Key Account Management Series: Why are Sales Compensation Hydraulics Still Leaking?

1.    Introduction

I developed this as a discussion paper for a client’s European Sales Management Effectiveness Project. The interesting perspective is how the issues raised in the early 90’s are still validated by Deliotte’s 2010 survey of 250 Sales VPs. It begs the question:

Why are Sales Compensation Hydraulics Still Leaking?

1.1.  How do you design a good sales compensation plan?

Specifically, a good plan:

• Uses performance metrics that drive the company’s overall strategy;
• Ensures roles, skills, selling, processes, internal culture, etc. are consistent with the overall sales force strategy
• Are mechanically sound ; and
• Can be administered efficiently.
• Fits for your sales organization?
• Can be administered with existing people, processes, data, and technology

(The following is based on Frank Cespedes book Concurrent Marketing, The Management of Major Sales (Neil Rackham) and 2010 Strategic Sales Compensation Survey by Deloitte & Varicent)

1.2.       Compensation Hydraulics springs a leak

Since the mid 90’s the great bulk of literature still emphasizes what might be called

“Compensation Hydraulics”: Push this pay lever and get this kind of behavior.

This type of thinking fails to recognize that sales compensation is dependent upon, data analysis, strategy, values and human motivation. Many forget to ask:

How should we pay our customer facing people? (Which inevitably involves a range of business issues?)

Sales Compensation usually impacts:

• Order quantity & type
• Cash flow
• Recruitment and training needs
• Daily organizational inter-actions among sellers and other functions

But, before worrying about the specific numbers or debating the balance between incentives and fixed-salary… What concerns need addressing?
The following addresses:

• What are the links between compensation, evaluation and motivation?
• How do you develop a sales compensation plan?
• What are you choices in setting goals and rewarding sales results?
• What are the roles and limits of compensation policies?

2.    What are the links between compensation, evaluation and motivation?

“Sales Compensation is a key means of guiding effort towards desired results”

Some say sales people are motivated to maximize rewards while mastering trying to master their environment. E.g.

• Why did that happen?
• Why did we win? and/or
• Why did we lose? and
• Does it really matter?

Their answers shape their behavior.  So, we need understand and manage the links between:

• Sellers’ personal characteristics vs. territory/account characteristics
• Links sellers make between effort, results and rewards
• Sellers view of the value of more rewards
• Effort, Quantity and Type of activity
• Short-term vs. Long-term goals
• Measurement criteria vs. information systems
• Evaluation process vs. compensation plan

It’s only with this understanding that sales compensation are goals set to guide efforts toward results. Once goals are set, results must be measured.  This raises issues of:

• What measurement criteria do we need?
• How can the available information systems give us what we need?
• How are we going to consistently evaluate performance

Commonly though firms don’t get the relevant data, or rely on unreliable sales reports.  Also, bonuses often contradict what the company says they want in sales performance.  The result is:

“Without clear alignment of sales execution with corporate goals, results are unpredictable and are typically driven by unintended side effects of poor, opaque sales commissions plans” (Cespedes)

So, what are potential pitfalls today?

Based on the Deloitte & Varicent survey results, show how these pitfalls could limit, waste new investments, or lead to unforeseen consequences.

• Only 43% of the participating sales leaders are satisfied or very satisfied with their sales compensation program going into the recovery

Are the metrics aligned with strategy?

In the Deloitte’s survey:

• 30% of respondents believe their sales compensation plan rewarded the right behaviors “not well” or “very poorly.”
• 42% said their top performers are “not at all” or “only somewhat” differentiated from other sales team members for carrying out the right selling behaviors.

Two of the potential plan improvements cited most often in the survey were:

• Differentiate top performers more clearly for carrying out the right strategic behaviors and
• Create a margin or profitability-oriented plan metrics.

If these actions were taken, it could instill a message that “smart, not reckless growth” is important during the next upturn.
Clearly from the mid-90s to 2010 demotivation, or, worse, motivation toward the wrong type of sales effort is still a major risk.  Sales managers may “pay for product, not process”, but they ignore process at their peril and so often don’t get what they pay for.
The key is that sales compensation is not isolated.  There are always links (intended or not) between compensation, evaluation and motivation.  So the advice of the early 90’s holds good:

“Start with the engine (the types of efforts and behaviours desired) and then design the transmission (the specific compensation plan for encouraging these efforts)” (Cespedes).

3.    Developing a Sales Compensation Plan

Try these six questions for starters:

• What are the sales tasks of the firm?
• What must the seller do to succeed?
• What do customers say about sellers’ current behaviors?
• What is market rate for the sellers we need to keep and attract?
• What should the salary-incentive mix be?
• How should the incentive part be designed?
• What are the sales tasks of the firm?

Managers need to consider the competitive environment, its marketing strategy in that environment (overall and by segment), and the essential functions of sellers.

What are the key tasks you want to encourage in your markets?

For example:
Do you want volume enhancing activities? like

• Orders which are simple to execute
• Orders with a minimum margin
• Orders which have a high in-house content
• Getting a higher proportion of a customer’s Capex budgets
• Getting on preferred supplier lists

Or relationship building activities? Like

• Auditing customer’s equipment, service etc.
• Handling the sales process from contact to fully installed
• Acting as a consultant on certain processes
• Helping develop budget proposals for customers
  • Developing relationships across key firms

Or,supply chain management? Like

• Co-coordinating different functions in-house
• Analyzing accountorder patterns

3.1. Sales forecasting

Incentives need to influence key players inside the firm to help in the sales process. In the Capital Goods market, managers must check what proportion of selling effort is spent on:

• Delivery, price negotiations, technical expertise
• Personal relationships with customers, changes over time (post sale or implementation service)

3.1.1.     Keep pace with the buying process

In capital goods, the amount devoted to each aspect of the sales process shift over a product’s life cycle or as the competition in the industry evolves.  Early in cycle, customer education and applications development are often the key sales tasks, especially technically complex products like food process engineering.   As the market develops and standards emerge, sellers spend more time selling against functionally equivalent brands or developing working relationships with intermediaries or end-users.  All too often compensation systems fail to keep pace with such changes.
(For example, see Sales Efficiency & Effectiveness Chapter in Management of Major Sales, for case studies.)
One reason for this misfit in a changing marketplace is that in many firms the decision makers responsible for the sales-compensation scheme base their decisions on an obsolete view of the field-sales tasks.

The lesson is that there is no substitute for on-going field experience, including actual sales calls, by those responsible for sales compensation policy.

3.2.   What must the seller do to succeed

The selling cycle often varies by key account or major segment.  So a plan that focuses only on short-term incentives will almost certainly discourage attention to longer-term (and often higher-margin) accounts and segments.  Sellers cannot control many of the elements that affect sales results (e.g. competitor strategies, macro-economic developments).  In many instances, therefore, the sales compensation plan can and should draw attention to these factors by rewarding accurate sales forecasting and market intelligence.  But it should focus on those factors sellers can control.  If not, important links get broken like between motivation, effort, results and compensation.
So, the key is understanding how a seller can make a difference – this is what the sales compensation plan should encourage.

4.    What is market rate for those we need to keep and attract?

Those with uncompetitive salary levels will eventually lose its best sellers.
Many companies spend much time trying to decide pay levels.  The basis of comparison is using public data.  In the USA, such as, Sales & Marketing Management Magazine publishes an annual survey by industrial groupings, by region, education level etc.  Unfortunately, different surveys use different criteria which makes comparison difficult.
Another issue in determining pay levels, concerns the potential influence sellers have on the buying decision and the abilities required to exert that influence.  The key transition is to watch for are changes which shifts the need toward or away from needing technical expertise.

4.1.   What should the salary-incentive mix be?

Factors which make a higher salary component attractive are:

• Relative difficulty involved in measuring an individual seller’s performance in a reasonable period
• The need for sellers to co-ordinate efforts of others
• The complexity and length of the sales cycle
• The amount of missionary selling involved
• The importance of non-selling activities
• The volatility of demand in the market

Many say that the mix is not as important as an influence on sales behaviours, such as:

• What time frame for compensation payouts and performance evaluations is acceptable?
• How sales credit is divided among an account team or different sales groups?
• What measurement units do we use to calculate pay (e.g. volume sold or gross margin)?
• How does the sales compensation plan fit into other more general reward and recognition systems?

Though easy to administer sales plans are not a replacement for lack of information systems or managerial skills, especially in the realm of the complex and long cycle sales.

4.2. How should the incentive part be designed?

Sales incentives should:

• Direct sales force effort toward more profitable opportunities
• Increase return on investment in the firm’s sales capacity; and
• Provide competitive pay levels
• Deliver a win-win.  A win for both employees and for the company.
• Have a meaningful spread for the highest to lowest performer.
• Have a time frame for incentives short enough to make an impact but long enough to make each payment significant
• Not discourage sales effort in a given year by sellers holding back orders to get a really good start for the next year.

The mix between incentive pay and salary involves the interplay of four key variables:

1. % of total compensation at risk with incentives
2. Sales force’s perceptions about this proportion of incentive pay
3. The degree of desired management control
4. The degree of fixed-cost reduction attainable through variable incentive compensation.

Lastly, performance metric incentives should show, aside from sales volume, typically:

1. Product mix
2. Pricing
3. Bad debt or implementation problems
4. Type of sale – important where profitability relies not just on equipment sales but after-market sales
5. Training – important where user training is needed

5.    Setting goals and rewarding results

A key element of any plan with two basic approaches.
Product sales over sales process.  It rewards on the basis of whether goals are met.  The reasoning being that the he seller can best decide how to meet those goals:

“Isn’t that what we pay them for anyway?”

Over time natural selection will keep the “best” people while others leave for lack of rewards. Sellers are entrepreneurs who resist controls.
Conversely,
Rewarding specific activities to get the desired results . This assumes sellers aren’t best at designing a strategy for reaching goals. For example, when sellers only have access to limited market information.  Sales managers should understand the nature of sales tasks and improve their execution:
Isn’t that what we pay sales managers for anyway?
Over time, being product focused can waste effort, especially when productive sales activities change over a product’s life cycle or as a market matures.  Also, sellers may well be entrepreneurs, but successful ones endorse processes that increase their earnings.  It’s not that sellers are told what to do, but whether they are influenced to move in the right direction.
These two approaches have real implications. The choice affects all dimensions of sales management and sales culture since the former rewards results on outcomes while the latter focuses on process.  At best, an outcome focus approach allows freedom to exploit customer diversity; at worst, sellers neglect customer service in favor of short-term sales.  At best, the latter approach keeps people focused on key revenue  and relationship-enhancing activities; at worst, sellers become excessively process-oriented.

5.1.  Compensation and team selling

Different tasks and selling cycles between key accounts and others mean that a single compensation plan is often counter-productive. If different people call on the same  accounts then teamwork is needed and a bonus based on the total account sales or profitability makes more sense
An important issue for team selling is the time frame.  Sales efforts in key accounts can take years.  Yet most sales compensation plans tie incentives to quarterly or annual performance.  The usual result, such as s:

“Because our plan is short-term oriented, I put my efforts where there are short-term benefits. Also, many short-term sales goals don’t need much teamwork. The longer sales mean more hassles of working with lots of people”

Co-ordination between sellers, engineering and others requires multiple-year planning, and qualitative objectives like building key relationships.

6.    Getting your sales force ready

The Deloitte’s survey highlighted four sales compensation design principles:

1. Keep sales metrics aligned with your strategy and market volatility
2. Review territory alignments and use both team-based pay and guarantees for new team members.
3. Speed up sales incentive payouts maintains good team spirit.
4. Don’t let the administrative tail wag the incentive dog! Make greater use of short-term promotions – they are simple to run and easy to change as conditions warrant.

Now look at your plans against the four principles. Get stakeholders and practitioners involved to look at the plan from different viewpoints. Then think about which sales performers needs to be retained— not just the current top performers, but “rising stars” who will make a difference in the long-term.

• Avoid quota windfalls. Use production bonus and overachievement cap to prevent windfalls from occurring because of poorly set quotas.
• Simplify compensation plans. Review and “prune” plans of rules or policies that add complexity to their administration, but do not drive sales behavior productively.
• Focus on a few simple changes. Targeted efforts will send more direct and powerful messages to   the sales team and mitigate administrative overstretch.
• Use plan designs already in place. Consider switching the weight of existing metrics in the plan, instead of adding new metrics.
• Develop administrative flexibility. Consider whether upgrading sales compensation technology makes sense for the longer-term. After all, this won’t be the last economic cycle where quick reactions will be needed.
• Include people outside sales. Ensure that those involved in customer acquisition and retention are managed, incented and compensated to encourage co-ordination among these groups?
• Integrate control systems. Ensure other influences on sales force behavior are congruent and consistent with, productivity measurements, performance evaluation criteria, and training programs

In most sales organizations the sales manager is a key player in the sales management control system.  Who gets his job?  What steps, if any, does the company take to  transition super-sellers to managers?  How do career paths and interaction patterns between sellers and sales managers affect selling behaviours?
Finally, what gaps exist between the requirements of sales tasks and current selling behaviours?  How, if at all, can a change in sales compensation or incentives help cut these gaps?

8. Finally

“You won’t get what you pay for”

Compensation plans are not substitutes for effective sales management.

Yet, 15 years on, it still remains a refuge of the lazy and squeamish, believing  that a well-designed compensation plan will ensure the desired sales behaviours.

Developing an outstanding sales resources is based on the ability to integrate organizational systems and capabilities with market conditions.
So, if you are contemplating changing your sales compensation plan consider:

• How does your marketing strategy affect personal selling?
• What specific tasks must field staff carry out to fulfill the strategy?
• Who are all the important people who sell in the company?
•  What are their competencies, experience and selling preferences?
• What other factors have to be actively managed

“You can pay your salespeople any way you want.  But if market coverage is inadequate (a deployment issues) or they don’t know what to do when they’re in front of customers (a training and development issue), the world’s best pay-for-performance system is of only limited use” (Concurrent Marketing by Frank Cespedes)
[polldaddy poll=4604847]


© Copyright All Rights Reserved, The Crispian Advantage [2010-2012]. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Nick Anderson, The Crispian Advantage