Lowering Your Breakeven Point

First, let's clarify what a breakeven point is. The simplest definition is that breakeven occurs when revenue equals expenses.

But since revenue and expenses are both moving targets, it helps to look at breakeven from a slightly different perspective.

There are two types of expenses: fixed and variable. Fixed costs are expenses that do not increase as business increases. Examples include office space, utilities and salaries.

Variable costs are expenses that vary with the amount of business you do. Commissions, telephone charges and manufacturing costs are variable expenses.

Variable costs are tied to revenue – if you don't have any sales, for the most part, you don't have those expenses. But whether or not you bring in any money, you still have to cover your fixed expenses. For the sake of argument, let's say that 80% of your revenue goes to variable expenses. That leaves 20% of the revenue to cover fixed expenses and profit.

At breakeven, that entire 20% goes for fixed expenses.

Once you pass breakeven – when you've got your fixed expenses paid for – the rest is profit. And lowering your breakeven point directly and immediately increases profit. Now, let's talk about why offering a choice of plans lowers breakeven (and increases profit).

1. Risk-sharing

Typically, at least one of the plans you offer will give sales representatives the option of taking on greater risk in exchange for a potentially greater reward.

A commission-only or 100% plan does this. So does a plan where the sales associate reaches a higher commission faster in exchange for paying for his own advertising.

The sales associate who has confidence in her own abilities chooses this plan because she believes she will make more money this way.

The company benefits because it is shifting an expense (like advertising or office expense) to the sales associate. Or the company is replacing a fixed expense (a salary) with a variable expense (a commission).

By reducing expenses like this, the company lowers its breakeven point and starts making a profit sooner.

2. Motivation

By offering a choice, you are allowing people to select the style of compensation that motivates them most effectively. This removes the disincentives to greater production that exist in so many commission plans. When sales representatives become more productive, profitability increases.

3. Turnover costs

Improving motivation reduces turnover. The expenses associated with turnover decrease; therefore, so does the breakeven point.

Offering a choice also helps retain those reps who want a different style of compensation. They no longer have to leave your company to obtain it.

4. Recruiting

Offering a choice expands the pool of potential recruits. If you offer only a straight commission, you are limiting the number of people who will be interested in working for you. When you offer more options, you can choose from a greater universe of talent. That lowers your recruiting costs and reduces breakeven.

Of these four factors, the first one is the most direct. Having sales associates pay some of the costs of running your business or having them take on additional risk has an immediate effect on your corporate profitability.

Is All Your Profit in Popcorn?

[Read time: 3 minutes]

By: David J. Cocks, CEO

"Get them in the theater, break even on tickets, and make your money on popcorn."

It's a business model that is used in movie theaters all over the country and has become quite popular in the real estate industry.

Many brokers are breaking even or even losing money on their core real estate business. All their profit comes from ancillary services, such as mortgages, title insurance and homeowners insurance.

What's wrong with that?

Nothing – as long as the profit from ancillary services is stable. But real estate is an industry that is in transition. There are many scenarios that could put that profitability at risk:

Legislation changes could keep you from owning a real estate company plus a mortgage company and a title insurance company.

New competition could enter your market, perhaps from banks or a more aggressive real estate company, causing margins to drop further.

Interest rates could rise.
Your market could cool down – or overheat.
Your agents might decide they want a piece of the ancillary services revenue.

You can even have problems if the only thing that happens is that your sales force gets more productive. Suppose they form teams or make better use of technology, so they reach higher splits faster. Your loses on the real estate side increase, so you need more and more profit from the ancillary services to cover those loses – money you may not be able to get.

What's the answer?

Fix your commission structures so you are making money on your core real estate business. Then you can make money on real estate and keep the profit from ancillary services too.

Without wanting to carry the movie theater analogy too far, many brokers assume that fixing commissions is like raising ticket prices. You're taking money away from the sales force and putting it in your own pocket.

That's not the case.

You should fix commission structures by tuning the way you pay your sales force as well as the services you offer them to better meet their needs. This rationalizes your costs: you spend more in some areas and less in others. You also adjust your commissions so they are fair to everyone. The result is a more nimble company that has a significant competitive advantage. (To see how this works, read some of ourcase studies.)

Then the next time you're at the movies, you'll be able to sit back, eat your popcorn, and think pleasant thoughts about how you are managing your business so much more effectively.

Pushing a Compensation Boulder?

[Read time: 5 minutes]

By: David J. Cocks, CEO

When your company's compensation plans were originally created, they were probably pretty simple and straightforward.

But then one of your top people was considering defecting to the competition, a new competitor entered the market, you acquired another company...

Now your plans are pretty complicated. You've got people grandfathered in. You've got exceptions – probably lots of different kinds of special deals.

When you think about updating your plans, there's a whole lot of baggage there.

Your compensation plans feel like a big boulder you are pushing uphill, with all kinds of sticks and leaves and moss and junk sticking out all over the place.

Making it move is a royal pain.

You think about chipping away at that – at making the changes you'd like to make in your compensation plans – but it just seems like it is going to be so painful.

It doesn't have to be like that.

You're getting caught in a trap.

Basically, you've been trapped by heuristics.

A growing body of research suggests that one of the ways humans have adapted to the complexities of modern life is by using heuristics, or rules of thumb, to navigate many decisions.

There are six heuristics that are recognized as being widely used in our daily lives, and a lot of them are relevant here:

Familiarity – the simplest decision in any given situation is the one you made the last time you were in the same situation. This means that it is easier to keep using your current compensation plans – making the same offers, handling problems the same way you have in the past – even if that isn't working well for you anymore.

Consistency – people want their actions to feel consistent, particularly if they are on the record as taking a particular position on an issue. If you've stated publicly that you are not going to change your plans or that you will meet offers by competitors, you feel you have to do that, even if it doesn't make sense anymore.

Acceptance – people want to be liked and accepted by others. This means it is hard, even for the toughest business owners, to do things that will cause others to resent them (including changing compensation).

Expertise – the natural tendency is to defer to the leader of a group or to those with the most expertise. Sometimes this means that people who have recruiting or financial expertise and state a strong position are the ones everyone falls in line with, even if those people don't fully understand the implications of the position they are advocating.

Social facilitation – people look to others like them when making decisions. If those people made a particular decision, the easiest decision for others is to make is the same decision. But this leads to group-think, rather than risk-taking.

Scarcity – people value opportunities in proportion to the risk that they will be taken away, which is why we all respond to time-limited offers or the news that "there are only 4 left at this price." This can come into play when a competitor is trying to steal away one of your people. Having a competitor want them can make them seem even more desirable than they are, and can lead to making special deals that are not cost- effective for the company.

When you combine all of these rules of thumb, you can easily see why it looks like it makes sense to keep pushing that boulder uphill – even as it gathers more and more junk as you go.

But sometimes the right answer is to leave that boulder right where it is. Walk away from your company's current compensation plans and start anew.

Look at what your sales associates want now – not what they used to want or what you negotiated for years ago.

Look at your company's current expense structure, your current competitors, your current market opportunity.

Then design a set of compensation plans that work for you now.

You might find that you have a tiny little rock – instead of a huge boulder – to deal with. And it becomes surprisingly easy to maneuver, making your company more nimble and more responsive to what is needed now.

You just need to let go of those old rules of thumb.

Is Your Profit an Illusion?

[Read time: 3 minutes]

By: David J. Cocks, CEO

"Of course we're profitable," says the broker. "I take a quarter million dollars out of this business every year!"

Every so often we hear statements like this from brokers. Sometimes it's an owner who is ready to retire and wants to sell the business to one of our clients.

But when we analyze their books, we discover that although the company appears profitable on the surface, it is actually barely breaking even.

To help determine a company's true profitability, here are the first three questions we ask brokers:

If you sell, are you paying yourself the appropriate split?

Very often, broker/owners don't take their split. They leave the money in the company account, and pay themselves out of what's left over after expenses are covered.

While this helps ensure that the company has the necessary cash flow, it can mask profitability issues. If the owner is the top-producing agent, that can really skew the results.

Are you paying yourself for the time you spend managing the company?

You need to determine how much of your time is devoted to administration and management. Then you need to figure out how much it would cost to hire someone else to perform those functions. Until you hire that person (or those people), you should pay yourself the same amount of money.

Are you getting a return on your investment?

You need to have profit built in separately from your split and the money you make performing management duties. This is your return on the capital you invested to buy

or start the business. If there is no return on capital, you are going to have a hard time selling your business for any significant amount.

The bottom line is that you need to structure your business financially so that if you decided to go live on a beach in Fiji and do nothing more than sip mango daiquiris in your beach chair, your company would still be profitable.

You have to make sure that you are paid for all the functions you perform: as an agent, as a manager, and as an investor.

Once you have done that, you will be able to sell the company at a substantial profit – or hire someone to manage your business while you go off to Australia!

Increasing Share Value through Sales Compensation Design

[ read time: 4 minutes ]

By David J. Cocks, CEO

While there are a number of factors that impact the share price of a company, the two basic drivers remain earnings (or profit) and the multiple applied to earnings.

Two companies with the same profit, working in the same overall environment, frequently have different multiples; these multiples dramatically impact the value of the company and therefore the share price.

For example, a company with a $10,000,000 profit and a multiple of 5 times earnings receives a $50 million valuation, while another company with the same profit and a 7.5 times multiple has a value of $75 million.

While many companies focus on increasing profit, and therefore shareholder value, relatively few focus the same effort on improving their multiple. So, what drives this multiple?

The first driver is economic expectations. If the economy is deteriorating, even though profits have not yet fallen, share prices will drop and multiples retract on expectations of leaner times. Despite the fact that this is outside of management's direct control, it is important to note that some companies do not drop as significantly as their counterparts.

This is due to the influence of the second driver, corporate expectations. These expectations are a function of the company's ability to lead the industry. Proven leaders typically have higher multiples than others in the same industry, regardless of economic expectations. One of the key leadership criteria is whether or not a company has a sustainable competitive advantage.

So if a company's compensation plans strengthen the company financially, increasing profit immediately and protecting earnings in a downturn, it would provide such a sustainable advantage.

Such a solution does exist today and has stood the test of time. It is particularly effective when the primary distribution channel is through people whose skill is key in binding the consumer to the company. Examples range from industries that use a typical sales force, like real estate and manufacturing, to professional service organizations, such as law firms and dental offices.

The companies that have used this bold new approach have experienced increased productivity from their existing staff and improved ability to recruit key revenue providers from their competitors. They typically have seen an immediate increase in profit and have been able to retain their lead even after competitors copied their strategy.

The essence of the approach is:

1. Design compensation plans so that after the company has recovered its costs plus a profit from each revenue-producing individual, those individuals can then receive substantially more of the revenue they bring in.

This drives productivity and immediately increases profit. It also creates a naturally cost-efficient environment and improves recruiting.

2. Offer choices that empower the individual to find the right compensation fit; usually this involves selecting the risk-reward relationship that works best for each revenue-producer.

This maximizes recruiting and retention and lowers the breakeven point of the company, increasing its survivability and maintaining profitability, even in a downturn.

If you have any questions, please call us, email us on hello@cmglobalpartners.com or schedule a demo here.

How to Introduce New Sales Compensation Plans

[ read time: 3 minutes ]

By David J. Cocks, CEO

No matter how you introduce new compensation plans, expect your salespeople to move through several stages in their response:

Denial

Many salespeople will deny that a change is required and will want to keep their current commission program.

Rejection

Even after you've explained why the change is being made and discussed it with them, they will reject your reasoning.

Exploration

Sales reps will begin to explore their options, perhaps at a competitor's office.

Acceptance

Your salespeople come to grips with the reality that change is required and become ready to commit to the changes.

You need to be prepared for these stages, so you can help your sales force work through them. A consultative approach usually works best - share the rationale behind the change and help reps understand how both they and the company will benefit from the new plans.

Here are some more tips that can help ease the process:

1. Consult sales associates during the process of determining new plans. Although you may believe you know what your reps want, your ear may not be as close to the pavement as you think. Asking for input can provide useful information.

2. Explain why changes are needed. When reps understand the issues and are consulted, they are more likely to buy into the solution.

3. Analyze the impact of the changes. Typically, some salespeople will come out ahead, others will see little difference, and some will see at least a temporary decline in income. Focus on those who are negatively affected. How likely are they to jump ship? If you don't want to lose those reps, perhaps there are some low-cost perquisites you could offer to soften the impact.

4. Offer a choice. Allowing sales reps to choose among several compensation plans restores their feeling of being in control. It also lets them match their tolerance for risk to their compensation, and choose the plan that motivates them most effectively.

5. Don't make exceptions. It destroys the trust between you and your salespeople. You do run the risk of losing some reps, but you'll lose more if others see you making exceptions and feel they haven't been treated fairly.

6. Remember that salespeople leave a company mainly for personal reasons or lack of good management – not for compensation.

If you follow these steps, you'll ease the transition and make it much easier to successfully implement your new compensation plans.

How to Change Sales Performance Management Plans

[ read time: 5 minutes ]

By David J. Cocks, CEO

I was talking to a sales executive the other day who was concerned about introducing new commission plans to her sales force. Her firm has several hundred sales people, and she was worried that changing their compensation structure would cause a lot of disruption.

I explained that if you follow best practices for introducing new plans, you minimize the disruption, can retain virtually all of your sales representatives, and get them powerfully motivated to sell even more.

Here is the process we use, which typically results in a 98% retention rate, a 30% increase in sales in the following year, and significantly enhanced profitability.

Needs Analysis

We start by asking your sales force, sales managers, and support staff what they want. They're usually very forthcoming about what they like and what they don't like, what's important and what they don't care about, what they want changed and what they would prefer to keep.

If you're doing this yourself, don't skip this step. Even if you think you already know what they are going to say, take the time to consult with members of each group. You may be surprised by what you hear.

Competitive/Market Analysis

We analyze the competitive factors in your market and determine the potential for growth as well as possible areas of risk.

If you're doing the work, update your information about what commission structures your competitors are offering. If there any new competitors, make sure you include them. Then analyze what's happening with your market. Is it growing or shrinking? Is anything going on that will affect the demand for sales representatives?

Financial analysis

We build a business model of your company and look at where you are now in terms of revenue, expenses, and profitability. We interview top management to find out what your goals are and determine where you want to take the company.

If you're doing this yourself, take a look at your numbers and the trends. What are your goals?

Design plans

Using all the information we've obtained so far, we design new compensation plans that meet your goals, address the desires of your sales force, and are competitive for your market.

If you're designing the plans, it helps to use software that lets you do what-if analysis so you can project the results of your changes. We think our software is the best for this, but you can use Excel too.

Risk Analysis

Once we have the plans designed, we run them through several tests. First, what are the implementation risks? We break your sales force into a number of groups and analyze the impact on each group. Given the market conditions and competition, who are you most at risk of losing?

For example, if top producers have been subsidizing the rest and we equalize the plans, are we at risk of losing mid-level producers? Perhaps not, because no competitor in town has a better offer for mid-level people. But there might be a group of new recruits who are at risk.

Then we determine whether the plans can be administered. There are some accounting systems that can't handle certain types of plans. There's no point in implementing a plan that you can't pay on.

If you're doing this, run some test transactions through your accounting system.

Calculate the results by hand and compare that with what your accounting system comes up with. Do they match?

Tweak Plans

Based on what we found out during the risk analysis phase, we adjust the compensation plans.

Introduce Plans

Once the plans have been finalized, it's time to introduce them to the managers, sales representatives, and support staff. We start with the managers, making sure every manager understands the plans inside and out, because they'll have to explain them.

Then we introduce the plans to the sales representatives, explaining the rationale for the changes and showing where sales force concerns and requests were addressed. We also sit down with each associate and show them what they would have made last year on the new plan. We show them how they will benefit. If a choice is now being offered, we help them make their selection.

This is the most important step. If you're doing it yourself, spend the time it takes to make sure everyone involved really understands what's happening, why you're doing this, and what it means for them.

When you follow this process for developing and introducing new compensation structures, you stay in control. You can project what your results will be ahead of time, and manage the whole process with confidence.

Are You Stuck in the Technology Sinkhole?

[ read time: 4 minutes ]

By David J. Cocks, CEO

How do you know you are in the technology sinkhole? You invest in technology...
Your agents become more productive... Your revenue goes up... BUT your profit goes down!

About three years ago, we started to see a pattern in the companies with whom we were consulting. Firms that had invested in technology, and had seen significant revenue growth as result, were now losing money.

WORSE in the second year!

Interestingly, a number of companies did see the increase in profit they expected in the first year. The losses didn't show up until the second year, making it difficult to identify the cause of the problem. We found it because of the thorough financial analysis we do as part of our consulting. When we noticed the same problem in company after company, we realized this was a problem affecting the whole industry.

How does an investment in technology cause this problem?

What we discovered was that the investment in new computers, new software, and the Internet worked the way it was supposed to – agents became more productive. Revenue went up. But selling more pushed many agents up to higher split levels. This reduced the company dollar, making it more difficult to pay for the increased technology expense. As an example, let's look at a company where:

GCI = $5 million
Company dollar = 32%
Profit = 2% (or $100,000)
Technology investment = $50,000 annually

Let's say the technology investment results in a 5% increase in revenue. 5% of 5,000,000 is $250,000. So revenue goes up by $250,000.

32% of $250,000 is $80,000. So the company dollar increases by $80,000. $80,000 less the technology investment of $50,000 leaves a net profit increase of $30,000. So in the first year, profit increases to $130,000.

So far, so good. Now, let's look at what happens in the second year.

Let's say all the agents benefited equally from the technology, and everyone moved up to a higher split. Say they go up 2.7%.

Now company dollar drops to 29.3%. You now have $135,000 less to pay your bills than you had last year. Your revenue is up, but your profit is gone.

The situation can be even worse if all agents do not benefit equally from your technology investment, which is what happens in the real world.

Suppose the entire increase in revenue comes from your top producers, who are at an 80% split level. The company dollar on those sales is just 20%, so instead of gaining $80,000 you only increase profit by $50,000 – just enough to pay for the technology investment. Although revenue increased, profit stayed the same. That's in the first year. It could be worse in the second year.

How do you get out of the sinkhole?

You need to be able to recover your investment in technology. Some firms do this by charging user fees for technology or referral fees for leads that come in over the Internet. Other companies increase off-the-top fees, like relocation, for business directly attributable to the new technology. However, these fees are not popular with agents, who feel they are being "nickel-and-dimed" on one thing after another.

The best approach

Your best strategy is to re-design your compensation plans so they are based on your current costs of doing business, including the amount you invest in technology. When you use CompensationMaster's system to design your plans, you can make sure your expenses are covered and build in the profit you need to grow your business. Our consultants can help you design compensation plans that are aggressive and highly competitive in your market. We can also work with you to introduce them to your sales force and managers, ensuring that the introduction occurs with a minimum of disruption and that you get the results you need. 

Get Nimble Again

By David J. Cocks, CEO

When you first start a business, it's easy to turn on a dime when you perceive an unmet need in the market or encounter a new competitive threat. But as the business grows, it becomes increasingly difficult to respond as quickly.

How can you make an established firm nimble again?

Use a Contribution-based Approach

The first step is to design compensation structures that get everyone pulling in the same direction.

Normally, when you design sales force compensation plans, your goal is to maximize revenue. But as a manager or owner, that's not all that concerns you. You want expenses kept as low as possible, so profit can increase too. Right?

A contribution-based approach allows you motivate sales associates to increase revenue, reduce expenses, and increase profit – all at the same time. With a contribution-based approach, sales associates are responsible for contributing their fair share towards corporate expenses and profit. Once that contribution has been made, they are able to keep most of the rest of the revenue they bring in.

Sales associates are motivated to increase revenue; as they sell more, they make more. But with this system they can also increase their income by reducing expenses. When expenses drop, the amount they have to contribute decreases, so they keep more of the money they bring into the company.

You would naturally expect profit to increase when revenue improves and expenses are reduced, but a contribution-based approach provides a higher level of control – you define the percentage of profit you want to achieve. That amount is then built into the plan design. The result is a system that provides automatic incentives for sales associates to increase revenue, reduce expenses, and increase profit.

Meet the Needs of the Sales Force!

Now that you've aligned the goals of the sales force with yours, the next step is to reduce unnecessary expense so you can run a more efficient operation.

If you're in a service business, your biggest expenses are related to your staff – salaries, commissions, and benefits. You can mandate across-the-board expense

reductions, but the way to really save money is to find out what your sales associates don't value and stop spending money on those items. Normally, you can't simply ask what sales associates want; they want it all.

However, with a contribution-based approach, your sales associates learn that benefits, perquisites and support services come out of their pocket – not yours. We recommend that our clients design several compensation plans that offer different combinations of benefits and support services. Let the sales associates choose the plan they prefer. If no one chooses the plan with the most expensive health and life insurance, and many choose the plan with additional administrative support, you know where to spend your money.

We've had clients save hundreds of thousands of dollars, simply by adjusting their benefits packages to line up more effectively with what the sales force wanted.

By using a contribution-based system, you take a holistic approach to designing compensation. You can factor in the company's level of expense, the competitive situation, the desired level of profitability, and the needs of the sales force. The result is a more efficient operation that responds to the needs of the marketplace quickly – and stays nimble over time.

Best Practices: Adjusting Compensation Plans for Inflation

By David J. Cocks, CEO

When was the last time you adjusted your compensation plans for inflation?

Does that sound like a crazy question given today's economy? It's not. Adjusting your compensation plans each year to match inflation is one of the best practices we recommend.

Many companies set up a compensation plan and then leave it alone for years - we've seen companies that haven't changed their plans in 15 or 20 years!

Yet each year the cost of doing business increases. The sales price of your products and services typically rises too. But that's not enough to protect you.

What can happen, particularly in commission-driven industries like real estate, insurance or medical is that the higher sales price allows your sales force to reach higher commission levels faster.

At those levels, you pay them a higher percentage of each sale, which means you have less money available to cover corporate expenses. Meanwhile, those expenses are increasing.

It doesn't take long for those plans to become outdated, so they no longer recover the company's expenses and the profit margin erodes. Once this occurs, it's hard to get the money back.

You have to make such a large adjustment that it can't be done all at once - you risk losing too many members of your sales force. So you implement the change over two or three years, and by then you're behind again.

Meanwhile, you're leaving the door open for a competitor to introduce more aggressive styles of compensation and steal away your top people.

The best approach is to revisit your compensation plans every year, using the Consumer Price Index (CPI) to adjust for inflation. You can find the CPI at http://www.bls.gov/cpi/.