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Sales Compensation: Starting With the Basics
By David M. Fellman-, President, David Fellman & Associates
Sales compensation seems to be a mystery to most of the specialty imaging industry. I receive calls and emails frequently about compensation standards, and the truth of the matter is that there aren't any. For every 100 printing/graphics companies, there are probably 120 compensation plans in place, with many individual salespeople operating on different plans within the same company. (That's not necessarily a bad thing, but I'll get to that later.)
The fundamental problem is that most sales compensation plans don't work very well. In other words, they don't motivate the performance and behavior that employers are looking for. That's why I'm getting all the calls with comments like, "my salespeople aren't performing. What are other people doing that I'm not? Somebody must be doing this right, right?"
Some are certainly doing it better than others, but industry-wide, I think there's a lot of opportunity to improve sales performance by improving sales compensation strategy. Let's start with the basics. The fundamental concept behind effective sales compensation is that money talks. When developing your compensation strategy, you need to ask yourself what you want it to say - here are some possibilities:
You may not care about all of these things, and there may be additional items that you care about. The bottom line is that sales compensation - money! - can be used to buy and motivate specific behavior. The more explicit you make a compensation plan, the more likely it is that your salespeople will hear what you're trying to tell them.
Salary Plus Commission
But it's not enough to let money's voice be the only thing a salesperson is hearing. In other words, don't think compensation is a substitute for management. Think of it this way: Compensation works best as reinforcement for management. For example, one of my clients, and I recently had this conversation with one of his salespeople, who could rightly be called lazy and sloppy: "Remember that you get paid a salary and commission. You could say that you earn the commission by working hard at convincing people to buy from you, but we pay you the salary to work hard at everything else!"
Salary Plus Commission, Plus Bonus
To address the issue of developing new customers, I might institute a short-term bonus program, such as 30-60 days of intense prospecting activity. That might mean identifying 100 "suspects" and running each of them through a defined series of contact activities.
I would be happy to pay a bonus to stimulate that activity - and here's why: The bonus is intended to reward the activity in the expectation that the activity will lead to the objective. This means managing on the front end of the sales cycle, rather than on the back end. Let's face it, most printers "manage" by looking at sales figures and then either congratulating or criticizing their salespeople. It's a far better strategy to manage on the front end of the curve.
To address the issue of increasing sales year to year, I suggest a full-year, quota-based bonus opportunity. I would be willing to pay a significant bonus in order to provide a full year's worth of motivational pull, and many of my clients have been successful by making the reward something other than cash.
"Tell me what you want," one of them told her salesperson at the beginning of this year, "and I'll tell you what your quota is." The key point here is that performance has to pay for the reward. In this particular case, the salesperson wanted a motorcycle, and justifying the cost of that required a quota that reflected a 15 percent sales increase. Through the first four months of the year, the salesperson is tracking toward an 18 percent sales increase. I think it's fair to say that he's highly motivated.
Sizing the Components
Let's do some quick math to see how much this job is worth. Forty percent of $350,000 equals $140,000 of gross profit, and 30 percent of that equals $42,000 in compensation. Please note that I'm not saying that $350,000 is reasonable for every salesperson, or that you should be operating at 40 percent gross profit, or willing to share 30 percent of it, or that $42,000 is the right amount to pay a salesperson. At this point, I'm just trying to show you how to work the math. Please also note that this analysis is where you start this process. The two most important questions in compensation planning are how much volume/profit can I reasonably expect, and how much am I willing to pay for it?
So far we have established that you're willing to pay $42,000 in return for $350,000 in sales. Obviously, that could be paid as a straight salary of $42,000, or straight commission at the rate of 12 percent. A better approach, however, would be a salary of $1,000 per month, seven percent commission, two short-term bonus opportunities paying $1,000 each and a $3,500 quota-based, full-year bonus opportunity. That all adds up to the same $42,000, and it provides motivation to address all but possibly one of the "I wants" above. Hopefully you see the wisdom in a three-part approach to compensation. Money talks and compensation works best as a reinforcement to management.
Revenue Sharing vs. Profit Sharing
Now let's change the commission rate to 17.5 percent of the gross margin. The revenue distribution of the full-price sale is exactly the same. The $900 sales pays the salesperson $52.50 and you net $247.50. Discounting further provides the same 17.5-82.5 percent split of every gross profit dollar.
Bottom line, you are better off sharing profit with your salespeople than sharing revenue. Again, don't read anything into these specific percentages, as they were just for illustration. If we changed the straight commission rate to four percent in this example, that would equalize at 10 percent of gross margin. Converting a revenue sharing commission rate to a profit sharing commission rate is really pretty simple arithmetic.
Salary vs. Draw
One solution to this problem is to allow a draw against future commissions. I have a situation going on right now where we're allowing the salesperson to draw the difference between what she actually earns in salary plus commission and $3,000 per month. We have shown her the pace at which we expect her to build earnings to more than $3,000 per month and to pay back the draw - which is essentially a no-interest loan, with future earnings serving as collateral - and everyone is comfortable with the arrangement.
In the past, the same client used to start with a higher salary and reduce it over time, but that never created the motivation he was hoping for. "They'd be complacent for the first six months at the high salary," the client told me. "And then they'd get panicked and start looking for another job. This way, she'll be aware of the draw balance she's building up, but she'll also be able to see progress against the timeline we've shown her."
Don't forget that established salespeople also have earning needs, and that the selling cycle and seasonality can make actual earnings somewhat irregular and unpredictable. Many printing/graphics companies allow its established salespeople to draw up to 80 percent or even 90 percent of its previous year's earnings on an annualized basis, which is a reasonable practice.
For example, if a salesperson earned $80,000 in commission last year, the monthly draw might be set at $5,333 ($80,000 x 80 percent ÷ 12) or even $6,000 (80,000 x 90 percent ÷ 12). For payroll purposes, a draw is typically paid on the same schedule as a salary, the total amount divided by the number of pay periods in the year. Commissions are typically paid after the middle of the month, allowing for normal month-end bookkeeping and accounting to be completed. In a draw situation, if a salesperson fails to cover the draw for the previous month, there is no additional payment, and that continues until any draw shortfall is corrected
Setting the draw at 80 percent or 90 percent of the previous year's earnings is pretty safe from the company's perspective, but it doesn't protect you against a major catastrophe, like the loss of a major customer. For that reason, I recommend setting a cap on the draw, usually five percent of the previous year's earnings. In other words, if the salesperson in this example got to a draw status of -$4,000, the draw would stop and only commissions actually earned would be paid.
It is a very bad idea to let a salesperson dictate compensation, and that's not even considering the fact that many "job-hoppers" have been known to exaggerate both their sales volume and their earnings when negotiating with owners, who often seem more interested in hiring sales volume than sales talent. Remember that the two most important questions in compensation planning are how much volume/profit can I reasonably expect, and how much am I willing to pay for it? Also remember that your raison d'ętre is profit, not just volume. The most frequent complaint I hear from printers is that: "I'm paying my salesperson too much (in return for the performance I'm getting)."
Having said that, I have no problem with individual salespeople working on different compensation plans within the same company. After all, different people will have different motivational triggers, and different compensation wants and needs. As long as each plan speaks clearly and effectively - and as long as you remember that compensation works best as reinforcement to management - you should be able to use compensation to achieve better performance from your salespeople.
Dave Fellman is the president of David Fellman & Associates based in Cary, North Carolina, a sales and marketing consulting firm serving numerous segments of the graphic arts industry. He is the author of "Sell More Printing!" and "Listen To The Dinosaur" which Selling Power magazine listed as one of its "10 Best Book To Read in 2010." email@example.com.
This article appeared in the SGIA Journal, July/August 2011 Issue and is reprinted with permission. Copyright 2011 Specialty Graphic Imaging Association (www.sgia.org). All Rights Reserved.
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