Despite the increasing popularity of digital sales channels, sending salespeople out in the field to pitch your product remains one of the best ways to expand your customer base and gain repeat sales. Typically, a salesperson will be paid a base salary with some performance-based compensation on top, however, many firms offer suboptimal incentives that are not aligned with organizational objectives, and ultimately encourage inefficacious behavior in their salespeople.
What Is Great Performance?
Before leaping into how you best compensate great performance, let’s first have a look at how you should evaluate the performance of your salespeople. Often, firms will reward based on output; that is, he who sells the most units will receive the greatest compensation; or she who generates the most revenue receives the greatest compensation. Now, this definitely incentivizes output-generation, but at the end of the day, is that really what you’re aiming for?
We have previously made the case that salespeople should be incentivized to generate profits as this encourages wise discounting; and from PriceBeam’s experience, firms that incentivize profit-generation will increase their profits substantially while revenue and sales only see a negligible decrease. Of course, some firms may have their reasons for wanting to maximize market share, but for the vast majority, performance evaluation should be done on the basis of profits. Period.
Setting a Challenging Quota
As noted in the introduction to this article, the typical compensation involves a base salary. For this base salary, the salesperson is expected to meet a minimum threshold (a quota), which, as argued above, should be a profit threshold, and not an output one.
A quota has several effects; firstly, it tells the salesperson what is expected of her given the territory potential. Disparities in territory potential are one of the main causes of salesforce ineffectiveness, and thus, setting a quota that mitigates this unfairness is crucial for the salesperson’s productivity.
Secondly, the quota is an important motivational tool that should be sufficiently challenging so that it creates psychological reward once attained; even if your salesforce only receive a small base salary, setting a challenging minimum threshold shouldn’t be neglected. All people need goals to strive towards to feel a sense of purpose and achievement, and sole financial incentive can’t act as a substitute for an explicit statement of expectations.
The point is that even if your salespeople are only paid sales commissions - and, if selling 0 units, you wouldn’t pay them anything - you should still set a challenging goal.
It may seem basic, but proper goal-setting is a vastly underestimated incentive. And it starts with the quota.
Post-Quota Payment: Bonus versus Commission?
Once the quota is met, the performance-based compensation starts. The most frequently used types of performance-based compensation are bonuses (a lump sum paid once the quota is met) and commissions (a percentage of additional profits beyond the quota).
Obviously, when comparing bonus incentives to commission incentives, the incentive plans must be equivalent in terms of financial reward; what we’re interested in is the behavior that the design of two equivalent incentive plans encourage. Based on a field study conducted by McKinsey & Co. in collaboration with leading scholars, the following effects were uncovered.
When comparing two equivalent incentive plans, it was found that salespeople paid with commissions had an average productivity that was 24% higher compared to those paid with bonuses. This effect on productivity was particularly significant for low-ability salespeople, who performed much better when incentivized by commissions. For high-ability salespeople, the effect was not significant.
Moreover, salespeople incentivized by bonus schemes would engage in so-called timing games where they would either forward or delay selling. For instance, if a salesperson was near the end of the period and close to meeting the quota, he would pull future sales forward, to meet his target. On the contrary, if a salesperson could see that it would be near impossible to meet the target in time, he would postpone the sale to have it count in the next period.
However, the bonus scheme had one big plus. Salespeople receiving this type of incentive were much more likely to tend to tasks that did not have a direct impact on sales, while those incentivized with commissions would neglect tasks that contributed to the firm’s welfare if this would not directly increase his compensation in the short term.
Summary: Which One Should You Use?
Even though it may seem that the findings are in favor of commission-based incentives, it should not be interpreted this way. In fact, the purpose of the study was to eliminate the perception that commissions would always be preferable to bonuses.
The tendency to prioritise tasks that do not have a direct impact on sales is a huge plus for many companies as it can improve overall performance from a more holistic point of view, and discourages an egocentric organisational culture. Especially for big organisations, bonus schemes could very well be the way to go.
That being said, if your salespeople are only doing a small range of tasks that all have some short-term effect on sales/profits, you would be better off incentivizing them using commissions as this maximizes productivity. Moreover, if forward selling or delayed selling incurs substantial costs, commissions are much more effective (timing games are non-present using commissions), and furthermore, this discourages poor discounting practices where salespeople will accept low margins just to meet a certain threshold, compromising profitability and brand equity.
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