Bonus Plan or Commission Plan? By Andris A. Zoltners, Prabhakant Sinha, Sally Lorimer and Stephen Redden, ZS Associates
Both bonus and commission plans are common sales incentive compensation approaches to attract, motivate and retain salespeople, but how should firms decide which is the most suitable? Several aspects of a firm’s selling process and environment influence the plan structure – bonus, commission or mixed – that is appropriate. The table below summarizes several characteristics of the selling process, salesforce culture and demand predictability that support each plan type.
Selling process characteristics
Salesforce causality is high – sales are determined primarily by the skill and effort of salespeople and are not substantially affected by factors outside a salesperson’s control.
Salesforce causality is moderate – sales are influenced by the skill and effort of salespeople but are also affected by outside factors.
Selling success is primarily the result of an individual salesperson’s effort (rather than a team effort).
Selling is a team effort, making it difficult to attribute specific results to an individual salesperson.
Carryover sales resulting from past salesforce effort are low, so that commissions reward recent sales effort. Commissions paid on carryover sales are “automatic” income for the salesperson, and thus are actually a “hidden salary.”
High carryover sales are generated without any extra effort or skill. A bonus plan allows the firm to set performance thresholds above the carryover sales level, inspiring salespeople to work hard to earn their bonus.
Selling cycles are short and performance measures are straightforward, allowing frequent performance measurement and incentive payout.
Selling cycles are long and/or performance measures are complex, making it difficult to measure performance and pay incentives frequently.
Salesforce culture characteristics
Sales management does not feel it is important to closely control salesforce effort; the salesforce is managed on the results achieved.
Sales management wants to control salesforce effort.
The salesforce is expected to sell; non-selling duties (such as service) are assigned to other company employees.
Salespeople are expected to perform non-selling tasks as part of their job.
Sales territories are equitable, so that earnings depend on skills and effort and not on the territory.
Sales territories may not be equitable. A bonus plan allows management to assign each salesperson an appropriate goal based on territory potential, so that earnings are driven by salesperson performance and not territory assignments.
It is unnecessary to manage salespeople’s earnings to a specified level; salespeople who deliver should have unlimited earnings potential, even if they are among the highest paid people in the company.
Salespeople’s earnings need to be managed to a specified level so that salespeople’s income is consistent with that of other company employees in similarly valued jobs.
The company wants to closely manage the salesforce expense to sales ratio.
It is more important to manage salesforce expenses to a predetermined budget, rather than to a percentage of sales.
The market is volatile, making it difficult to predict future demand.
The market is stable and the company can predict future demand with a high degree of accuracy.
Data for setting accurate goals at the territory level are not available.
Data are available that allow management to set accurate goals at the territory level.
With a bonus plan, each salesperson is typically given a quota for a territory, and incentive payments are tied to performance relative to defined quota gates, targets or thresholds. For example, the salesperson might receive a first bonus payment at 90% of quota, a second payment at 100% attainment, and a third at 110%. Bonus plans typically include a sizeable salary component, so that if salespeople do not sell enough to earn the bonus, they can still earn a decent living.
Because most bonus plans have a large salary component, such plans are often attractive to salespeople with a longer-term focus who want to stay with a firm and build a career. They also attract salespeople who in addition to selling, are interested in problem solving, consulting and servicing customers.
Commission plans pay continuously for every sale. A commission rate is multiplied by a performance measure, such as sales or gross profits, to determine payout. Sometimes the commission rate varies by product or customer. Often, the rate varies depending upon the level of performance attained by the salesperson. For example, a salesperson might earn 3% on sales up to a territory goal and 5% on sales beyond the goal. Many commission plans include a salary component, but usually the variable component is larger than it is in a bonus plan. With most commission plans, a salesperson relies on commission earnings, in addition to salary, as an important part of income.
Commission plans that pay mostly variable pay with little or no salary tend to attract result-oriented salespeople who believe they can sell anything to anyone. Such plans also encourage poor performers to leave the firm, as they will not make enough money to earn a decent living. However, sometimes such plans generate little firm loyalty from salespeople. A salesperson paid mostly on commission is likely to jump ship if a competitor makes a better offer, and may take many of the firm’s customers.
By adapting the sales incentive compensation plan to the selling process and environment, firms can establish an incentive compensation design that will drive sales by attracting, motivating and retaining salespeople consistent with the desired salesforce culture.
This article was adapted with permission from “A Complete Guide to Sales Force Incentive Compensation” by Andris A. Zoltners, Prabhakant Sinha, and Sally Lorimer (AMACOM, 2006).
Stephen Redden is the Incentive Compensation Practice Area Leader at ZS Associates, a management consulting firm specializing in addressing sales and marketing issues. Redden can be reached at 847-492-3423 or stephen.redden @zsassociates.com. For more information, please visit us at www.zsassociates.com.