Pushing a Compensation Boulder?
There are six heuristics that are recognized as being widely used in our daily lives, and a lot of them are relevant here…
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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.
Increasing Share Value through Sales Compensation Design
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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?
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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
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Explain why changes are needed. When reps understand the issues and are consulted, they are more likely to buy into the solution.
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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
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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.
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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?
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?
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How do you get out of the sinkhole?
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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
How can you make an established firm nimble again?
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
When was the last time you adjusted your compensation plans for inflation?
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/.
TOP 6 Tips for Compensating Sales Managers
The following tips can help you design compensation packages that will motivate your sales force managers most effectively.
Managers should be compensated, at least in part, for their performance – for the degree to which their decisions influence the company and contribute to its success. However, sales force managers have a wide range of duties; some sell, some don't; some own part of the business, while others are employees. Designing incentives that balance all these factors can be a challenge.
The following tips can help you design compensation packages that will motivate your sales force managers most effectively.
1. Base Salary
Start with a base salary that reflects the marketplace value of the manager's administrative duties. For example, if those duties are expected to take up to 60% of the manager's time, the base should be approximately 60% of what a full-time administrative manager in the open market would receive.
2. Overrides
Overrides can be calculated in many ways: on gross revenue, net operating income, earnings of the sales representatives, or profit before interest and taxes (EBIT).
Consider carefully which measure you use. When an override is calculated as a percent of gross revenue, the impact of poor sales is not felt as dramatically as it would be if the override were on net operating income.
Paying on the net operating income also encourages recruitment, and rewards the manager who devotes time to getting sales representatives to the breakeven point. It provides a disincentive to managers who readily give exceptions or cut deals to recruit new reps – the manager's own income is affected proportionally.
3. Task Completion Incentives
Many companies are instituting financial rewards for successfully recruiting new associates, offering training or coaching, or increasing the percentage of productive sales representatives.
Recruiting. If you pay a flat amount as a reward for recruiting, consider a sliding rate relative to the value of the new recruit. Make the payment in stages, as the associate makes sales, to help guard against a body shop operation. Even better, pay when the associate reaches breakeven, as this ensures that the bonus comes from profit built into the breakeven point.
Training. Offering an incentive for training or coaching helps ensure continuous improvements in production. Try paying a flat fee for the amount of time invested or giving a bonus based on the number of associates who complete training programs.
Productivity. Incorporating an incentive for increasing the number or percentage of active representatives encourages motivation of all reps, and helps prevent preferential treatment of high producers.
4. Bonuses
Offering rewards for reaching targeted production levels can be highly motivational. Bonuses might be given for reaching a certain level of revenue or profit each month, or for bringing down the company's expenses.
5. Profit Sharing
You may want to pay a top manager a set percentage of any profits retained by the company over a specified period of time. For this to work, your company should have well-controlled expenses and a generally stable economic situation. The manager should have access to all of the company's financial information, and feel that he or she has enough influence in the company's day-to-day operations to control the factors that affect profitability.
One risk is that relations between the manager and senior management may become strained if the top executives want to make investments that will grow the business at the expense of short-term profitability. For this reason, profit sharing is best used as a component of a compensation plan rather than as the whole means of compensation.
6. Offering a Choice
One of the most important factors in manager compensation is the competitive situation in the market. Where lots of good managers are available, companies do not have to pay as much. However, where talent is scarce, more aggressive plans are essential.
One innovative approach is to offer managers a choice of compensation plans. In the same way that you allow your sales associates to choose the plan that best motivates them, you can allow managers to choose the compensation structure that best meets their needs.
Whatever form of compensation you choose, it is important that managers clearly understand how the commission or bonus will be calculated, and feel that they have control over the factors that will affect those numbers. Without that understanding and that power, they won't be motivated effectively.
Compensation plans should not only be attractive to the manager, but should also be tailored to the needs of the company, providing incentive in those areas most needing improvement. When compensation is carefully thought out, managers can be motivated to lead the company in directions well above and beyond the daily operations of the business.
How to Handle Sales Performance After a Merger or Acquisition
No matter how generous the plans are, representatives are going to feel that "the other guys have a better deal."
When companies go into a merger or acquisition, there is often a tendency to leave compensation alone – the feeling is that the ownership change will be traumatic enough without changing the commission structure too.
However, this leads to problems. Invariably, representatives compare plans. There are bound to be differences: different commission levels, base salaries, incentives, perquisites, benefits and more.
No matter how generous the plans are, representatives are going to feel that "the other guys have a better deal."
One company's reps see that sales associates at the other company receive a higher commission, while the other company's reps notice the higher level of administrative support and lead generation the first company provides.
To keep everyone happy, there's a tendency to creep towards a plan that has the best of both – higher commissions and higher levels of support, services and benefits. This can be disastrous.
The longer it goes on, the worse it becomes. Top producers have the leverage to cut better deals for themselves, and resentments build and fester.
Additionally, the longer plans are left alone, the harder it becomes to find a good time to make a change.
Right after a merger or acquisition is the perfect time to rationalize compensation. Creating new compensation plans makes a clear statement of the company's goals and positions everyone to move forward without the baggage of the old arrangements.
Start by asking sales people from both companies what they like and don't like about their compensation structures. You'll get good feedback that will help you design new plans, and you'll also have information about what works and doesn't work that you can use to better manage the combined sales force.
The simple act of asking what they want sends a powerful message to the sales force and is an excellent retention device.
Then you need to decide what value proposition you want to offer the sales force. Can you combine what each company is doing now? If one company has a particularly attractive culture, you may want to transition everyone to that offering. Or it may make sense to start over with something brand new.
You can take this opportunity to rationalize the compensation structures, bringing them into line with what the sales force needs and wants. Maybe some of the services or benefits one of the companies offered are no longer needed. We have actually seen companies pay for an acquisition simply by restructuring compensation.
Don't forget to do a thorough financial analysis of any proposed changes. We saw a merger once where one of the companies offered a very generous commission at high sales levels, which they could afford to do because very few people ever reached that level. The company they merged with had far more high producers, and when management decided to offer that plan to everyone they quickly found themselves in serious trouble.
Of course, you need to take into account the revised cost structure of the new company. You'll be saving money through consolidation and reducing duplicate costs. Those savings can go to the bottom line.
Or you might invest them in your sales force by designing plans that provide higher commissions – which would be highly motivational to the existing sales force and very useful for recruiting.
By taking advantage of a merger or acquisition to revise your compensation plans, you can better meet the needs of the combined sales force and position your company for greater growth in the future.
How to Make Each Sales Associate a Profit Center
View each sales associate as if he or she were an individual company. (Your firm as a whole is then like a big conglomerate.)
Are some members of your sales force subsidizing others?
In some companies, the top producers carry the burden. In others, it's the mid-level or lowest producing members of the group.
Either way, it's not fair.
Consider treating each sales associate as a separate profit center.
View each sales associate as if he or she were an individual company. (Your firm as a whole is then like a big conglomerate.) Does each sales associate bring in more revenue than it costs to have him or her on board?
If not, what can you change to generate a profit?
You might want to create a commission structure designed specifically for new hires that allows you to provide the training and intensive support services they need to be successful – while ensuring that you recoup those costs. When associates are ready, they can move up to a commission structure designed for solid mid-level producers.
You can create another set of commissions for top-producing sales associates who don't need a lot of support and want to do things their own way.
When you set up commission structures like this, you can do a better job of meeting the needs of the sales associates. You can provide a higher level of support to those associates that want it, while offering independence to others.
You're also virtually guaranteeing corporate profitability. When you make a profit on each member of your sales force, it's hard not to make a profit on all of them put together – which makes your company more stable financially. But what's more important is that you are treating all members of your sales force in a fair and consistent manner.
But the increase in productivity is the most powerful benefit. It is not at all unusual to see productivity gains of 30% in the first year sales representatives are given a choice of compensation plans.