(product specialists, inside sales, administrative personnel), but also warehouses and inventory. It became imperative that new customers be brought on board. Then, as the economy faltered, so did the company’s sales and bottom line. The problem was that the level of urgency among the salesforce was not as high as that among the managers of the business.
The company president and the vice president of sales devised a new sales compensation program, moving from straight commission to a program where commission varied from 3% of gross profit for sales to existing customers up to 10% of gross profit for sales to new customers. This program didn’t work well, primarily because the sales representatives could generate significantly lower sales and gross profit yet still make a good amount of money because of the sizeable difference in commission rates.
This episode convinced the president and vice president that not only was there a problem with the sales compensation program, there was a problem with the prospecting and customer-development functions of the company. The two devised a quota program where sales representatives were provided a salary and commission, but commissions were paid only on gross profit above the quota. To keep the new-customer incentive in place, they devised a method where gross profit to new customers would count double towards quota.
Most of the old reps left the company for one reason or another, but with the existing job market, finding qualified replacements was not too difficult. Overall, the sales decline was reversed and new-customer development was ingrained as part of the distributor’s culture.
J. Michael Marks is principal and managing partner at Indian River Consulting Group. He is also serving a four-year term as a Fellow of NAW’s Distribution and Research Education Foundation. Michael Emerson is the Sales Compensation Practice Manager at IRCG. They may be reached at 321-956-8617 or www.ircg.com.
2004 NAW/DREF. This case study is from the book What’s Your Plan? Smart Salesforce Compensation In Wholesale Distribution, published by the National Association of Wholesaler-Distributors Distribution Research and Education Foundation. The book details a comprehensive process to avoid the common pitfalls companies make when redesigning their compensation programs and walks the reader through effectively designing and implementing compensation programs that support company objectives. For more information on the book or to order, go to NAW Publications at www.nawpubs.org.
Here are two case studies with tactical illustrations of how two separate distributors revised longstanding sales compensation plans to adapt to a new competitive environment.
The Margin Conundrum
This is an example of a straight-commission compensation program with a few twists. The company was clear on what it was trying to accomplish and did a good job of communicating and transitioning the sales representatives to the new program.
The net profits of a multiple-branch building products distributor kept decreasing as sales and prices for the products sold were increasing. Investigating the cause, executives realized that sales representatives were not passing along price increases to their customers. Asked why, the sales representatives replied that they didn’t want to increase their customer’s prices because they were afraid they would lose the business. The existing sales compensation program provided no salary and paid a fixed commission on gross profit.
The company’s CEO realized that with the current compensation program, the motivation to maintain or increase margins was much less than that of maintaining volume. With a 20% of gross profit commission, a 1% drop in margin resulted in a 5% pay decrease for the sales representative. But the same 1% drop in margin equated to a 20% loss in net profit. The CEO had just finished doing an activity-based costing analysis for his company and realized that most of his costs were variable, not fixed. This meant that any given sales decrease represented an almost equal decrease in costs. Knowing this information, he would be happy dropping sales 10% or even 20% if he could raise his margin 1% or 2%. Margin was the key variable for this wholesaler-distributor, since it dropped straight to the bottom line.
The CEO’s first step was to charge his controller, personnel manager and divisional sales managers with researching alternative methods of compensating the salesforce, but with one big caveat: He wanted to keep 100% of pay at risk. No salaries. After considerable research, the team came upon a structure that seemed to serve its purposes: a loaded commission.” A flat percentage of sales would be deducted from gross profit before commissions were paid. The effect of the program was that instead of the relationship between gross profit and commissions being a flat line, as it is with a straight-commission program, the relationship is a curve. This sophisticated technique had a powerful impact on the profitability of the firm. Sales representatives earned much more in incentives at any given level of sales if they could increase or maintain a higher margin.
The team presented the program structure to the CEO and received his approval. The team then modeled the program, identifying the optimal load and commission rate. The final step was communication. The company’s 16 branch managers were told of the new program during an all-day off-site meeting. Each sales representative was educated about the new program by a two-person team that consisted of one of the two divisional sales managers and a branch manager. In an effort to encourage the success of the program, each sales representative was guaranteed that he would make at least his average monthly income over the past six months during the first three months of the new program.
The clear cause and effect established by the CEO on the detriments of the compensation program made the road this team traveled in gaining alignment a straight one.
Not According to Plan
An electrical apparatus distributor glided through the late ’90s growing like a weed. It had tripled in size without acquisition in less than 10 years. Many sales representatives had made a good amount of money due to the straight-commission incentive plan. Along with the growth had come an expanded infrastructure consisting of not only employees