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Going through the company archives recently, I stumbled upon an article written several years ago by my colleague Mike Marks. The article was titled, “Hey CFO, What is Wrong with Sales Incentives?” I had long forgotten it existed. What struck me in rereading this article was that many of the issues it addressed are still relevant nearly ten years later.
The main point of the article was that CFOs should challenge sales leadership to generate the best possible ROI on selling expense. It pointed out that up to 40 percent of a distributor’s gross profit is selling expense and too often this cost goes without scrutiny. In the article, Mike referred to this as one of distributions “sacred cows.”
Many of the issues tackled in Mike’s article are perpetual and will still be present 10 years from now. However, when it comes to optimizing selling expense there are a couple things that have changed since the article was first published, which only strengthen Mike’s argument.
Companies today have analytical capabilities that did not exist a few years ago. Part of the reason a percentage of gross profits were used to compensate sales people was because gross profit was often the extent of what business systems could provide in a timely fashion. Today’s business systems are capable of slicing and dicing nearly every conceivable combination of customer and product in near real time.
Furthermore, software applications that provide some version of net profit by customer or product are also available. The options available for measuring sales performance is much greater than it was several years ago, which in turn means the metrics available for incentive pay calculations are also more robust.
From a CFO perspective, these analytics make it much easier to understand what good business is and what it is not. After using some standard analytics, many of our clients have come to the realization that over half of their business was marginally profitable to unprofitable. From a sales compensation perspective, someone needs to be asking why this type of business continues being incented.
It is hard to argue against incenting sales reps to focus on profitable or strategic business. However, as with most things, the devil is in the details. Presupposing that “good business” has been identified, the challenge becomes implementing an aligned sales compensation program.
There is no single right answer, or as Mike wrote in his article: “The ‘goodness’ of an incentive plan is ONLY determined by its ability to help you achieve your business objectives.” But there is a process that will help in getting to the right answer most efficiently.
The first, and arguably the most important, step is determining if your organization is capable of transitioning from a self-directed sales compensation structure to a management-directed sales compensation structure. Sales compensation programs where business is not differentiated can be thought of as a self-directed program. If all gross profit dollars are the same, it is up to the individual sales person to decide which business is worth pursuing. Mike's article refers to this as, “the inmates running the asylum.”
Conversely, a management-directed sales compensation program is, as the label would imply, a program where management influences a sales person’s focus by aligning pay with company objectives. Choosing the right structure starts with determining whether there are sufficient capabilities within the company to utilize performance objectives or goals. Goals allow a company to tie company objectives to individual sales territories based on opportunity, whereas other non-goal options paint with a broader brush as structures are based on “the average sales rep.”
However, if a company lacks the competencies to establish realistic and effective goal target values, using goals is probably not the right first step. Many distributors have not developed adequate budgeting mechanisms and practices. The values must be seen as achievable by the sales reps and ideally capture their discretionary energy.
Creating a management-directed sales compensation program without using goals will typically be less effective than if goals were employed and is a little trickier. But hey, you need to start somewhere.
The use of different commission rates is the most common approach in these situations, but it is critical to model the impact of new rates on each sales representative – not the average sales representative – because each rep’s existing business mix will be different. Implementing new commission rates has the potential to create a group of compensation “winners” and “losers,” which frequently does not correspond to top performers and under performers.
With the technology that distributors have at their disposal today, data is no longer a reason to shy away from maximizing the ROI on selling expense. With the data, aligning selling expense with company objectives is not only easier today, the precision available makes it more powerful.
Mike’s closing comment is as true today as it was when he wrote it: “If you are less than thrilled with your incentive practices, go invest some time to find out about the many alternatives. This is much more rewarding than perpetual complaining in a ‘data free’ discussion.”
Mike Emerson is a partner at Indian River Consulting Group. Learn more about IRCG at ircg.com.