Compensating Salespeople

Beyond the "salary versus commission" debate: thoughts on how to align your sales force's success with yours. December 2, 2006

My company does commercial cabinetry and millwork. I am reviewing my sales staff structure and considering switching over to a commission based format in lieu of a salary based format. What is a fair salary base plus commission? What is the commission based on? Percentage of total actual job cost or percentage of total profit at the end of the job?

Forum Responses
(Business and Management Forum)
From contributor C:
The link below will take you to a good discussion regarding this matter, which transpired last December. I opted to offer a package which includes a base salary plus a percentage of gross profit as well as health insurance, vacation, etc. I am very new to this aspect (employing a salesperson), so it is premature for me to attest to the efficacy of this system. Basically I offered a salary one can survive on, but to live well and prosper the salesperson will have to generate sales.

Setting Sales Rep Commissions

From contributor V:
Give a salary that is just enough to cover most salesmen's basic expenses, in other words not too high, but add the difference into the commission so that they can make good money if they work. This gives incentive.

If you try to base it on profit, then you have unhappy sales staff accusing you of lying or padding the books. You will get into arguments about what expenses are added. Also, whether you can properly run a business or complete a job or lose money is not the salesman's fault, and should not affect his income. If it does, he will leave. Therefore it has to be a percent of the gross sales price. It is the only thing he can see and know for sure.

From contributor T:

One thing you should consider when putting this together is that most owners want to lay the large portion of the sales risk onto the salesperson. While this makes sense in theory, it also can have the negative effect of putting the salesperson into business for himself, if the risk is about the same.

From contributor P:
Give some thought to sales compensation from the 30,000 foot level as you think your way through this.

Most sales compensation plans tend to focus on motivating particular behaviors. And that's where they routinely fail. A better approach is to focus on your business rather than the behavior and activity of the salespeople, and figure out what kind of plan will align their interests with yours so that when you win, they do, and when you lose, so do they.

If you have a pure salary plan, then you may have too much of a cushion under them, and your company may be experiencing annual ups and downs that the salespeople are not sharing (due to sales volume fluctuation). If you have a pure commission plan, you may have much steadier and more predictable cash flow while the salesperson may be worried about making the mortgage payment next month and acting much more desperately than is in your interest.

I'd suggest that you consider two ideas, for whatever they are worth. First, a base salary sufficient to keep the salespeople from selling jobs that really don't fit your shop well (just because they are worried about keeping their kids fed) is a good idea. Second, an incentive that motivates them while spanning a fairly long period of performance will align their interests better with company performance. An annual bonus plan based on 2 or 3 measurable criteria (new business, repeat business, year over year volume growth, new market segment sales... whatever objectives are most closely aligned with the growth/development of your business) should be the measures you use. Paying the bonus once a year also aligns their interests with yours, and reduces the likelihood that short-sighted behavior to make their bonus numbers will run contrary to your interests.

The bonus should be 20% to 33% of their income. And the bonus should be based as a percentage of their base salary so that the opportunity for your experienced and established salespeople doesn't have a ceiling. New people will see the plan as fair since the percentage is the same for everyone.

Then, if you base the salary each year on a percentage of prior year's sales, the overall plan will track with company performance (growing when the business is growing, dropping if a recession or something in your market moves company volume backward) because salaries can go both up and down based on the prior year performance of the salesperson.

Again, this is just one approach and it really is intended just to illustrate the value of working to align their interests with yours. Since your interests aren't simple, and involve both reward for progress and risk reduction at the same time, the plan should put the salespeople in the same position.

One final thought: this kind of plan is very easy to defend to a salesperson who questions it because you can point out that it does align their interests with the company's interests. If they push back, you can ask the question: "Why shouldn't your interests and the company's be aligned as best as we can?" That's an impossible question for even a very self-serving salesperson to answer.

From contributor W:
If you're in commercial millwork and casework, I take it that you bid a lot, if not all, of your work? Are your salespeople responsible for finding projects to bid or do you use services like Dodge to find work to bid? Do your salespeople also run the jobs? Now, most importantly, do your salespeople use a uniform pricing system to ensure profitability on projects? I ask these questions because I was personally involved in a firm that had a salary and commission structure format and it was abused by one of the sales staff at great loss to the company. That salesperson intentionally miss-priced items from the takeoff to get work. He did get lots of work. We did lose lots of money on his short tenure with the firm. If I have described the way your firm operates, I would say that you are far better off in refining your pricing methods than you are adding a commission structure to improve sales. Anyone can price a job cheaply in the competitive bid market. The thing you need to ask is, can your company make money with your staff pricing like it is?

From contributor D:
I work as a sales consultant. I am not a professional woodworker, but love reading the forums. We specialize in developing proper sales systems and processes that work for our clients (we do not have clients in your industry). The vast majority of companies in the marketplace do best by developing a 50/50 approach; that is, if the target dollar amount that you want to pay an above average sales rep is 60k, then 30k should be the set salary, and the other 30k should be derived from commissions earned throughout the year. To set the salary target, though, you need to work the numbers backward to insure the income level is attainable and to be able to coach and monitor the salespeople.

I would imagine most of you have done this already, but for example, you would determine what the total revenue sold would be needed to support the 30k commission target. From this dollar amount, you would need to divide that by the your average sale amount. How many field sales calls does it take to sell a job? Most industries are 20%, so for every 5 proposals, you will have one sale. Your numbers obviously vary. Now a salesperson knows how many field sales calls they need to make to earn "X" amount. By knowing the metrics, you have a way to monitor and coach your salespeople to better success and they have set goals! If they aren't making the required calls, you shouldn't be surprised they aren't earning their keep. If they are making the required calls, but not making the sales, then it is a training issue. It really makes the decision making process much simpler as a manager of the salespeople. I am simplifying things quite a lot in this case, but hope this may help.