.
Question: how do you handle start-up organizations? Should you put them on a producer model? Should you put them on a sales representative model? Well, if you consider them market makers, then take a look at the individual commission rate model. Each sales rep gets their own commission rate. You take the total amount of money that you want them to earn and you divide it by the expected volume at that time, and that gives you the ICR.
So those are our suggestions for the day. If you want to learn more about the Alexander Group’s sales compensation consulting, please visit us at our website at www.alexandergroup.com. We look forward to having you join us again on future podcasts. Thank you.