Devising a Sales Compensation Plan

Whether contemplating major or minor changes or drafting a completely new sales compensation plan, the sales executive approaches the project systematically. Good compensation plans are built on solid foundations. A systematic approach assures that no essential step is overlooked.

1. Define the Sales Job

The first step is to reexamine the nature of the sales job. Up-to-date written job descriptions are the logical ways to start. If job descriptions are out­dated, if they are not accurate, or if complete descriptions of the sales job objectives and work are not given, then a revision is in order. The effective sales executive asks: Does this description convey a realistic picture of what the salesperson is supposed to accomplish and to do? If there are no writ­ten sales job descriptions, they are prepared. Other aspects of company operations are considered in relation to their impact upon the sales job. Sales department objectives are analyzed for their effect on the salesper­son’s job. Sales volume objectives, for instance, whether in dollars, units of product, or numbers of dealers and distributors, are translated into what is expected of the sales personnel, as a group and individually. The impact of sales-related marketing policies are determined. Distribution policies, credit policies, price policies, and other policies affect the salesperson’s job. Current and proposed advertising and sales promotional programs assist in clarifying the nature of the salesperson’s goals, duties, and activities.

2. Consider the Company’s General Compensation Structure

Most large companies, and many smaller ones, use job evaluation systems to determine the relative value of individual jobs. Job evaluation procedure is not scientific; it is an orderly approach based on judgment. It focuses on the jobs, without considering the ability or personality of individuals who do the work. Its purpose is to arrive at fair compensation relationships among jobs.

There are four job evaluation methods. Two are non-quantitative: simple ranking and classification or grading. The other two are quantitative: the point system and the factor-comparison method.

Simple ranking. In this inexpensive job evaluation method, widely used by small businesses, an executive committee sorts job descriptions in the order of worth. This is done without considering the individuals currently in the jobs or their compensation levels. No attempt is made to determine critical factors inherent in the jobs; only overall appraisals of the relative worth of different jobs are made.

Classification or grading. This approach utilizes a system of grades and grade descriptions, against which individual jobs are compared. The grades, sometimes called classes, are described in terms of job responsi­bility, skills required, supervision given and received, exposure to unfa­vorable and hazardous working conditions, and similar characteristics. Job descriptions are then classified into appropriate grades—this is done by an executive committee or by personnel specialists. The basic process is to compare job descriptions with grade descriptions. All jobs within a grade are treated alike with respect to base compensation.

Point system. The point system is the most widely used job evaluation method. It involves establishing and defining the factors common to most jobs that represent the chief elements of value inherent in all jobs. The specific factors chosen differ from one company to another, but generally include mental and physical skills, responsibility, supervision given and received, personality requirements, and minimum education required. Each factor is assigned a minimum and maximum number of points, different ranges being associated in line with the relative importance of the factors. Next, appraised factor scores are combined into a total point value. Finally, bands of points are decided upon and become the different compensation classes. Less arbitrary judgment is required than under the classification method; the use of point values makes it possible to determine the gap, or distance, between job classes.

Factor-comparison method. This method resembles the point system but is more complex. It utilizes a scheme of ranking and cross-comparisons to minimize error from faulty judgment. In a process similar to that used in the point system, the factor-comparison method employs selected factors and evaluation scales. However, the scale values are in dollars and cents, and no upper limit exists to the valuation that can be assigned to any one factor. A selected number of key jobs, typical of similar jobs throughout the com­pany, are then evaluated, factor by factor. This is done by arranging them in rank order, from highest to lowest for each factor. As a check against this judgmental evaluation, the compensation dollars actually paid for each job are allocated to the factors; the allocation automatically establishes the rela­tionship among jobs for each factor. The judgment ranking and the ranking by allocation of compensation are compared and differences are reconciled, or else the jobs are removed from the key list. On the basis of the dollar amounts assigned to the several factors making up key jobs, additional jobs are evaluated and their monetary values for each factor interpolated into the scale. This procedure is repeated until all jobs are evaluated.

Job evaluation and sales positions. Job evaluation occurs whenever decisions are made about the relative worth of jobs, and it is inescapable in organizational life. If, for example, the owner of an automobile dealer­ship decides that the new car sales manager should be paid more than the service manager, the jobs have been evaluated. So informal job evaluation exists in firms not using formal job evaluation.

Traditionally, sales executives have opposed using formal job evalua­tions to determine the compensation levels of sales personnel. They con­tend that compensation levels for sales personnel are more closely related to external supply-and-demand factors than to conditions inside the company. Sales personnel enjoy greater job mobility than most other employees, and are in everyday contact with potential employers.

If a company has a formal job evaluation program that includes the jobs of sales personnel, there should be sales department representation on the committee that arrives at quantitative evaluations. If the job eval­uation program does not cover sales personnel program or the company does not use formal job evaluation, it is important for the sales executive to establish the value of sales jobs relative to other company jobs. This helps assure that the monetary attractiveness of sales positions is no less than for comparable jobs elsewhere in the company. If the sales executive keeps informed on the relative differences between sales jobs and other company jobs, he or she is preparing for the day, which is probably inevitable, when sales positions are regarded as appropriate for inclusion in formal job eval­uation programs.

3. Consider Compensation Patterns in Community and Industry

Because compensation levels for sales personnel are related to external supply-and-demand factors, it is important to consider prevailing compen­sation patterns in the community and industry. Management needs answers to four questions: (1) What compensation systems are being used? (2) What is the average compensation for similar positions? (3) How are other compa­nies doing with their plans? and (4) What are the pros and cons of departing from industry or community patterns?

If there is a company-wide formal job evaluation program, it should take into account the current rates for sales positions in the community and industry. A program for setting compensation of sales personnel is sound only if it considers the relation of external compensation practices to those of the company. Effective sales executives maintain constant vigi­lance against the possibility that the pay of sales personnel will get out of line with that paid for similar jobs in the community or industry.

4. Determine Compensation Level

Management must determine the amount of compensation a salesperson should receive on the average. Although the compensation level might be set through individual bargaining, or on an arbitrary judgment basis, nei­ther expedient is recommended. Management should ascertain whether the caliber of the present sales force measures up to what the company would like to have. If it is too low, or if the company should have lower-grade people than those currently employed, management should determine the market value of sales personnel of the desired grade. Management weighs the worth of individual persons through estimating the sales and profit dollars that would be lost if particular salespeople resigned. Another con­sideration is the compensation amount the company can afford to pay. The result of examining these and other factors pertinent to the situation is a series of estimates for the total cost of salespeople’s compensation. It is excellent practice to plot each cost estimate on a break-even style chart. When the several plots are compared with the company’s cost goals, the sales volume needed to break even at each compensation level is revealed. The compensation levels for individual salespeople under the proposed plan also should be plotted in break-even style.

In some firms, companywide formal job evaluation programs are used to set compensation levels for sales positions. The procedure recom­mended earlier serves as a check on the compensation levels prescribed through job evaluations. Any discrepancies should be reconciled. When the job evaluation program is sound, there should be few, if any, discrepancies.

It is not unusual to find that two companies operate under similar selling conditions but with different sales compensation levels. Sales per­sonnel in one company earn more than those who do essentially the same work in another company. Relatively speaking, the first group of salespeo­ple is overcompensated. What explains such situations? Sometimes, man­agement does not know the true worth of individual sales personnel. In other cases, management regards some sales personnel as indispensable, or managerial inertia prevents adjustment of the compensation level to changed selling conditions. In still other cases, sales managers are biased in favor of high compensation for selling jobs.

5. Provide for the Various Compensation Elements

A sales compensation plan has as many as four basic elements: (1) a fixed element, either a salary or a drawing account, to provide some stability of income; (2) a variable element (for example, a commission, bonus, or profit-sharing arrangement), to serve as an incentive; (3) an element cover­ing the fringe or “plus factor,” such as paid vacations, sickness and accident benefits, life insurance, pensions, and the like; and (4) an element provid­ing for reimbursement of expenses or payment of expense allowances. Not every company includes all four elements. Management selects the combi­nation of elements that best fits the selling situation. The proportions that different elements bear to each other vary. However, most companies split the fixed and variable elements on a 70:30 basis.

6. Special Company Needs and Problems

A sales compensation plan is no panacea for marketing ills, but it is often possible to construct a plan that increases marketing effectiveness. If a company’s earnings are depressed because sales personnel overempha­size low-margin items and neglect more profitable products, it may be possible, despite the existence of other managerial alternatives, to adjust the compensation plan to stimulate the selling of better balanced orders. Specifically, variable commission rates might be set on different products, with the higher rates applying to neglected products.

Or, as another example, a firm might have a “small-order” problem. It is possible to design compensation plans that encourage sales personnel to write larger orders. Commission rates can be graduated so that higher rates apply to larger orders. However, it is desirable to supplement such a revised compensation plan with a customer classification and call schedul­ing system, enabling management to vary call frequency with account size.

As still another example, a company may want to obtain more dis­plays or local advertising by retailers. The presence or absence of point-of- purchase displays can spell the difference between marketing success or failure. Securing retail displays is a task that sales personnel may neglect, especially if they are paid commissions based on sales volume. To over­come this tendency, an incentive payment for obtaining retail displays is often incorporated in the compensation plan.

Numerous other possibilities exist for using the compensation plan to help solve special company problems. Plans may assist in securing new customers and new business, improving the quality of salespeo­ple’s reports, controlling expenses of handling complaints and adjust­ments, eliminating price shading by the sales staff, reducing traveling and other expenses, and making collections and gathering credit information. Management, however, should recognize that other means exist for dealing with these problems, which are generally transitory in nature. Repeated tampering with the sales compensation plan frequently results in complex and difficult-to-administer plans.

7. Consult the Present Sales Force

Management should consult the present sales personnel, in as much as many grievances have roots in the compensation plan. Management should encourage sales personnel to articulate their likes and dislikes about the current plan and to suggest changes in it. Criticisms and suggestions are appraised relative to the plan or plans under consideration. But at this point, management compares the caliber of the present sales force with that of the people whom it would like to have. If the present salespeople are not of the grade that the company wishes to attract, their criticisms and suggestions are of limited usefulness. Since, however, nearly every sales force has some people of the desired caliber, more weight can be attached to their opinions than to those of others.

8. Reduce Tentative Plan to Writing and Pretest It

For clarification and to eliminate inconsistencies the tentative plan is put in writing. Then it is pretested. The amount of testing required depends upon how much the new plan differs from the one in use. The greater the difference, the more thorough is the testing.

Pretests of compensation plans are almost always mathematical and usually computerized. Past payrolls, perhaps for a year or two, are reworked to check operation of the proposed plan against experience under the old system. Analysts compare what happened with what would have happened had the new plan been in effect. If the sales pattern has shown considerable fluctuation, calculations are made for periods repre­sentative of average, good, and poor business.

Then a look is taken into the future. Utilizing sales forecast data, new and old plans are applied to future periods. The plan is tested for the sales force as a group and for individuals faced with unique selling conditions. Analysis reveals whether the plan permits earning in line with the desired compensation level. If deficiencies show up, the plan may not be at fault; weaknesses can trace to the way territorial assignments have been made or to inaccuracies in sales forecasts, budgets, or quotas.

To conduct a pilot test, several territories representative of different sets of selling conditions are selected. The proposed plan is applied in each one long enough to detect how it works under current conditions. Pilot tests are invaluable for spotting possible sources of trouble and other deficiencies.

9. Revise the Plan

The plan is then revised to eliminate trouble spots or deficiencies. If alter­ations are extensive, the revised plan goes through further pretests and perhaps another pilot test. But if changes have been only minor, further testing is not necessary.

10. Implement the Plan and Provide for Follow-up

At the time the new plan is implemented, it is explained to sales personnel. Management should convince them of its basic fairness and logic. The sales personnel are made to understand what management hopes to accomplish through the new plan and how this is to be done. Details of changes from the old plan, and their significance require explanation. All sales personnel should receive copies of the new plan, together with written examples of the method used for calculating earnings. If the plan is at all complex, special training sessions are held and aimed at teaching sales personnel how to compute their own earnings. If sales personnel do not understand the plan or certain of its features, such as quotas and variable commission bases, they may think that the company is taking unfair advantage of them. Inadequate under­standing of the sales compensation plan is common and often a cause of low morale. No effort is spared to make certain that everyone on the sales force fully comprehends the compensation plan and its workings.

Provisions for follow-up are made. From periodic checkups, need for further adjustments is detected. Periodic checks provide evidence of the plan’s accomplishments, and they uncover weaknesses needing correction.

Source: Richard R. Still, Edward W. Cundliff, Normal A. P Govoni, Sandeep Puri (2017), Sales and Distribution Management: Decisions, Strategies, and Cases, Pearson; Sixth edition.