Roll the footage…coming down the hallway are the GM of the division and the head of finance. They are heading for a meeting with the VP of sales.
Finance chief (mutters under his breath): “We have to solve this discounting problem.”
GM (stiffens): She has had this conversation with the VP of sales in the past. The division is bleeding profits, and the sales force is the epicenter of this problem. Her view: Sellers should not treat division pricing as a throw-away starting number.
GM continues, “I know we are going to get the same argument from the VP of sales. Do you want volume or profits? You decide! However, you can’t have both at the same time.”
She has resolve: The sales compensation plan will be modified to pay on profits and not just revenue.
In a sense, both viewpoints have merit. The GM and finance head cannot operate the division with eroding profit margins regardless of the source. Fortunately, if sellers are the source of price discounting, it’s a solvable problem. Meanwhile, the VP of sales is correct to anticipate that higher pricing may suppress sales revenue. This outcome will also hurt division profits by driving up unit costs.
If sellers are the source of price discounting, changing the sales compensation plan might help. But only to an extent. Pricing issues are seldom the sole fault of sellers. Yes, sellers can be contributing agents by accelerating price erosion. However, pricing pressures often (and more likely) arise from neglected product strategies, unanticipated competitor actions and shifting buyer sentiment. The sales compensation plan is ill-equipped to solve these systemic issues. More on these issues later.
Yes, there is a lot of finger-pointing. Before we get to both short- and long-term pricing solutions, let’s examine the logic of paying salespeople on profits. In some instances, it is fully warranted. In other cases, not so much.
First, let’s start with market practices. Yes, in some cases, sellers are paid on profits. The Alexander Group’s 2021 Sales Compensation Trends Survey reveals the most popular incentive pay measures. Profit ranked number two on the list by 30.5% of the participants, trailing revenue by 85% of the respondents. (Multiple selections were permitted.) What does this mean? Slightly less than a third of the companies use profit as a sales compensation performance measure.
Source: Alexander Group’s 2021 Sales Compensation Trends Survey
So, what is the conclusion? It’s not unusual to pay sales personnel on profit performance. Okay, when should this occur (i.e., paying salespeople for profit performance)?
Here are some examples of when paying for profit performance is a good idea.
In each of these cases, sellers affect profit outcomes. The purpose of sales compensation is to pay for successful persuasion: getting the order and getting better profit dollars when sellers can influence profit outcomes. In such cases, profitability is a suitable sales compensation element. As expected, the reverse scenarios operate, too: If the seller cannot affect price, mix, features, inducements and terms, then the sellers’ pay should not be tied to profit outcomes.
EBITA (earnings before interest, taxes and amortization) and net operating profit are effective corporate profit measures. Consider the following seller-centric profit measures.
Sales compensation formulas can successfully reward profitable selling. The best designs have two elements: a production measure and a profit measure. Gross profit dollars and gross profit margin are a natural pairing. Another effective pairing is sales revenue and price realization. Using a sales compensation “linked” formula design allows the first measure (volume) payout to be modified by the second measure (profit percent). Linked designs include hurdles (minimum level of performance of second measure affects payout of first measure), modifiers (first measure payout modified/multiplied by second measure performance) and matrices (a grid with increasing rewards for both volume and profit improvement). Expect numerous iterations when creating such formulas. Testing and modeling different payout scenarios will ensure plan designers have crafted the payout formula to accomplish both objectives: volume growth and profitable sales.
When sellers find they are pressured into discounting, there are often upstream challenges driving this behavior.
Upon entering the office, the VP of sales says: “Well I am glad you are here. I know we have a pricing challenge. So, we are planning to introduce a new training program called Performance Pricing. This will teach our reps how to achieve the best pricing for our products. Next, we plan to add a profit modifier to the sales compensation plan. And, finally, we are changing the criteria of the President’s Club to recognize more profitable selling.”
The GM and head of finance are gracefully speechless.
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©2021 The Alexander Group – All Rights Reserved – Issue No. 200821
READ ALL ISSUES:
2021 Sales Comp Hot Topic Findings
Should Salespeople Be Paid on Profits?
Sales Compensation Starts With Job Design
Sales Compensation Victims
Global Sales Compensation
Are Salespeople Coin-Operated?
2021 Sales Comp Trends Findings
Is Sales Compensation Just for Sellers?
Sales Comp: Rewarding Sales Profits
Pay Equity and Sales Compensation
2021 Sales Compensation Planning
Avoiding Common Misunderstandings
2020 Sales Comp Hot Topic Findings
What COVID-19 Found in the Shallows
Best Revenue Recovery Solutions
Save the Sales Force
Sales Dept Seek to Protect Incentive Pay
Should You Protect Sellers’ Pay?
Use the Right Measures!
Are Sales Comp Plans Industry Specific?
Careful About That Threshold
Commit to the Money Not to the Mechanics
Should You Change Your Sales Comp Plan?
Are sales comp costs variable?