Friday, October 28, 2005

Sales Compensation Structure

In most organizations the compensation program for sales personnel is different and separate from that of other employees. This different treatment has to do with the nature of the job, the importance of the job, and the nature of sales personnel. The dominant feature of sales compensation is the use of incentives. Whereas incentive plans are becoming more popular for a wide range of employee groups, the sales group has always been paid on incentive due to the nature of the job.

The Sales Job

Sales work involves working with customers – people outside the organization – to convince them to order the products or services of the organization. The importance of this activity is obvious. Except in the odd circumstance where the organization's product sells itself, this activity is vital to the continuing operation of the organization. Furthermore, this importance of the job is highly visible in the organization, making the impact of the job even clearer. But an in-depth analysis shows two things about sales work that should be kept in mind: not all of the salesperson's activities are sales work, and not all sales activity is carried out by staff labeled sales personnel.

Sales activity

Most sales jobs include activities such as soliciting orders, servicing customers, seeking out buyers, obtaining information, and performing missionary work such as cold calls and product promotion. Some sales personnel also engage in credit-information collection and analysis, product modification, customer-personnel training, and technical advice and assistance. All sales jobs require that the salesperson perform some administrative work, such as making reports and keeping records. Depending upon the market, the products, and the organization, various aspects of these activities are more or less important in particular sales jobs. Further, although some of these activities are important and necessary, they may not really be sales work, indicating that sales personnel do more than just sell.1

This variety of sales activities suggests that it is necessary to develop job descriptions for sales jobs that describe clearly the contributions required of the employee. When the salesperson is paid on an incentive basis the non-selling activities can often be neglected unless they are clearly spelled out as a part of the job. These descriptions are most useful where there are a number of different types of sales positions in the organization. Sales job descriptions typically include not only information about activities but also information about number of customers, volume of sales, diversity of products sold, and geographical area covered.

Sales support

The typical picture of the salesperson is someone operating alone with the customer. This is often inaccurate, however. Sales work requires the support of others in the organization. At one level there is administrative support enabling the salesperson to operate in the field. Some of this support is clerical, but a larger part in today's complex economic environment is support of the field sales effort by inside sales personnel. Many sales situations also require help in the form of technical expertise that is available from others in the organization. All of this support both changes the picture of a salesperson as an independent operator and has a considerable impact on developing incentive programs, which assume that it is the activity of the salesperson that brings in the sales orders.2

Characteristics of sales jobs

Despite these complexities, there are a number of dimensions of sales jobs that make establishing incentive programs useful and perhaps necessary. The first of these, importance of the function, has already been discussed. The others are independence, boundary spanning, and measurability.

Independence. As indicated, the typical picture of the salesperson is of someone working one-on-one with a customer outside the organization. For many sales positions this is still an accurate picture. Direct supervision and control of the salesperson in this circumstance is therefore very difficult. The traditional reliance on tools such as performance appraisal does not work as well since the supervisor does not see the salesperson in action. This makes reliance on the outcomes of the job more attractive. It should be noted, however, that the degree of independence of salespeople varies with the job situation. There is a great deal of difference between a salesperson who is on the road and one who operates in a store where the supervisor is present.3

Where the employee is autonomous, control of behavior must be more internalized. One way of doing this is to reward the desired activities or the outcomes of the activities. In the case of sales personnel, rewarding sales volume keeps employees motivated. The problem is to have the salesperson achieve the outcome without doing so in an unacceptable manner.

Boundary spanning. The salesperson represents the organization to the customer. Often it is the salesperson that is the organization to people outside the organization. This makes the sales position an important one for the organization's reputation.

Likewise he or she represents the customer to the organization. This creates a situation within the organization of split loyalties, some to the organization and some to the customer.4

Boundary spanners must be able to see both groups' point of view and to collect and transmit information between groups. The salesperson is often seen as giving trouble to other employees inside the organization in order to serve the customer. Thus, the loyalty of the salesperson to the organization is likely to be perceived as less than that of other employees. This puts pressure on the compensation program, since it is compensation that is the major method of maintaining a positive membership decision.5

Measurability. These characteristics of sales jobs make incentive programs an attractive way to compensate salespeople. That the results of sales work are highly measured makes the incentive idea possible. Sales volume, either in units or monetary, is easily measurable and is connected with the efforts and ability of the salesperson. There is also considerable variation among salespeople in volume of sales – an important consideration in establishing an incentive program. Further, the salesperson expects to be rewarded by the use of an incentive program.

Using sales volume alone, though, can be a problem in rewarding salespeople. Connecting performance with reward focuses the person on the chosen performance factor to the exclusion of other job activities. If the organization wants results other than sales volume, it is not likely to get them if only sales volume is rewarded. Thus, salespeople have a reputation for not doing their paperwork correctly or not doing other things, such as making cold calls or giving product presentations, which do not in the salesperson's eyes clearly lead to more sales volume. So most sales compensation programs need to reward more than just sales volume.

Last, there is the problem of connecting performance with effort. Sales jobs differ greatly in the degree to which the effort of the individual salesperson influences the measured output. If the sales effort is a group affair or the sale takes the efforts of other jobs in the organization, then using simple output measures may not be appropriate.

The Salesperson

Salespeople are often perceived as extroverts who can meet and deal with strangers and friends alike and get them to do what they want them to do. This, of course, is a stereotype. Like all stereotypes it has some truth to it, but overall it is too simplistic. Some sales positions do require the aggressive extrovert. But others require a high degree of technical skill and a great deal of patience to sell highly complex organizational outputs, one order of which may take years to complete. Studies do show, however, that successful salespeople are relatively aggressive, outgoing, self-motivated, and materially oriented.6 The sales job does seem to attract people with those distinct characteristics: a tolerance for ambiguity and a high achievement drive.

Tolerance for ambiguity

The rewards of sales work, both extrinsic and intrinsic, are not constant or consistent, as they are in many other organizational jobs. Some days the salesperson comes home feeling that much has been accomplished, since in selling one can see positive results immediately. Other days there is no positive feedback: there have been no successful sales efforts, or other activities have prevented the salesperson from spending time on sales efforts. Thus, the salesperson experiences wide swings of positive and negative feedback. He or she must be able to adapt to this variation in reward structure. In fact this stimulation and uncertainty can act as stimuli to the salesperson.

The nature of sales work also leads to ambiguity. The lack of performance feedback from the supervisor, the focus on outcomes and the consequent uncertainty of how to perform the job, and the lack of participation in decision making all lead to a lack of role clarity for the sales job. The salesperson experiences this as an ambiguous situation.7 Added to this is the boundary-spanning aspect of the job, which creates role conflict as well as ambiguity.8

Achievement drive

Psychologist D.C. McClelland has studied a number of socially derived needs of individuals.9 One of the most-studied of these is the drive to achieve. A person with a high achievement drive has a number of distinctive characteristics. The first of these is a desire to take moderate risks and to decide upon these for oneself. These risks are achievable but not easy to reach, and in this way provide a challenge rather than discouragement. The second characteristic is the need for immediate feedback. The person must be able to see that he or she is moving toward the goal. Third, the high achiever finds the path to the goal as rewarding as the extrinsic reward at the conclusion of the activity. Last, the high achiever is preoccupied with the task, focusing on the goal and keeping at it until it is achieved. If we put the last two together we can see why the high achiever often feels a letdown upon reaching the goal: it was the pursuit and not the product that was stimulating.

These characteristics would seem to fit sales jobs and the compensation program typically developed for sales work. The sales job allows one to set one's own challenging goals, there is immediate feedback, and one can immerse oneself in the process of the sale and enjoy that process. In fact, McClelland found that the most likely place in the organization for high achievement drive to show up is in sales personnel. There appears to be a self-selection process whereby those with a high need for achievement find sales work to be most satisfying.

SALES COMPENSATION PLANS

As indicated, the dominant feature of sales compensation is the use of incentive plans. The purpose is to align the objectives of the organization and those of the sales person. The objectives that may be used in sales compensation incentives include:

1.

Sales Volume. The amount of sales over a specified time period.

2.

New Business. Sales to new customers. This may require a great deal of cold calling.

3.

Retaining Sales. Keeping customers from one time period to another.

4.

Product Mix. The organization may wish to sell a pre-determined mix of products. This will help the competitiveness of the company by selling the whole product line.

5. Win-back Sales. This is sales to old customers who are regained as clients.

Straight Salary

Some organizations pay sales personnel a straight salary without any incentive. This makes setting wage rates for sales jobs similar to setting wage rates for other jobs in the organization. The positioning of the sales job can be arrived at through job evaluation and the appropriate salary range assigned to the sales job.

Sales pay ranges are affected by the same forces that influence other wages within the organization. The labor market is a major influence. Surveys of sales compensation are made by trade associations, consultants, and the organization itself. Variations in salary rates, however, tend to be larger for sales jobs than for other jobs. The ERI Salary Assessor software has wage survey data for over 150 different positions related to sales work in organizations.

Salary relationships within the organization also influence sales wage rates. The sales-manager position and sales-support positions in the organization often are used as buffer positions; they can be compared with both the sales job and other organizational jobs.

Sales jobs are often more influenced by the incumbent than are other organizational jobs. The skills and abilities of the individual often dictate the particular activities that constitute a particular sales job.

Straight-salary plans do not preclude the use of performance motivation. A pay-for-performance program can be used to focus the salesperson on high performance levels. (See Chapter 17.) The sales job has the advantage of having a more measurable standard than other jobs, so the performance measurement is less judgmental. The danger is that the sales volume alone will be used as the measure of performance when other job factors may also contribute to the definition of performance.

Equity is always a problem in sales compensation. When sales personnel are paid a straight salary, the comparison with other organizational jobs through job evaluation reduces the equity problem within the organization. But it increases the equity problem with other sales jobs that are paid on an incentive basis. It is difficult to compare sales positions paid on a commission and straight salary, for they often involve quite different work.

There are a number of circumstances that make straight salary plans advantageous. These all center in the inability to connect either performance to reward or effort to performance. Where the product is highly complex, the time taken to culminate a sale is long, and/or the sales effort is a team affair, an incentive program is infeasible. In some sales jobs the non-sales aspects are of primary importance to the organization, and the results of these activities are difficult to measure. In general, the less impact the salesperson has upon the sales results, the less argument there is to establish an incentive program. Also, an incentive program may be unfair to new salespeople, who do not know the job or the customers well enough to meet sales goals.

Advantages of straight salary plans

A straight-salary program has certain advantages to the organization, the salesperson, and the customer. From the salesperson's standpoint, a straight salary takes the ambiguity out of how much salary he or she is receiving. Some people are very uncomfortable not knowing how much they will make next month, or are unable to budget the good times to cover the bad times. For the organization, a straight salary plan is much simpler. In addition, it gives the organization more control over the salesperson. One of the aspects of placing a person on incentives is that the person feels much more independent of organizational control. It has also been found that salespeople under a straight salary plan are more willing to perform the non-sales aspects of the sales job.10 From the standpoint of the customer, the sales person on a straight salary is more likely to provide service and less likely to pressure the person into a sale and move on.

Disadvantages of straight salary plans

The disadvantages of a straight-salary program reverse the advantages above. They center in the lack of connection between performance and reward and therefore suggest that motivation levels among salespeople paid in this manner can be expected to be lower than those of salespeople on incentives.

From the organizational viewpoint, straight salaries are a fixed cost rather than a variable cost, making sales salaries a burden in times of low sales. Furthermore, poor performance must be dealt with administratively, a requirement that is becoming more difficult each year.

Commission Plans

A straight commission plan is like a straight piecework plan in that the salesperson's earnings are in direct proportion to his or her sales. It is probably the oldest form of compensation program for sales personnel.

In theory, a commission plan is very simple. A commission is ordinarily defined as a percentage of the sales price of the product.11 The exact percentage is highly variable with the product being sold, the industry practice, and the organization's economic situation. It also varies with internal organizational factors and the exact nature of the sales job. For instance, the directness of the relationship between the salesperson's efforts and the sales volume usually affects the percentage given to the salesperson.

Two things need to be noted about providing a percentage of the sale to the salesperson. First, the percentage need not be the same at all levels of sales; it may increase or decrease with volume. This increase or decrease can be related to the effort the salesperson must exert to increase the sale's volume. The second point is that sales may be stated as sales price, sales units, or some other measure that reflects the variation in sales. In particular, the point in the sale process when the sale is counted is important. Sales percentages calculated at the point of sale versus the point of delivery are different figures and occur at different times for the salesperson.

The effects of the commission system need to be examined before it is put into operation. The basic calculation that needs to be made is an estimate of what amounts will be paid to sales personnel in the form of commissions. This information should be used in a number of ways. First, it should be used in the pay level sense of determining the total cost of selling the product. Here the concern is whether sales costs are in line with other costs of production. Second, estimates of commissions should be used in a wage structure sense of determining whether wages paid to salespeople are in line with wages paid other jobs in the organization and with those paid sales jobs in other organizations. Third, these estimates should be used to determine the expected income to the sales personnel. An incentive program may look like a good plan, but unless a sufficient percentage of the sales force are likely to make a minimum amount over expectations, the incentive value of the program may be negative.12

Performance motivation

The performance-motivation model specifies that for an incentive plan to be effective the following conditions must be met:

1.

Employees must believe that good performance leads to more pay. A commission plan should clearly do this by its construction. This belief is strengthened because the measurement of results is clear and objective. If there is a long time between point of sale and delivery or if many sales are not converted to delivery, this relationship can be weakened.

2.

Employees must desire more pay. This seems obvious, but it is more complex than that. First, people differ in their desire for more pay, although sales personnel are reputed to be a group that strongly desires pay.13 Second, the increased pay must be worth the foregone opportunities: if more sales, and therefore more pay, mean more overtime, some people will choose not to pursue more pay. Organizations may be safe in assuming that through self-selection, those who enter sales work highly desire pay, but as sales jobs become more complex and technical this assumption may become less valid.

3.

Employees must believe that good performance will not lead to negative consequences. Unfortunately, this is a likely consequence of commission plans. Sales incentive plans are often changed by the organization. These frequent changes are perceived as ways to solve two opposite problems – lack of sales and perceived overpayment of sales personnel. From the salesperson's viewpoint these changes create confusion in the performance-reward connection and a feeling that the organization is cutting the rate. Further, many sales incentive plans are so complex that the salesperson becomes confused as to what will happen if he or she takes certain actions. So some actions are avoided because the salesperson does not know what the consequences of taking action will be. Last, the sales incentive plan can put the salesperson in conflict with the rest of the organization. Difficulties between sales personnel and credit, finance, manufacturing, and shipping are everyday events in many organizations.

4.

Employees must see that desired rewards besides pay result from good performance. Sales incentive plans are mixed on this. Feelings of achievement, esteem, and respect are quite likely to occur along with high incentive pay for most sales personnel.14 On the other hand, high pay restricts long-term movement within the organization. Sales positions are often perceived as having little career-growth opportunity.15

5. Employees must believe that their efforts lead to good performance. This perception varies widely among sales incentive plans. Where certain activities clearly lead to sales then this perception is strengthened. However, there are a number of hindrances to this connection. Since sales are highly affected by the economy, the product, past relationships, and other factors beyond the salesperson's control, the connection is often tenuous. The sales incentive plan itself may be perceived as not rewarding important efforts of the salesperson or rewarding efforts that are of little importance. The problem is that if the plan includes a wide range of relevant efforts, then it becomes so complex that the performance-reward connection is not clear and the dysfunctions of condition 3 operate.

Combination Plans

A little over half of the sales compensation plans surveyed are some sort of combination of base salary and incentive. The reasons given for developing combination plans are that (1) the salesperson is not the only influence on the sales volume, and (2) some parts of the sales job do not involve direct selling and these need to be rewarded also. Done properly, a combination plan should contain the advantages of both straight-salary and incentive plans. On the other hand, such plans can also be seen as management indecision as to what they want of salespeople, and they can confuse the salesperson as to what is important in the job.16

Sales standards

All combination plans involve the establishment of a sales standard – the expected volume of sales for a particular time period. In the sales field this standard is usually called a sales quota. But the standard may be broader than just sales volume: other factors, such as obtaining new customers, retaining customers over time, and doing missionary work, can be included. The advantage of including a number of variables in the standard is that the plan then more clearly covers the whole sales job. The disadvantage is that the complexity of the plan is increased and the salesperson may become confused about what he or she is being paid for.

The basis for developing the standard is the level of sales and other factors that the salesperson can be expected to achieve. Establishing this standard is more difficult here than it is in most incentive plans in a number of ways. Sales jobs tend to be individual, in terms of both the salesperson and the customers dealt with. Also, outside influences can easily affect the sales volume. In setting sales quotas it is useful to consider the past year's performance, economic conditions, technological changes, and competitors' strategies. For these reasons setting the expected volume is more often a figure negotiated with the individual salesperson than a standard for all salespeople to meet.

The standard generally sets the level at which the salesperson's straight salary is considered covered by the sales volume. But this can vary, with the incentive starting after some percentage of the standard has been reached. Straight salary usually constitutes around 75 percent of the total salary in combination plans, but this percentage can be planned as high or as low as desired. The incentive portion will be lower where the direct contribution of the salesperson to sales volume is low, where non-sales activities are valued by management, and where there are considerable variations in sales over time and between sales areas.17

Payment structure

There are a number of ways of establishing the incentive portion of sales compensation. Probably the simplest system is to use a commission combined with a draw. The salesperson receives a specified salary each payday. At periodic times, such as each quarter, the total commissions due the salesperson are calculated. The amount taken as a draw is deducted from this and the salesperson then receives the remainder. If the draw exceeds the commission, the organization must decide whether to reduce the draw, carry over the deficit, and/or retain the salesperson in the position.

A bonus system provides incentive payments after a given level of sales has been reached. These plans can be quite simple or very complex. Simple ones resemble a commission-draw system with a percentage payment made for sales above a standard. More complex plans have payment schedules that vary with sales volume or payments for a variety of things beyond sales volume, such as obtaining new accounts, reducing sales expenses, improving market penetration, and increasing order size. A variation on the more complex bonus plans is the point plan. Here the salesperson receives points for meeting and exceeding goals or quotas in a number of areas. These points are then converted to monetary values.

Completing the Sales Compensation Package

Sales compensation considerations do not end with the design of the direct pay system. There are other aspects of sales compensation that are unique, including the use of contests and benefits.

Contests

The measurable-output of sales jobs allows the organization to design a short-term reward system that gives prizes for accomplishing certain quotas or selling more than all others. This is often attractive to the type of person who enjoys sales work. The prizes can be either monetary or non-monetary but more often are not direct pay. Most popular are non-monetary prizes such as vacation trips or goods such as golf clubs or other recreational equipment.

These contests have a number of advantages. First, they provide a very visible reward. Records of who is winning what can be placed on bulletin boards and put in the newsletter. It is interesting that this publicity seems natural for a contest but out of place for direct pay. Second, a contest, like any bonus, is a one-shot affair: it does not add to the overall wage costs beyond the time of the contest. This allows the rewards to be large and still not have a detrimental effect on labor costs. Last, contests extend to the salesperson's family more clearly than direct pay. Such awards as vacations are shared with family members, ideally creating company loyalty within the family as well as the salesperson.

Contests also have some disadvantages. The publicity can be very discouraging to those salespeople who perceive they have no chance to accomplish the level of sales necessary to win an award. Not only is one not receiving a reward but all one's colleagues are aware of one's shortfall. This is particularly hard on new sales personnel or those in difficult territories. Contests may also shift the focus from the main job to side issues. If the awards are for selling items that are not important to the overall sales effort, then the total sales of the company may actually decline as a result of the contest.18

Benefits

Salespeople used to be perceived almost as independent contractors. As such they were not included in benefit programs to the same extent as other employee groups. This situation has changed, and sales personnel are now recipients of regular organizational benefit program and at times more.19 This inclusion in benefits programs should have the effect of increasing the commitment of the salesperson to the organization.

Sales personnel are usually granted two benefits that are not common to other employees: expense accounts and travel allowances.

Expense Accounts. Typical expenses covered include meals with customers, car phones, pagers, company credit cards, etc. Ordinarily, the only other employees to have these benefit are executives. Because these expense accounts have the potential for abuse, they are watched closely by the IRS.

Travel allowances. Sales people, more than any other group in the organization, travel. Some of this travel is around town from one location to another during the day. Other travel requires the sales person to be "on the road" for some period of time away from home. This creates costs that are business expenses and are ordinarily reimbursed by the organization.

The IRS ( look into your Govt laws) classifies reimbursement plans into two categories, accountable and non-accountable. Accountable plans are classified as a business expense and are not income to the employee. Non-accountable plans are considered income to the employee although he/she may itemize these expenses as deductions on the personal income tax form. This section deals with accountable plans.

The employee may be paid before the expense is incurred, as an advance, or after the expenditure (as a reimbursement or an allowance). In any of these cases, in order to be qualified as an accountable plan:

1.

The expenses must have a business connection, they must have been incurred while performing job duties.

2.

The employee must account for the expenses within a reasonable time period.

3. The employee must return any excess reimbursement within a reasonable period of time.

The employer may reimburse an employee for travel expenses on the basis of actual expenditures. In this case, the employee must keep and present all expenditures to the employer. The employer may also develop an allowance plan. Under such a plan the employee may be considered to have accounted for travel expenses if the amounts of the allowance do not exceed the rates established by the federal government. For further information go to www.irs.gov.

There are two main types of travel allowances – automobile allowances and per diems.

Automobile allowances. There are two methods of calculating rates for automobiles:

1.

The standard mileage plan. This method pays the employee a set rate per mile traveled. For 2001 this rate was 34.5 cents per mile, but it changes periodically.

2. Fixed and Variable Rate. The employer reimburses the employee for automobile expenses under 2 categories of costs: fixed and variable. The variable costs are the cents per mile costs of running the car and vary depending on the miles driven. In addition, the employer pays a fixed amount to cover costs such as depreciation, maintenance, leasing and insurance. Developing this type of program is highly complex and is taught in ERI DLC Course 38: FAVR Automobile Allowances (currently underdevelopment).

Per diems. A per diem allowance is a fixed amount of daily reimbursement the employer pays the employee for lodging, meals, and incidental expenses.

Federal government per diem rates can be figured by using one of the following methods:

1. The regular federal per diem rate. This rate varies with location. It includes all the lodging, meals and incidental expenses. These per diem rates can be found online at: www.policyworks.gov/perdiem.
2.

The standard meal allowance. This alternative is used when the employee does not have any lodging expense, such as when the employee stays in a company room or with relatives. It covers only meals and incidental expenses. The above sources also have calculations for this category of expenses.

3. The high-low rate. This is a simplified computation with one rate for high cost cities and another for regular locations. The amount changes each year. In 2001, it paid $125 a day in most cities for lodging and meals, while it paid $201 for high cost cities. The current amounts and cities may be found in IRS Publication 1542.

SUMMARY

Organizations identify certain groups in order to establish special compensation programs for them. They do this for a number of reasons including organizational tradition, employee expectations, importance and centrality of the job, and the law. This chapter discusses one such group – salespeople.

Salespeople are paid primarily on an incentive basis. There are a number of reasons for this, not the least of which is organizational tradition. Sales jobs tend to be central to the organization, are carried out away from direct supervision, have measurable outcomes, require the person to be a boundary-spanner, and attract people who like incentive programs.

Sales compensation plans may be straight salary, straight commission, or a combination of these two. The latter is the most common. Since sales incentive plans are ordinarily individual plans, there is an assumption that it is the sales person's efforts that makes the difference. This assumption is called into question more often as selling becomes more of a team effort. Sales compensation plans also may include competitive contests and special benefits, such as a car.

A second part of sales compensation is the reimbursement for business expenses. Development of a program in this area is tied closely to the demands of the IRS ( Local Govt Law) so that reimbursement [an expense] is not in fact income. The most common program for reimbursement is one that pays for both per diem and automobile expenses tied to federally defined rates.

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