Legends of sales: it's time to debunk the four most common sales compensation myths

Prosales, July, 2003 by Clark S. Colvin

Gather a bunch of dealers together to compare compensation strategies, and you can bet there's going to be a lot of debates over the best ways to motivate reps and boost the bottom line. Unfortunately, many commission plans prove ineffective when you read between the lines. Here are four of the most common sales compensation myths:

Myth No. 1: Incentive calculations based on gross sales increase overall company sales. In my experience, this approach typically does little to boost sales. What it does do is decrease profits because salespeople aren't focused on margin percentages.

Myth No. 2: Tying an incentive to gross margin dollars increases gross margin percentages. This approach, as well as incentives based on gross sales, can emphasize the volume of transactions rather than the profit of each transaction.

Consider, for example, a rep who sells $100,000 of plywood at a 20 percent gross margin. If the reward scheme is based on gross sales and the percentage is 4 percent of gross sales dollars, this salesman would earn $4,000. Now assume that the compensation scheme is based on a percentage of gross margin dollars. For that same salesperson to generate $4,000 in commissions, he must be awarded 20 percent. Most business owners currently pay in the neighborhood of 10 percent to 14 percent. Hence, from the salesperson's point of view, pay based upon gross sales is most likely preferred over a percentage of gross margin dollars.

To achieve the $4,000 in commission under the percentage of gross margin dollars scheme, the savvy salesperson also can sell more plywood at a lower gross margin percentage to get the same reward. For example, $200,000 of plywood at a 10 percent gross margin equals a $4,000 payout. As a result, under both of these schemes the salesperson can still focus on selling more dollar volume at the sacrifice of gross margin percentages--not to mention the bottom line.

Myth No. 3: Calculations based on gross margin percentages eliminate problems associated with myths 1 and 2. While on the surface this type of compensation package appears to conquer the problem of reps selling for dollar volume only, it does not take into consideration a product's break-even point, which includes overhead. Framing packages, for example, typically have low margins that may not recover the full cost of overhead. Couple these losses with the salesperson's commission and you may end up deep in the red.

Myth No. 4: Profit sharing schemes eliminate worries about product break-evens because rewards are based on the company's bottom line. Profit sharing often fails to motivate highly productive employees and typically is seen by less-productive employees as an entitlement. Most importantly, it does not consider the profit center makeup of a company with reference to individual revenue and profit streams. (This obviously parts with the opinions of many HR compensation analysts and industry consultants.)

In light of these problems, one of the best ways to ensure profit per transaction and/or salesperson is to link a pay-for-performance system into financial statements that break out each product line by profit center, inclusive of expenses. This causes gross margins and profits both to rise because salespeople are focused on both margin percentages and volume sales.

Clark S. Colvin is the managing general partner of CSC Capital Partners Ltd. in Salem, Ore., a firm specializing in corporate restructuring and company turnarounds. 503-540-0888. E-mail: csc@csc-capital.com.