In today’s competitive marketplace, companies are expecting more out of their sales people and to deliver not just sales but sales profitability. A sales compensation plan tied to company profitability is not right for all businesses and needs to align with overall corporate strategy. The article below provides guidance and best practices while determining the viability of this kind of compensation plan.

It is almost that time of year again for companies both big and small, the dreaded compensation season. Numbers are crunched, budgets are realigned, and a firms overall compensation strategy is brought into the spotlight once again. As your company begins to reevaluate its current plan, it is important to ensure your comp plans and corporate objectives are aligned.

 

Let’s say you are the Sales leader of a rapidly growing technology company and your Executive team believes it is time to redesign your sales compensation plan and move to a profit based model. Your CFO believes this will be more competitive with the market place and will align better with the corporate strategy. So what’s next?

 

Download the Margin Based Compensation Checklist to provide your organization with a starting point for Margin Based Compensation design, and to utilize a checklist which lays out key questions which should be answered as you begin to think through designing your own plan. If there are more than two “No’s”, margin Based Compensation should not be used.

 

There are some factors you want to consider when designing this plan:

 

  • Profitability/margin are important for companies as they begin to mature. If the company is in start-up mode and trying to grow rapidly, it should be more focused on sales. Sales teams should only be compensated for profitability if it is a strategic goal of the firm. If there is another goal in mind, compensating them on profit will be counterintuitive to grow sales.

     

  • What is the level of control a sales person has over the profitability? Profitability-based measures should only be used when the reps have material influence on the sales price. This could be accomplished through selling multiple products at different price points or having discounting power. Implementing margin-based compensation will disincentivize sales people from discounting because it directly affects margins.

     

If these questions have been answered, you need to determine if the performance conditions are appropriate for this type of compensation plan:

 

  1. Ability to track gross margins with current systems

     

  2. Gross margins can be measured at a territory level

     

  3. Corporate strategy needs to have specific margin goals that are known to employees

     

  4. Solution-specific profitability information is shared with the sales team

     

  5. Product & Sales strategy is aligned and the responsibility is shared across the organization

     

Now that these questions have been addressed, you can move on to building out the structure of the plan. It is important to know the implications of a Margin Based Compensation Plan to ensure your organization is both ready and aligned to this idea. A plan focused on margins adds a level of complexity to your organization around metrics and targeted customers.

 

With a Margin Based Compensation plan, the sales reps needs to know where they stand with margin % after each transaction. This is where a Sales Operations leader role becomes crucial.  The Sales Operations leader needs to be able to visualize these numbers to provide reporting on metrics at both a rep level and executive level to ensure there is alignment on the company’s strategy.

 

Another implication to a Margin Based Compensation plan is it encourages the sales of products with higher margins.  With this plan implemented, a sales rep will not go after the biggest deal, they will go after the most profitable deal. A sales rep will be incentivized to go after a lower dollar deal with a higher margin % versus the higher value, more complex deal. This implication is important to understand to ensure both your business and sales strategies are aligned to this behavior.  Sales reps can manipulate the system when the plan is based on margin % and not dollars, so it is important to be cognizant of that as a sales leader.

 

There are some additional things to keep in mind when designing your plan:

 

  • Keep it simple: If a plan is overly complex, sales reps can lose focus and get distracted by the excessive administrative workloads. The performance metrics attached to the compensation plan need to support the business objectives. The plan should have a maximum of three metrics to ensure it is simple and easy to track. The margin can be managed outside the compensation plan, but the sales manager will have some responsibility in making sure the rep is not selling at price floor.

     

  • Transparency with the sales reps: Sales reps should have transactional level visibility to each order they complete to understand what drives performance. Using technology such as a dashboard or reporting tools to track, measure and report profitability for each sales person becomes crucial for incentivizing the sales reps as well as ensuring their efforts are aligned with the business.

     

  • Is your business mature enough: We primarily see this Margin Based Compensation model work well with mature businesses that have an established position in the market. Understanding your business objectives and growth strategy will help you determine if this type of model makes sense for your own business. Companies in rapid growth should be more concerned about getting billings/bookings, not as focused on margin that they may turn down a deal because it does not meet a margin criteria.

     

In the design process it is important to take a step back and look at your organization to see if this model aligns with your strategic priorities.

 

Download the Margin Based Compensation Checklist to provide your organization with a starting point for Margin Based Compensation design, and to utilize a checklist which lays out key questions which should be answered as you begin to think through designing your own plan. If there are more than two “No’s”, margin Based Compensation should not be used.

 

Also, take a look at the SBI Sales Compensation Best Practice Guide. This is a comprehensive guide which will help your organization as you get through compensation season.

 

 

Additional Resources

 

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ABOUT THE AUTHOR

Ben Durst

Prior to SBI, Ben spent his career in a variety of strategic roles in both consulting and corporate strategy.  He uses a data driven approach to tackling complex business problems while utilizing his diverse industry experience and strategic background.

 

Ben has worked on a variety of global product strategy projects focused on sales and marketing related initiatives including; branding and market positioning, market entry strategy, market segmentation, and market analysis.  He brings creativity and passion to every engagement coupled with his demonstrated skill sets in data analysis, marketing strategy, and business development. With a diverse background across multiple industries, Ben is able to quickly provide market driven decisions which result in his clients making their number.

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