ONE OF THE GREAT MYTHS in business compensation is the belief that paying people more automatically costs the company more — and that cutting pay necessarily saves money. In reality, neither assumption is reliably true. What matters more than how much you pay is what you are paying for.
A client of mine often laments, “Where’s all the money?” His revenues are strong — he’s likely in the top five to ten percent of stores in the country by volume, but he feels like he should be more profitable. And he should.
He isn’t channeling Jerry Maguire with a dramatic “Show me the money!” moment. Instead, he’s dealing with a far more common and costly issue: stubbornly rewarding the wrong behaviors. His compensation plan pays for sales, not profits. In an environment where discounting is allowed, that distinction is critical.
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It’s worth restating an obvious but often forgotten truth: We take profits to the bank, not revenues. Yet many compensation plans treat low-margin sales the same as high-margin sales. In that scenario, the business is literally paying salespeople to give money away.
There is one overriding principle that should guide every compensation decision: Pay for what you want to happen. If you want profitable sales, then your plan must explicitly reward profitability (not just activity or volume).
One of the simplest ways to align pay with profit is to base commissions on gross margin dollars, with a required minimum gross margin percentage. For example, you might require a 45 percent gross margin before full commission is earned. A $1,000 sale that produces at least $450 in gross profit qualifies. The same sale delivering only $400 in gross profit might earn a reduced commission — or none at all.
Salespeople will always figure out the most efficient way to earn more for themselves.
That’s a feature, not a bug. The problem only arises when the easiest way for them to earn more is bad for your business. When that happens, the responsibility lies squarely with the plan, not the people. Here are a few additional thoughts to consider:
- Salespeople should have an opportunity to earn commissions or bonuses; base pay alone rarely attracts or retains top talent.
- Commissions and bonuses should be paid as close to the time they are earned as possible, and plans must be transparent. Research shows that unclear comp systems are perceived as unfair.
- All-or-nothing bonuses or commissions can backfire. These are sometimes referred to as cliffs — you win or you die — and they probably do more to invite gamesmanship than most other plans. If the salesperson knows they are going to miss their monthly goal, they’ll sometimes try to hold the sale until the next month.
- Surprise bonuses, used sparingly, can be powerful motivators, but should augment, not replace, a solid compensation plan.
Fairness doesn’t mean paying everyone the same; it means giving everyone the same opportunity to earn more. Sales is a meritocracy and should be managed accordingly.
Before implementing or adjusting any compensation plan, ask one critical question: What behaviors am I trying to drive?
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