The sales compensation package for the salespeople at this particular Company was formally set in signed agreements between the parties. The commission rate was based on a sliding scale tied to both volume of sales and the gross profit margins. However, the original performance measures were faulty because gross profit and sales targets proved to be unrealistic. In discussions with the CFO, it was agreed that the previous formula for sales commissions was poorly structured. It was based on unproven expectations of both sales and profit margins.
The Need for a Review Process
There was no systematic review of the salespeople’s performance. No corrective action was taken to adjust the goals or promote better performance. Furthermore, clawing back the overpayments would have caused severe, mutual repercussions. The commission deficit has already been written off in the past financial statements. Therefore, the CFO decided to make no adjustments against current sales compensation. However, the negative balances will be brought to the attention of the salespeople. In addition, a more attainable commission formula, and specific quarterly goals were set.
Setting a Competitive Sales Compensation Rate
This was achieved by adjusting the existing formula to produce a more competitive industry commission rate of 7.0% at the targeted gross profit. With this in mind, it was recommended that the targeted gross profit be set at 2.0% over the historical average of 33.0%. Also, the car expense allowance, cellular phone, and health care were deducted from the calculation of commission as before.
Fair Sales Compensation Formula
Completed, paid jobs x existing gross profit x 0.20)–expenses
This formula will have the following effect on the senior salesperson’s projected sales for the new fiscal year:
$935,000 x 0.33 (GP) x 0.20 $61,710
Expenses charged $536/month $ 6,432
Commission to draw gain/(deficit) $ 9,778
Payout to Salesman after expense deduction $55,278 5.9%
Maintain the same car allowance of $75/week + fuel of approx $50/wk.
Fairness of the New Formula
As an example, last year the company paid their senior salesman $55,873 in draw and expenses on annual sales of $536,942. There would have been a net reduction in commission using the new formula. However, the large draw to commission adjustments of the past three years proved that the gross profit goal was flawed. If he can reach the targeted 35.0% GP and $1.0 million in sales, then the compensation will be $63,570 ( 6.4% of sales). This is closer to the rate paid by prominent competitors in the industry.
Lack of Reviews Leads to Discontent
The lack of quarterly sales compensation reviews and adjustments is the cause of serious discontent in this Company. It may cause some of the salespeople to search for other employment. Unfortunately, most of them have not performed as originally expected. However, the sales that they generated in products and services, at a 33.0% GP, exceeded the average gross profit achieved by the Company. So, they have still made a significant positive impact on revenues.
Set Quarterly Sales Goals
Sales compensation packages must be connected to quarterly sales goals and gross profits. It is the task of the Sales Manager to do this regularly. They must find ways to help the salespeople consistently achieve their sales goals.
The Company set unattainable goals for the salespeople in the past. This was exacerbated by the practice of benign neglect in making the draw and commission adjustments. In fact, the company was paying what amounted to a fixed salary + expenses.
Sales Compensation Tied to Competitive Criteria
By connecting the commission structure to historically achievable gross profit and revenue goals, salespeople are fairly rewarded on performance. Furthermore, the commission rate is closely aligned with that of the competition. Considering the payout of the past years, there will be a reduction in cost when the new formula is applied.
To achieve their targeted sales compensation levels, the salespeople will have to increase their sales and average gross profits. Quarterly sales goal setting and regular commission to draw adjustments will result in more consistent growth. In addition, it will provide win-win scenarios for the Company and the salespeople.