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Commission Schemes - Questions and Answers
In March 2020, I was invited to a Q&A on commission schemes by a journalist from PrintWeek. Here is a transcription of the salient points from the Q&A.
How should salespeople be rewarded? Should they receive a higher basic and lower commission or vice versa?
Without being glib, that depends. For instance, in software, once the product has been developed, every transaction is new income and typically contains high-profit levels. In software sales, the 'cost of sale' is usually low, and therefore, many pay both high basic salaries AND high commissions. In many B2C environments, the base salary is lower, but the commission percentages are high. In industries such as engineering, or medical devices, where niche expertise is required to sell the product, you tend to find that Basic salaries are higher, but the potential to earn is no more than circa 20% of the base salary.
What is the right level of basic and commission percentage - how should this be calculated? Why should employers not use a scheme that advances commission to sales staff?
This is a huge generalisation as it differs from industry to industry, but a commonly used 'rule of thumb' is that a salesperson should generate five times their total cost in gross margin. However, in some sectors, software again, for instance, it could be many multiples of this and in, for example, the professional services industry, it may be as low as two times. However, if you think of a £35K Basic salary field account manager with a car and £50K OTE, their real cost with employer's NI, expenses, etc. is more likely to be £70K; therefore, they should generate £350K of GP.
Why (how) can a sales commission scheme make or break a firm?
I have known companies where commission was paid on all sales, regardless of profitability. To elaborate, I once knew a firm that was paying a flat % on all sales income as commission, and there wasn't a process to control discounting. Consequently, the firm was winning unprofitable business AND paying commission on top, so a double loss to the firm.
Good commission schemes should i) Motivate each sales team member to push for more significant sales numbers, ii) be easy to calculate for both the firm and the salesperson and iii) should work in conjunction with the company's broader values and vision.
You have said that there are four common types of commission scheme. What are they and how do they differ?
- A commission scheme based on a percentage of Sales Income – easy to calculate but fraught with potential hazards unless the pricing is fixed or the salesperson is not authorised to discount.
- % of GP – probably the most common scheme in the UK. However, unless there is a standard margin on every project won, it can be difficult for the salesperson to calculate and therefore not particularly motivating. However, a simple spreadsheet, and some CRMs, can calculate the commission for the firm and their sales colleagues.
- Commission paid on GP or Sales Income but also upon meeting other factors such as customer satisfaction surveys, key performance indicators, or changing behaviours in agreement with their line manager.
- % of GP above a threshold – the salesperson has to generate their real cost in a particular month/quarter for the commission scheme to apply. Therefore, if they do not cover their cost, they don't earn any commission that month or quarter.
However, there are many more commission schemes, such as a percentage based on individual performance and the remainder based upon meeting team targets or overall company profitability. These schemes seem great in theory but are entirely unfair for the top salespeople. For example, is it fair that the top salesperson bringing in 30% of the firm's income earns the same to their colleague that generates just 5%? Consequently, in this culture, firms often lose their top performers.
How can firms use a scheme to encourage the right behaviours?
Firms can implement a simple mechanism whereby KPIs have to be met for the commission to apply. Most salespeople, naturally, aren't great at detail or process and see 'paperwork' as a necessary 'evil'. However, many firms have introduced CRM systems and then calculated commission based on the CRM system. Consequently, the salesperson immediately starts to input the required data – a tremendous win-win to simplify commission calculations and get the data on the system!
How should a salesperson be rewarded for helping the company achieve a sale when they themselves didn't actually make it - they, for example, passed an enquiry on to someone who did make the sale?
Many companies offer split-commission, where some is paid to whoever uncovered the lead and the remainder to the person that closed the deal. Some firms have introducers, nurturers and closers that each look after a different part of the sales process and they then secure business as a 'team'. Personally, I don't think that it provides the best experience for a customer, but many firms have successfully deployed their best-skilled person to an individual segment of the sales process.
Working collaboratively to achieve account penetration is something that should be actively encouraged by all sales leadership teams. I'm also a big believer in 'what comes around goes around', so if the Northern Account Manager uncovers a lead for one of the Southern depots, it should be passed on without reward. They would do this in the knowledge that their corporate culture ensures they'll get a 'lead back' in the future.
Many companies offer split-commission in this situation, but one party in the arrangement always feels that they 'did more work to earn their share' and just causes ill-feeling in the sales team. I have seen feuds between good people go on for years over split-commission, together with physical fisticuffs on one occasion. Split-commission should only apply when it is carefully mapped out and contractually formalised so that all parties understand the 'rules of engagement'.
How should commission be paid - an element paid quickly (monthly) or more slowly over a quarter or at year-end?
Most salespeople want to 'feel' successful, so I encourage firms to pay monthly or quarterly so that they receive the 'big cheque' when they have the 'stellar month'. Commission paid annually can often have an adverse effect, mainly where commission is 'capped'. I have known many salespeople that have hit their sales target by, say, month seven in a financial year and then 'downed tools' as they couldn't earn any more commission. They then float around for a few months until the end of the financial year to pick up their commission before moving on. The second biggest' golden rule' of creating commission schemes is 'don't cap them'.
How should a scheme be implemented? And should it change with a salesperson's experience?
Schemes should be altered by including long-standing top-performers in the dialogue. However, the golden rule is that every commission scheme must have a caveat along the lines of the 'directors have the right to vary the amount or terms of the commission scheme or withdraw it, providing you with x weeks' notice'. This means it can be tweaked without consultation if a new scheme isn't working. Also, in times like the current COVID-19 era, it means that firms can protect their cash assets by postponing commission payments until the business returns to something resembling normality.
How should commission for 'bad' sales be clawed back without causing ill-will?
In theory, many firms pay a month in arrears, so it's clawed back before it is paid out. Others hold it against future commissions. The key, like most things in life, is communication. Salespeople don't like surprises, particularly when it impacts their income.
Some companies pay 70% of the commission payment every month and the remaining 30% as a quarterly target, which considers things like debtors, bad debt, or 'bad sales'. This 30% could also be based on meeting broader business goals such as company profitability team targets or meeting the key performance indicators required for consistency.
To reward consistent performance, a 'clever' scheme would be one that pays 70% for meeting individual monthly targets, but the additional 30% would only be paid for exceeding the quarterly target.
What is the importance of having a transparent and flexible commission scheme?
Commission schemes should be as simple as possible so that they meet their main objective for the salesperson to keep pushing and striving for higher sales. Regardless of past performance, longevity, etc., everyone in a 'like for like' role within a sales team should be on the same commission scheme.
Personally, I think that all sales data should be visible so that it generates healthy competition amongst members of the sales team. It also helps discourage things such as 'holding back business' to the following month or 'top drawing' leads so that they're not in the sales forecasts for next month, etc.
Do you have (anonymous) examples of bad schemes made good or good schemes ruined by management?
I would disregard any commission scheme that is so complex and convoluted that a salesperson cannot calculate their earned commission in under a minute. Also, it's preferable if they can make that calculation without using a company commission spreadsheet.
I was once on a commission scheme where you scored a 'goal' for every £1K of sales. Then every £250 discount was a 'goal against' and every week was a game. You were then in a league against colleagues, and the percentage you earned changed upon where you were in the league at the end of each month. It was a brilliant scheme in theory and a very early attempt at 'sales gamification'. I can imagine the directors at the time in their boardroom feeling ever so chuffed with their scheme that protected margin, reduced discounting and formed healthy competition. But it just didn't work. It didn't motivate the sales team, so it failed to meet a commission scheme's primary criteria. Consequently, sales activity dwindled, and after three months, it was scrapped.
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