How to Reset Your Sales Compensation Plan in the New Year

Now may be the perfect time to build and implement a new sales compensation plan, according to Mike Emerson of Indian River Consulting Group. As he explained to attendees of MDM’s fourth annual Sales GPS conference, it requires just three steps — and if done right, they can lead you to a more profitable company.

 The increase in omnichannel sales and other business pressures related to COVID-19 have stressed sales compensation and incentive design like never before. But companies that understand how to maneuver the sales comp levers that drive down their total selling costs while retaining the key talent necessary for success will be better positioned in the post-pandemic sales environment.

If 2020 — a year defined by coronavirus-driven restrictions — has taught us anything it’s that distributors are rethinking their sales model. A key component of this sales transformation is a compensation plan that aligns.

“This pandemic has brought an interesting dynamic, and sales consulting has become the personal protective equipment equivalent of this pandemic,” Emerson said. “There are a lot of people that say now’s the time to embark on this journey and change the sales compensation program.”

To help distributors on this journey, Emerson and Mike Marks — his IRCG colleague and the firm’s managing partner — presented a session called “Masterclass: Resetting Sales Compensation Plans” at MDM’s 2020 Sales GPS, held virtually for distribution executives at all stages of the sales transformation process.

As Emerson and Marks noted when kicking off the session, the first rule of rebuilding sales compensation is “do no harm.” This is important for companies because a sales comp restructuring is likely to upset long-tenured employees.

“Changing sales compensation programs is fairly disruptive, and all of us probably have either firsthand or secondhand knowledge of epic failures where everyone quit the Friday after the new comp program was announced,” Emerson said. “Or, over time, things were reversed [back to the old comp plan].”

But as companies transform their sales models to meet today’s evolved — and still-evolving — customer demands, that’s another reason to refresh a sales compensation program, and do it the right way. When a company no longer ties incomes to territory size, a hallmark of the old method, it can grow gross profit (GP) by better aligning resources with opportunities.

By following the steps outlined during the masterclass session, and with the right mechanisms and leadership guidance in place, rebooting your company’s sales compensation program can cut costs and improve GP.

Even if you haven’t begun reassessing your sales compensation program, it’s not too late to start that pursuit. Because while the best time to launch such an initiative was nine months ago, the second-best time is now.

Step 1: Define Success

This was the fourth year that Sales GPS included a sales compensation component, but it was the first time the session featured a “how-to” guide, Emerson noted. This three-step process begins with a distributor first clarifying what “success” means for the company and what the business is trying to accomplish.

“It might sound surprising as you go on this journey that there are some misalignments where some people are thinking this is about cost neutrality and other people are saying this is ultimately something where, three years from now, we want our selling expense to be lower,” Emerson said.

“Everyone, generally speaking, is looking to grow their business. But they ask themselves, ‘Where are we going to get that growth? Are we going to get it from expanding our customer base? Are we going to get it from getting shared wallet by adding product categories?’ This is all about focus, and the clearer we are in terms of what we want to emphasize, the better and more aligned a new sales compensation program is going to be.”

The big question around measuring the success of a sales compensation reset — or, really, any transformation a company implements, whether it’s around sales, marketing or operations — centers on profitability. In other words, will it improve the bottom line? In this case, Emerson wants distributors to focus on the metric of gross margin. And here, he added, is where companies need to understand that improving gross margin doesn’t mean that the company isn’t profitable or that its sales comp program is disastrous, but rather that there are incremental improvements it can make.

“This isn’t solving for a toothache,” Emerson said. “We don’t have an acute pain that we want to fix. We may have a toothache, but this is more about creating a healthy lifestyle. If we’re going to go through this, let’s build it to last. Let’s not just fix the toothache and then next year deal with the earache or the ingrown toenail. Let’s think about it, take the time, build this for the long term.”

Any talk of defining success during a sales compensation rehab needs to consider the potential for employee turnover. While the goal is to be as minimally disruptive as possible, whenever a company starts recalibrating the formula by which salespeople get paid, there will be an immediate and delayed backlash as the new comp program is rolled out.

“Having a sober conversation around turnover should be early in the ‘define success’ conversation,” Emerson said. “You can generally expect a quarter of your salespeople to leave over the next 18 months because they opt out. It has been disappointing, in certain instances, where you go through a sales compensation reset, and you get to a point of, ‘This is aligned, this makes sense, the economics are right, we can be very proud of all the work that we’ve done, we’ve put a path forward for our sales organization to be very successful and to make potentially more income than they had made the past.’ Then we get to launch, and there’s pushback from the salesforce, and everything just stops. But we need to understand that this is the right thing to do and if there is going to be pushback, we have to ask ourselves if we’re willing to go to the mattresses or not.”

Emerson said that defining success also means being determined to stand by that aspirational measure of success even when rank-and-file sales professionals express doubt or, worse, decide to leave.

“If the salesforce pushes back, we just need to be very clear that this is about moving the company forward,” Emerson said. “And we don’t have any intention of doing it on the backs of our employees. We’re not trying to try to make more money by paying less. What we’re trying to do is be more effective in the market, and the way we pay people right now is an obstacle to us doing that, so we put something together that is very fair.”

Step 2: Define Selling Roles

After defining what success looks like, next is determining which sales roles will change in your organization. And the degree by which those roles will change, specifically in the next few years, will be critical in identifying potential sales compensation structures — “absolute” commission” or “relative performance” commission. Let’s look at the difference between the two sales comp programs, according to IRCG.

• Relative performance programs measure results by expectations, tying compensation to specific objectives, quotas or targets. These provide flexibility to move accounts around and position different salespeople for different targets.
• Absolute performance programs are traditional commission programs where set goals have little influence. Rather, the commission is primarily driven by how many Gross Profit (GP) dollars a territory or customer assignment generated, regardless of growth or how margins increased or decreased in a set period.

“Relative performance means the results are tied to expectations,” Emerson said. “If there’s a goal, a target, a quota, an objective, then that’s a relative performance component. If it’s defined, it’s not absolute.

“If I pay a 10% commission on all the GP dollars generated, then that’s absolute. If a territory generates twice the GP dollars that another territory does, that territory’s sales rep will make twice as much money in commissions — whether the person who makes you generates twice as much went backward 10% and the person who generates half as much went forward 20%, whether the margin is 26% versus 19%. None of those things matter. It’s absolute dollars, and it’s tied to customer assignment and territory size.”

With absolute being rather straightforward, here are some examples of the more complicated relative performance program:

• Variable pay earned through a 10% of GP dollars commission would be 100% absolute performance-based.
• Variable pay earned through a commission where the rate is 9% if the monthly gross profit dollar goal is not achieved and 11% if it is primarily absolute with an element of relative.
• Variable pay where 50% of salary is earned upon achievement of a gross profit dollar goal would be 100% relative performance-based.

There are varying degrees of this, Emerson said. For example, if a company’s incentive program is 10% commission on GP dollars but it pays 12% on growth, that would still be an absolute program because there’s no objective put in there. If the company pays 10% of percent commission to goal and then 12% above goal, that is a relative-type program because someone is defining success.

This distinction is important to understand when defining sales roles for your organization, perhaps as part of a transformation of your entire sales model.

But, Emerson cautioned, “This doesn’t mean that we need to have absolute clarity on what roles look like going forward; we just need to ask ourselves — as we’re looking at improving the alignment of our sales compensation program — is a change in roles imminent or expected? Because the answer to that question is going to narrow the potential structural compensation options we have available to us.

“If for the foreseeable future — and by that, I mean over the next three to five years — we don’t expect there to be material changes, we might add a specialist here or there, we might create a hybrid role, but fundamentally we’re going to still be organized with an outside sales force and an inside salesforce, that broadens whether we can use absolute performance programs or relative performance programs.”

If little change is expected, both absolute and relative performance program options can be considered. But if change producing the import and export of gross profit dollars is expected, it is a near certainty that a relative performance program will be necessary for at least some roles.

As mentioned, many sales compensation overhauls are happening as part of a larger sales transformation within a distributorship. And if a company anticipates some changes in that model, then IRCG says it’s time to “think strongly about using a relative performance program.”

Step 3 will look at that shift to a relative performance program.

Step 3: Design a Relative Performance Program

The third step outlines the basic structure of the relative performance program, which many distributors are favoring over the absolute method as they move away from their legacy processes. According to IRCG, the design of a relative performance program can be broken down into two steps:

• Step one is building the primary structure and entails solving for three variables:

1. Base versus incentive pay: What portion of income should be salary and which portion variable?
2. Window of performance: At what point does variable pay commence?
3. Risk versus reward: How does variable pay decrease below goal and increase above?

• Step two is determining which performance measures to use:

o The two basic questions are:

1. Which GP$s are most valuable?
2. How, if at all, should profitability be included in the program?

o Complexity is a sales compensation program’s No. 1 nemesis, so:

 In general, use a maximum of three factors;

 Use adders or deflators to help reduce complexity.

Let’s unpack each of these two steps. When building the primary structure, the three variables you’re solving for are:

1. Base Salary versus Incentive Pay: The process of determining how much money a salesperson will earn by generating a certain amount of GP dollars in relation to their base salary can be done objectively.
2. Inflection Point (At What Point Does Variable Incentive Pay Commence?): Setting an inflection point assumes that a certain amount of business can be expected, but, beyond that, sets a point at which incentive dollars start to be earned.
3. Risk versus Reward: Make sure the risk/reward tradeoff of a new compensation plan exceeds that of the existing plan.

The second step is that a company’s leadership must return to their definitions of success to select factors upon which to measure a relative performance program, according to IRCG. These are:

• A single-factor performance measure may be built around the percentage of GP dollars. It is often initially the best model to use to move away from the prevailing paradigm built around total dollars as opposed to total dollars being relative to expectations. This can align everyone in a given role around a common goal and can be organized around a fixed amount or percent of salary.
• Introducing a multifactor payout structure adds one or two factors, allowing the relative performance plan to align with many goals. Beware of adding more than three factors, however, as that begins to complicate the structure and can result in frustrating instead of motivating salespeople.

As Emerson noted to close the call, there’s a certain amount of relief when a company has rebuilt its sales compensation program correctly, but it’s important to analyze whatever changes have been made to ensure that employees are being paid fairly and equitably.

“It’s less prevalent today than it has been, but there has been a mindset among sales personnel that, ‘I’m a salesperson, I’m paid commission, I’m an independent operator, I am a sole proprietorship. And therefore, certain rules may or may not apply to me,’” Emerson said.

“But as soon as you insert management into that prevailing mindset, don’t be surprised when you’ve got to have some difficult conversations,” he added. “As long as you believe you’re doing the right thing, and you’re being fair and that this is something that needs to be done to move the company forward, then you need to persevere.”

These are just the starting points for resetting your sales compensation program. To learn more consider joining the MDM Sales GPS Network; members can watch the entire video at https://www.engagez.net/mdm#lct=conferencecenter–360183. To join the Network or learn more about it can help your company transform its sales force, visit https://www.mdm.com/sales-gps/.