Commission accomplished

Adam Bernstein
Thursday, July 23, 2020

Every commercial operation needs good salespeople if they are to sell their products, but while pay can be easier to set for some employees, it has been notoriously difficult to create a commission scheme for salespeople that works for employer and employee alike.

Rewarding results

Richard Cummings, managing director of HR consultancy Moore Kingston Smith, thinks that salespeople should be rewarded where effort is required to make a sale.

He says: “You reward the outcome: the sale. And that reward should drive the activity that closes deals.” He believes that there is little point paying salespeople for volume of work as this doesn’t necessarily drive income-generating activity. On the contrary, he says that if employers reward only when a sale is made, then salespeople will direct activity into higher quality activities.

Charles Cotton, senior reward adviser at the CIPD, a professional body for personnel managers, sees the key challenge as avoiding payment structures that inadvertently create behaviours that employers don’t want: “You want enough checks and balances in place to prevent [behaviours] but without so many the scheme doesn’t work.”

Critical elements

So, how should a commission scheme be set up? What should it feature?

First off, every scheme needs a carefully thought out structure with the right level of basic salary and a suitable commission percentage to incentivise. But as Cummings explains, “there is no ‘one size fits all’ structure. If there were you wouldn’t be able to attract or retain good sales talent because good salespeople could go anywhere”. He feels that basic salary should depend on the market while commission will depend on “how much can be passed back to sales without denting your bottom line or enabling your salespeople to retire too early”.

Rob Scott, managing director of Aaron Wallis Sales Recruitment, considers product and market the key drivers of a commission scheme. He says that companies selling products with high margin levels, software, for instance, “can pay top basics and higher commissions because the cost has already gone into the development of the product”.

He adds: “Likewise, for industries such as engineering, or medical devices, where niche expertise is required to sell the product.” In contrast, in many B2C sectors, he sees lower base salaries and higher commission percentages.

There are of course many different types of commission structure – too many to list here. However, the simplest is a payment or percentage for each sale. But, as Cummings points out: “Firms need to a sell number of ‘whatever’ to cover costs, so the salesperson shouldn’t get anything for the first batch sold, or they shouldn’t receive a payment for that batch until they’re on to the second.”

Scott worries that any commission scheme based on a percentage of sales income “is easy to calculate but fraught with potential hazards unless pricing is fixed, or the salesperson is not authorised to discount.” With this in mind he offers yet another option – paying a percentage of gross profit. Here he warns that “unless there is a standard margin on every project won it can be difficult for the salesperson to calculate, and therefore not particularly motivating.”

Another possibility is where firms cap commission to balance production and demand (in service industries, it’s used to maintain customer service levels). The problem with this – for Cummings at least – is that salespeople tend to hold back deals until the next period, which is why “it should be avoided or managed to avoid the setup being exploited”. He continues: “Where there is no cap, it’s generally because the company wants to sell as much as possible; companies in this situation are best to tier commissions.”

On top of this is a percentage of gross profit above a threshold where salespeople have to generate their real cost in a particular month or quarter for the commission scheme to apply. It’s a winner for Scott because “if they do not cover their cost, they don’t earn any commission for that period”.

As to revenue to drive this, it’s a huge generalisation as it differs from industry to industry, but Scott says that “a commonly used rule of thumb is that a salesperson should generate five times their total cost in gross margin”. In software it could be many multiples of this, while in professional services it may be as low as two times. Scott gives an example: “If you think of a £35,000 basic salary field account manager with a car and £50,000 on target earnings (OTE), their real cost with employer’s national insurance, expenses, etc. is more likely to be £70,000; therefore they should generate £350,000 of gross profit.

Salespeople might be inclined to oversell themselves and so when hiring it is good to ask for copies of payslips or P60s to see if they have actually earned the commission claimed. As Cummings puts it, it’s fair to question why a good salesperson, earning a good level of commission would move on. “After all, an experienced and good salesperson may be leaving a commission behind which will not be paid on their exit,” he says. In these circumstances, to counter losses, Cummings suggests an advanced commission scheme where, for example, the employer expects OTE of £100,000 with a basic of £20,000: “Employers may decide to pay the monthly equivalent of £80,000 per annum reducing by a certain percentage each month, during which time actual sales commission is increasing.” This, he says, eases the financial pressure on a new starter.

It’s easy to see why those in recruitment look at just the mathematical calculations, but from a human perspective, Cotton says firms should look to engage those that the scheme affects. He says that there should be a shared understanding, that “when creating a commission scheme you seek input from sales staff, managers, and clients about what things they would like to see rewarded and recognised, as well as from colleagues, such as in legal, compliance or risk.”

He would then have employers question whether commission should focus just on sales, customer service, or somewhere in between; whether commission should reflect what individuals have achieved and how much teams have accomplished; whether the scheme is all about encouraging performance or if should there be non-financial rewards; and how commission stacks up with the employer’s culture, mission, purpose, etc.

As Cotton says: “Once you’ve engaged with your stakeholders, you’ll get an idea of what the right balance should be for your organisation. It will also encourage a sense of ownership among the sales staff as they helped create the scheme rather than the scheme being enforced on them.”

He makes one further point here, that “ideally, the organisation should help their employees become financially resilient so that they don’t find themselves in trouble”. This can range from financial awareness programmes covering such topics as how best to save, spend and invest money to providing benefits that help protect their people from certain risks, such as illness. “Unexpected emergencies can happen, such as a car breaking down, a bereavement, divorce, etc, so employers may want to offer support through a hardship loan.”

Encouraging the right behaviours

But apart from pay, commission schemes can be used to encourage the right behaviours. As Cummings has witnessed, a salesperson can damage a corporate reputation, therefore he says: “Employers should put guidelines and parameters in place to ensure the sales process follows the company’s procedures. Failure to comply could result in commission not being paid, or more severely, a disciplinary process.”

By extension, a commission structure should reward good salespeople, but not those that do not perform. There will be situations where commission is not paid to some for a period while others are achieving. Here Cummings says that “this could indicate a training need or an internal issue such as territory or product”.

“Alternatively, it may be the case that these employees aren’t cut out to be salespeople.”

It’s interesting that Cotton reasons that the best way to weed out those who aren’t meant to be in sales is through the recruitment and selection process and not via the commission scheme. He expands: “Not all sales environments are the same and just because someone is good at selling one type of product to one type of clients doesn’t necessarily mean that they will be successful in selling another type of product to a new set of customers – the interview process should help with that.”

But commission can do more – especially if it is dependent upon, as Scott suggests, “meeting other factors such as customer satisfaction surveys, key performance indicators, or changing behaviours in agreement with their line manager”. He thinks firms might want to put in a simple mechanism whereby KPIs have to be met for commission to apply. He gives an example: “Most salespeople, naturally, aren’t great at detail or process and see ‘paperwork’ as a necessary ‘evil’. However, many firms have introduced CRM systems and then calculated commission based on what was on the CRM system.” As a consequence, salespeople input their own required data – “a tremendous win-win as it helps them get paid”.

Beyond the scheme goal thought should be given to how can it be abused. But as Cummings says, “every single scheme has a downside for someone somewhere but, as long as it truly rewards the best salespeople, you have got it to where it should be.” Even so, he advises reviewing the setup periodically.

One key tip from Scott: all sales data should be visible so that it generates healthy competition among members of the sales team. He says: “It helps to discourage things such as ‘holding back business’ to the following month, or ‘top drawing’ leads so that they’re not in the sales forecasts for next month, etc.”

And Cotton agrees: “It’s up to an employer what factors they use to determine bonus pay, so having measures which ensure that sales are made in an ethical way is legitimate. The challenge is not to use so many different targets and measures that the scheme becomes so complex to understand and so difficult to make money that the commission plan does not motivate.”

The bigger picture

It’s not just the frontline salespeople that sell – others are in the process too, which is why there’s sense in having a commission scheme with a percentage based upon individual performance and the remainder based upon meeting team targets or overall company profitability. But as Scott warns, it’s great in theory but is entirely “unfair for the top salesperson that is bringing in 30% of sales income, but earning the same in commission as a peer that generated just 5%.” Consequently, in this culture, businesses often lose their top performers.

Taking the concept further is the ‘split’ commission where money is divided among a team of sales specialists. Some firms have introducers, nurturers and closers that look after a different part of the sales process and they secure business as a team. Scott isn’t in favour of this though: “Personally, I don’t think that it provides the greatest experience for a customer.”

His vehemence against split commission is based on ill-feeling in a sales team: “I have seen feuds between good people go on for years over split commission, together with physical fisticuffs on one occasion.” For it to work all parties must understand the ‘rules of engagement’.

Further, while all sales can be attributed to one salesperson in most organisations, there is a sales manager who rarely sees a customer; Cummings thinks they should be rewarded too. He adds that sales managers’ commissions (bonus) “should have an element of ‘management by objectives’ to ensure they are developing their team properly”. As an aside, it shouldn’t be forgotten that great salespeople don’t necessarily make great sales managers.

Should commission be paid monthly, or over a quarter or at year end? There is no set rule for this reckons Cummings: “For fast-moving sales, monthly is the norm. For longer transactions quarterly payments are acceptable. However, paying monthly does even out the payments, helps from a payroll and tax point of view, and also can keep sales staff motivated.” The problem is that where commission is paid quarterly, a slow month can be recovered, but a month with limited sales activity drags on; paying monthly maintains monthly targets and keeps the sales process moving.

Scott warns against paying commission on all sales, regardless of whether they are profitable or not: “To explain, I know of a firm that was paying a flat percentage on all sales income as commission, and there wasn’t a process to control discounting. Consequently, the firm was winning unprofitable business and paying commission on top, so a double loss.”

For him, a good commission schemes needs three key elements: it should motivate each sales team member to push for more significant sales numbers; be easy to calculate for both the business and the salesperson; and also, it should work in conjunction with the company’s broader values and vision. Communication is paramount; salespeople don’t like surprises, particularly when it impacts their income.

Even so, Scott says that most salespeople want to ‘feel’ successful and he encourages firms to pay monthly or quarterly so that staff receive a ‘big cheque’ when they have the ‘stellar month’. He worries that commission paid annually can have an adverse effect, especially where commission is ‘capped’: “I have known many salespeople that hit their sales target by say month seven and ‘downed tools’ as they couldn’t earn any more, holding on until the end of the year to pick up their commission before moving on.” For him, one of the ‘golden rules’ of creating commission schemes is to not cap them.

Taking a contrarian view, Cotton believes that if employees keep being given money to sell, they will carry on selling, “even if this causes problems in other parts of the business” with a potential adverse effect on, say, production or logistics. He thinks that a cap might also prevent employee burnout.

Schemes should be transparent and be flexible. Even though they form a contractual agreement, Cummings says it should be made known that the mechanics of the scheme are fluid and may be updated: “Employers should be able to adjust targets and percentage payment to recognise internal or external factors.”

Scott echoes this. He reckons that every commission scheme “must have a caveat along the lines of the ‘directors have the right to vary the amount or terms of the commission scheme, or to withdraw it, providing you with X weeks’ notice’”. And in the current challenging coronavirus environment, he says that it means that firms can protect their cash by postponing commission payments until business returns to something resembling normality.

But for all the talk about commission schemes, Cotton offers an alternative: non-cash incentives (NCI). Like commission, NCIs can be linked to the achievement of individual or team sales, etc. “The difference is that rather than cash, employees get rewards,” he says. These may be an experience that individuals have problems sourcing, gadgets that the organisation is able to purchase at a discount, or a competition with top sales staff taken to an event overseas. So long as they are appropriate and valued by salespeople, they can have the same effect.

Dealing with ‘bad’ sales

No one likes returning money; it leaves a bitter taste in the mouth. As Cummings highlights: “It’s an administrative and payroll burden and the process of explaining to a salesperson can cause real friction between managers and teams.” It’s for this reason that “it is advisable not to pay any commission until the payment is received. This removes the issue of claw back and also makes the salespeople your credit control team”. He adds that if the salesperson is tasked with ensuring payment is received before commission is paid, employers will quickly see their debtors reduce.

Cotton takes the same line. He sees employers holding back commission or waiting until the customer has paid before paying. Others, he says, check to ensure that the sale was conducted correctly before paying. As he explains, “it can be very hard to claw back a bonus from an employee once it has been paid and spent”.

He advises being “open and transparent about how the commission process works and why sales staff shouldn’t expect to see commission immediately; it’s easier to delay payment and adjust downwards than trying to get money back from the employee and the tax office.” But he adds that “the organisation should stress that it won’t withhold payments for longer than is necessary and that internal processes to check that the sale is legitimate are carried out as quickly as is possible”.

Again, consulting staff about clawback when designing a scheme will help with acceptance.

Finally, Scott advocates paying 70% of commission payment every month with the remaining 30% as a quarterly target, “which will take into account things like debtors, bad debt, or bad sales”.

In summary

Salespeople are a very distinct breed and a conundrum. They need to be avaricious, able to see the bigger picture and be a team player. The right people managed correctly will do wonders for the bottom line.

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