Linking payday to cash in hand - compensating salespeople only after customer pays

Nation's Business, May, 1996 by Harvey R. Meyer

Some small companies find that compensating salespeople only after customers pay up helps cash flow and revenue.

When Robert Kramer worked as a real-estate agent, he learned he couldn't begin to savor a fat commission check until a deal was done. When he launched Brookdale Plastics, a Plymouth, Minn., custom-plastics manufacturer, it made perfect sense to Kramer not to compensate his salespeople until he had customers' cash in hand.

"I figured if I could do it in real estate, my salespeople could do this, too," says Kramer, owner of the 31-employee, $4.5 million firm. "We've got all this [financial] exposure in the firm in labor and materials, and we really don't derive any benefit until we're paid. So there's no reason to pay our salespeople until the customer pays up."

When--and how--to compensate salespeople is an age-old concern for businesses large and small. Many companies pay their sales staffs as sales are "booked" (registered into the company's order-entry system) or invoiced, or upon shipment of goods or delivery of services.

Others tie salespeople's income to collected sales--a compensation method that offers several notable, and often. unexamined, advantages. Depending on how the compensation system is structured, paying salespeople upon collection of the payment due may offer some growing companies a way to improve cash flow.

The practice also can boost sales while encouraging salespeople to pay closer attention to customers' needs. Further, such a system discourages sales forces from obtaining hollow commitments from customers just to meet a sales or income target. (Stories abound about how salespeople working within a payment-upon-booking system inflated their sales productivity--and income--by attributing orders to dead people.)

"If you pay upon booking, sometimes the salesperson will put tremendous pressure on a customer to buy something he isn't ready to buy," says Larry Ramackers, a principal with Jay Alix & Associates, a Southfield, Mich., consulting firm specializing in turnaround management, or helping to resurrect companies in trouble. Ramackers also is a director of the Turnaround Management Association, based in Chicago.

"Maybe the customer didn't want to buy in March, but in April or May, so you may end up with an incomplete or canceled order," says Ramaekers. "Salespersons are sometimes more concerned about a customer signing an order than [about] whether the sale actually occurs."

While few reliable estimates are available on when companies pay their salespeople, a 1993 survey by the American Electronic Association of 183 firms--most of them association members--showed that payment upon collection was the least-prevalent compensation system practiced, with 14 percent using it. The system used most was paying salespeople upon invoicing (36 percent). That was followed by payment upon booking (28 percent) arid payment upon delivery (22 percent).

"The best possible arrangement for the company is for the salesperson's economic incentive to be tied directly to the company's," says Ramaekers. "The company shouldn't really care about orders or shipments, but about getting paid."

Theoretically, payment upon collection encourages salespeople to do a better job of examining a customer's credit worthiness because their income is contingent on the client paying up. And frequently, salespeople, not credit managers, are in a better position to determine credit quality because they're closer to customers.

Mark Swepston, president of Atlas Butler Heating and Cooling, in Columbus, Ohio, instituted payment upon collection four years ago when he revamped the company's sales-compensation system. Swepston was exploring ways to increase sales.

The six full-time salespeople are now on 100 percent commission, receiving 50 percent of a job's net income after a customer's payment is received. The salespeople are responsible for picking up checks from the company's primarily residential customers.

Swepston believes the new system has played a vital role in doubling his 75-employee firm's sales since 1991 to $8 million today. He says customer payments are received within 10 to 12 days of a residential job's completion, or about four times faster than when Atlas Butler paid salespeople upon booking. Additionally, the percentage of bad debts relative to sales has shrunk sharply, to 0.3 percent from 2.7 percent.

"It has changed our cash flow phenomenally," says Swepston.

Before instituting the payment-upon-collection system, Swepston tested it first with a salesperson who believed in the practice. It worked very well. The system not only improves Atlas Butler's bottom line but also enhances the sales staff's customer-service and other skills, Swepston says.

"It's made them pay more attention to customers' needs, because if the customer isn't satisfied, the salesperson won't get paid," he says. "They cared before, but this practice brings them one step closer to customers because their pocketbook is affected."

Adds Brookdale Plastics' Kramer: "It reaffirms in the minds of everybody here that it all boils down to the customer. We live and breathe for the customer to be No. 1. If the salespersons know they won't get paid if the customer isn't happy, they work hard to make sure the customer stays happy."