Monday, May 9, 2011

Incentive Compensation Not Working? Try Plan "B"

I recently had a conversation with a business owner about some troubles he was having with a sales person's incentive compensation. Not surprisingly, it wasn't working -- most don't.

In this case the problem was a "reimbursable draw". The way that scheme works is this:
  • The job is designed as full commission. Most people initially can't handle that at home -- either they can't buy groceries or they can't sell it to their spouse. 
  • Sales person comes to work in "training mode" at a base salary for, say, 6 months or so
  • Then the salary changes into a reimbursable draw against commissions. Each month's draw is treated as an advance against commissions to be earned.  In this case, the commission plan was a "first-dollar" plan -- full commission is paid from the first dollar of sales (typical in straight commission)
  • That's where the trouble starts. The draw remains in place, and any shortfall between commissions earned and draw paid begin accruing in an "advance" account. If commissions exceed the draw, they're applied first to any unpaid balance of the advance. Thus, the sales person doesn't really see her commissions in her monthly check -- until the advance is completely satisfied and commissions regularly exceed the draw floor.
The plan had become a demotivator, due the depth of the advance hole she had dug. Regardless of her success, this sales person was never seeing anything other than the draw, and it appeared it could be months, even a year, before that situation changed.

With some outside help, he redesigned the incentive plan. He changed it to a base salary plus commission plan, a variation on ideas described in "The #1 Incentive Compensation Plan Design Mistake"  The basics of the new plan:
  • The base salary was reduced to a "subsistence" level -- about 2/3 of the former draw
  • Rather than $0 commission for sales below a monthly "quota", sales below quota pay a small commission -- about 1/2 of the full commission rate
  • At the monthly quota, commissions change to the full commission rate, and continue without any cap
There are several key success factors in this approach:
  • The demotivating factor -- the "bottomless pit" of the reimbursable draw is eliminated
  • There's some commission, although not a lot, paid every month, even if sales are below the monthly quota
  • The commission steps up 2x for every dollar of sales north of the monthly quota
The result? Amazingly, that sales person "reignited". She began making more calls, resulting in more proposals and she's getting more orders. She's on track to succeed, whereas she had been on track to fail.

A couple of other observations. It happens that this plan is based on gross margin, rather than gross revenue. That's popular in businesses where the sales person has some pricing flexibility -- if she gives away gross margin, she contributes part of the discount in forfeited commission. That's insignificant in the overall plan design -- it only changes the commission rate (higher if gross margin based, lower if gross revenue based).

Oh, what about the pre-existing "advance" balance created by the draw scheme? He suspended that, saying it may be incrementally forgiven based on performance.

If you have examples of incentive systems that work (or don't work), please click "Comments" below and share them with others. 

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Terry Weaver

Chief Executive Boards International

Chief Executive Boards International: Freedom for business owners & CEOs -- Less Work, More Money, More Freedom to enjoy it 

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