Companies invest in creating incentive structures to motivate their sales force. When incentives are not driving incremental sales, however, they can lead to wasted money and lower sales force engagement. This can be especially damaging for companies today when margins are slimming and there is a need to spend every incentive dollar efficiently.
According to the 2009 Incentive Practices Research study by ZS Associates, there are numerous things companies are doing today to account for the economic downturn, including lowering quotas and freezing base salaries. Fortunately, there also are strategies companies can use to ensure their incentives are driving salespeople to meet and exceed goal.
But before delving into ways a company can effectively adjust their incentive plan, it's important to note how incentives can become ineffective—despite a company's best intentions.
Free Sales = Free Incentives
It may sound counterintuitive, but many companies pay their salespeople incentives for sales requiring little or no effort. For example, some customers make purchases based on ingrained buying habits, while other sales come as a result of a prior sale (think of a razor/razor blade model on a larger scale).
In these instances, the sales today don't result from efforts made today. These "carryover" or "free" sales can distort incentive payments and create a sales force that isn't motivated to maximize sales.
The amount of carryover depends on several things, but one of particular note: the salesperson's investment required on every sale of an item. Products requiring less ongoing sales effort once the product is adopted, such as soft drinks or pharmaceuticals, have very high carryover.
Other products requiring intense salesperson effort with each and every sale, such as capital equipment products sold to hospitals, have very low (or even zero) carryover. Many products fall in the middle of these two extremes.
Paying for sales below the carryover level of sales results in wasted incentive dollars that essentially become "hidden base salary." In other words, since the variable pay is guaranteed for these sales, it is no longer an "incentive."
For example, one company thought it kept its sales force "hungry" by giving salespeople 45 percent of their pay in base salary and tying 55 percent of pay to sales performance and earned incentives. Upon closer inspection, however, they discovered a moderately high carryover level for their product sales.
This meant a large part of its incentive was guaranteed. When this hidden base salary was factored into the mix, the new salary/incentive mix was closer to 75/25.
Unfortunately, this is not an isolated example. The good news, as mentioned earlier, is there are strategies companies can use to ensure their incentives drive sales force performance.
Making the Incentive Plan Work
Companies can change their incentive payout curve or add thresholds below which no incentive is paid to account for the carryover rates in their products. To address each of these options in turn:
1. Change the payout curve. For example, if a company determines the first 60 percent of sales are "free," they can put a lower rate on the first 60 percent of sales (perhaps a one percent commission rate), and a higher rate on the portion of sales a salesperson actually influences (say, a four percent commission rate).
This helps the company provide higher pay to those who are truly selling more, and lower pay for those simply sitting on a large territory.
2. Add a threshold. If the first 60 percent of sales is truly "free," then a company can also choose to add a "threshold" into its plan at 60 percent of quota. By doing so, its salespeople receive no incentive below that level. Doing this allows the company to pay an even higher rate above the threshold, which encourages better performance.
This is not a one-size-fits-all solution, however. Roles with little or no carryover ("hunter" roles, such as capital equipment specialists) should not have any threshold.
These strategies are built on the premise and realization the salesperson is not driving all sales, and therefore should be paid less incentive for sales they did not work to secure today. The most appropriate choice between adding a payout curve and adding a threshold depends on many factors, such as the amount of pay at risk, the length of the performance period, and the amount of complexity senior management will allow in the incentive plan.
For some companies, the best solution may be doing nothing to account for carryover. These companies know there is less pay "at risk" than what their salary/incentive mix suggests, and they want to keep it that way.
For example, a sales force on 100 percent commission may consider themselves on a 0/100 plan, but if no one has ever received less than 40 percent of their pay, it is more like a 40/60 plan. Some companies like the perception of higher risk or the increased flexibility of a higher leverage plan and prefer to keep it that way.
Now's the Time
Today is when executives must challenge commonly held beliefs about salary/incentive mix and about how much incentive pay is truly at risk. Companies that haven't considered the impact of carryover in their incentive plan are likely giving away free money.
Incorporating a threshold into the sales incentive plan, or lowering the pay rate for carryover sales, will allow companies to ensure that salespeople have rightfully earned every incentive dollar they are being paid. It also allows firms to pay more incentive dollars on the sales their salespeople truly influence, driving incremental results when companies need it most.
Chad Albrecht is an associate principal with ZS Associates, a global management consulting firm specializing in sales and marketing consulting, capability building, and outsourcing. He can be reached at firstname.lastname@example.org.