Profits are the lifeblood of a company. A profitable company delivers on its commitment to create shareholder value, enables continued investment in business innovation and growth, and contributes to an environment in which employees can enjoy their work. At many companies, managers and employees are challenged with how to improve business profitability, as the last global recession continues to negatively impact company profits in many industries, particularly those that previously enjoyed double-digit growth.
Increased attention to sales profitability typically causes top management to look to sales and the role it plays in contributing to profit results. One way companies can protect and expand profit margins is to connect sales profitability to their salesforce incentive compensation plans. Profit leakage is often traceable to discounts negotiated by sales teams who do not understand the negative financial consequences of such discounts to the business. Companies that recognize this reality are interested in how to include profit-oriented measures in their sales compensation plan.
The purpose of this article is to provide guidance to sales compensation plan designers who are chartered by management to determine how to take action on including such measures. This guidance centers on four questions that should be addressed during the design process.
1) Which sales jobs are best-suited to the use of profit measures? Any sales job that controls price and influences resource investments devoted to customers, both current and future accounts, should be considered for a profit-oriented sales incentive opportunity. Consideration should be given to:
2) What types of profit measures should be adopted? The type of profit measure connected to the sales incentive plan should clearly support the company’s business objectives and sales strategy in its customer markets. The three most common business goals and related performance metrics that should be considered are highlighted in the table below:
|Business Goal||Performance Metrics
(One or More Could Be Used in an Incentive Plan)
|Increase customer profitability||
|Reduce margin leakage (i.e., decline in margins beyond price discounting)||
Whatever measure is selected, it must be tracked and measured on a timely basis. The authors believe the use of profit-based measures in sales incentive plans becomes more practical as companies adopt newly available software solutions that enable them to measure, track and report sales profitability by each salesperson’s portfolio of customers’ purchase transactions.
3) How much incentive weight should a profit measure be given? When designing sales incentive compensation plans, a common practice is that no measure should ever be worth less than 10% of the incentive opportunity. The reason for this rule is easily illustrated by calculating the amount of pay designated by 10% of target incentive, dividing it by the payout frequency and then subtracting taxes. The amount typically is not meaningful enough to motivate behavior.
The authors’ experience working with companies in 38 of the Fortune 500’s 72 industries shows that when a profit measure is a new metric in the sales compensation plan, typical practice is to allocate 15% of the incentive opportunity to it, and increase it to within a range of 25% to 40% as the company gains experience and confidence in its usage.
4) What changes in selling behaviors are potentially associated with sales profitability incentives? Companies that use a profitability metric in their sales incentive plans report to the authors they saw or continue to see three types of changes in selling behavior as a result of connecting sales profitability to incentives:
To connect profitability to a sales incentive plan, sales compensation plan designers must understand which sales jobs are best-suited to the use of profit measures; the types of profit measures that should be adopted; how much incentive weight a profit measure should receive; and the changes in selling behaviors that are potentially associated with sales profitability incentives. By addressing these issues during the design process, designers can ensure the resulting plans best direct salespeople to protect and increase profit margins.
About the Authors
Read the May edition of Sales Compensation Focus.
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