Rationalizing Salesmen's Compensation Plans

Rationalizing Salesmen's

Compensation Plans

FREDERICK E. WEBSTER, JR.

Here is an answer to the need for a compensai'ion plan closely tailored to man- agennent objectives, and to the abilities and needs of the individual salesnnan.

Journal of Marketing, Vol. 30 (January, 1966). pp. 65-58.

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However, because of the complexity of factors involved in the compensation problem, the design of the sales compensation plan is frequently less than ideal. An inadequate compensation plan can have adverse effects on virtually every aspect of the sales operation—including control, motivation, turnover, and level of performance.

"Rationalizing" describes a process of relating methods to ob- jectives for optimum results. A "rational" compensation plan, therefore, is one which helps management to achieve its objectives at a maximum level. Conversely, an "irrational" plan is one which does not allow management to achieve its objectives, or one in which two or more objectives are in direct conflict.

This article is a brief discussion of a method for developing a rational compensation plan by combining the individual sales- man's needs, abilities, and preferences with management's ob- jectives into a compensation program that provides maximum flexibility at the local level.

Developing the Compensation Plan

A well-thought-out compensation plan vrill be the result of a careful procedure encompassing each of the following steps:

1. Establish clear and consistent compensation objectives.

2. Determine the level of income desired for the salesmen.

3. Determine the relative portion of each of three elements:

a. Base salary

b. Individual incentive c. Group incentive

4. Establish the measurement criteria to be used to evaluate performance.

5. Relate the method of incentive payment to the measurement criteria to establish the compensation "formula."

6. Apply the "formula" to the past experience of several indi- viduals and groups, to test results on historical performance.

7. Make a field test of the new compensation plan, to determine its acceptability to the sales force and to measure its infiu- ence on sales performance.

The application of this procedure can be illustrated by the fol- lowing example drawn from the author's experience in helping to

§5

56 Journal of Marketing, January, 1966 develop a new compensation plan for a major in-

dustrial equipment manufacturer.

Step 1: State the objectives

After consultation with the company's 12 field sales managers, the sales manager and the market- ing vice president arrived at the following state- ment of compensation objectives:

1. To reward salesmen in proportion to the re- sults that their efforts produce.

2. To provide maximum stimulation and moti- vation.

3. To provide a guaranteed income plus an order- ly individual growth rate.

4. To adjust the commission portion of income to generate individual sales initiative.

5. To encourage teamwork in generating maxi- mum sales volume by a group-incentive pro- gram.

6. To provide flexibility so that local manage- ment can fairly administer and adjust com- pensation levels within the framework of the plan.

The field sales manager was given major respon- sibility for administering the plan. This decision reflected the importance of orienting the plan to the individual salesman in order to achieve the above objectives. Management believed that a care- ful periodic appraisal of each salesman's abilities and performance, conducted by his local manager, was of major importance in achieving its objectives.

Step 2: Determine the level of income for each salesman

The field sales manager's first task in implement- ing the plan was to establish a "target income" for each salesman under his supervision.

This desired target was to be based upon ability and experience. To assist the local manager in this judgment and to provide consistency among sales districts, management provided each local manager with a set of curves illustrating the influence of a salesman's ability and experience upon his "market value," as shown in Figure 1. These estimates were based upon careful appraisal of the salaries being paid by the company and by competitors for sales- men.

All the salesmen were college graduates in engi- neering or science. It was the local manager's re- sponsibility to decide which category (high, mean, or low) applied to each salesman at the time of his performance review. An appropriate total-income level for an individual salesman thus reflected his superior's appraisal of his ability, his years of ex- perience, and his value in the labor market.

Step 3: Determine the portions of fixed and incentive income

Rather than specify a common salary as a per- centage of targeted income for every salesman, the

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FIGURE 1. Market value of a salesman in an industrial company.

national sales manager decided to let the local sales managers make this decision.

In consultation with the individual salesman, the local manager would be responsible for setting a base salary for each salesman, subject to the con- straint that base salary must be at least 65%

and no more than 90% of the salesman's targeted income. These constraints were established by management to ensure against insufficient income for the salesman who had a "bad year" and to provide some incentive for each man.

This decision about base salary as a percentage of total targeted income infiuenced the individual's commission rate. The higher the percentage of base to target, the lower was to be the commission rate. This feature of the compensation program had the distinct advantage of allowing an adjust- ment according to the individual's relative prefer- ence for a secure guaranteed income, or a more

"risky" chance for higher earnings. A better "fit"

of compensation methods to the individual's needs and preferences was expected to provide a higher level of motivation and job satisfaction.

The difference between targeted total income (at 100% of quota) and base salary was to be an indi-

• ABOUT THE AUTHOR. Frederick E.

Webster, Jr., is Assistant Professor of Business Adnninistration at the Annos Tuck School of Business Administration, Dart- mouth College, where he earned his M.B.A. in I960. He has previously taught at Stanford University where he received his Ph.D. in 1964, and at Columbia Uni- versity.

Dr. Webster has worked with several companies as a consultant, and has

taught in the Advanced Management Program at the Transpor- tation Center at Northwestern University. He is the author of recent articles in the JOURNAL OF MARKETING RESEARCH BUSINESS HORIZONS, and the JOURNAL OF PURCHASING!

vidual incentive payment based on a commission rate geared to a quota. A "bonus" would also be paid to all employees under the local manager's supervision, the amount of the bonus depending upon the level of quota attainment for the whole district. The district group incentive payment, when earned, would boost the salesman's total income beyond the target. The group bonus was set at a maximum of 7% of targeted income for the sales- man, reflecting a management profit-sharing policy designed to provide an average of 6 to 7% above salary for all company employees.

The salesman's total income was therefore ex- pected to consist of a base salary, an individual commission payment, and a group bonus. Base plus commission was designed to equal target income at quota, and the bonus would be a maximum of 7%

above targeted income. Additional income was also generated by commissions on sales above quota.

Step 4: Establish measurement criteria

Because the compensation program had two parts

—fixed and incentive—two sets of measurement cri- teria were needed.

A major portion of the salesman's total income was to come from his base salary. This reflected the fact that much of the salesman's efforts would not produce immediate sales results. A large amount of servicing, followup, customer problem- analysis, and market investigation was expected of the salesman (and stated in his job description) ; and his salary compensated him for these activities.

The local sales manager's evaluation of the sales- man (to establish his target income for the coming period) was to be based upon how well the sales- man had performed both his selling and nonselling responsibilities, and the amount of improvement and "personal growth" he had demonstrated.

Sales volume was selected as the sole criterion for the incentive compensation part of the plan. In consultation with the salesman, the local manager was to establish a sales quota for each man based upon the following factors:

1. A review of each account assigned to the sales- man, including past sales and anticipated changes in the account.

2. Economic conditions expected to prevail in the local market during the coming period.

3. An assessment of competitive activity in the local market, and competitive standing with each account.

4. Planned promotional activities by the com- pany, including new product introductions.

5. The salesman's appraisal of his own growth opportunities and increased effectiveness.

By allowing the salesman to participate in estab- lishing his own quota, the likelihood of his accept- ing the quota as a reasonable goal was increased.

He was more likely to feel that he had been fairly

evaluated and that his future activity had been carefully planned. On the basis of this meeting between the salesman and the sales manager, a target income and a target sales quota were estab- lished for the salesman. The summation of quotas for each salesman in the district resulted in a dis- trict quota for the coming period.

Local managers were allowed flexibility in de- termining the relative importance of individual in- centives as compared with group incentives. The plan provided the option to the district sales man- ager of using only a district quota, without indi- vidual quotas. In the latter case, the local sales manager was responsible for developing an equi- table method for allocating the group incentive pay- ment among the members of the group.

Step 5: Establish the compensation formula

Because individual local market areas experi- enced rather wide fluctuations in sales from period to period, management decided to pay commissions on sales volume in the range from 50% to 150%

of quota.

It was felt that sales above 150% of quota could result only from either a poor estimate of sales or from sales-causing factors beyond the control of the salesman. Thus, sales above 150% of quota would reflect "windfalls."

The decision to pay commissions on sales above 50% of quota was based on a desire to provide in- centive over a wide range of sales expectations and experience. It was felt that the salesman's motiva- tion would be improved by getting him into the incentive plan as early as possible. Conversely, it was believed that sales would reach 50% of quota even without the salesman's effort. Thus, given a reasonable estimate of sales, the salesman could in- fluence results over the range from 50 to 150% of quota. The compensation plan was designed to in- fluence his performance within that range.

Incentive income was calculated and paid on a quarterly basis. If the salesman achieved his quota exactly, his total income before the group bonus would just equal his target income. In other words, commission income at 100% of quota exactly equaled the difference between target income and base sala- ry. These relationships are expressed in the fol- lowing formula:

P where P B T Q S

= B -I- (T - B) (2S - Q)

Total income (except for bonus, calcu-Q lated separately)

Base salary

Target income (at 100% quota) Quota

Actual sales results

The next step was to establish a commission rate which gave the desired results. Because target in- come and base salary would probably be unique for each salesman, commission rates would therefore be different for each salesman. Commission rate

58 Journal of Marketing, January, 1966

Salts as a pti-ctnfage. afqi/ota (S)

FIGURE 2. Dollar income as a function of quota attainment.

was to be a function of the difference between target and base, and was also a function of the size of the quota. The logic of this plan required that commis- sion be geared to the percentage difference between quota and sales, rather than the dollar difference.

A salesman's commission rate varied directly with the difference between his base salary and his tar- get income. The larger his base salary as a per- centage of his target income, the smaller was his commission rate; and as a result the smaller were the additional earnings he could receive for sales above quota.

Incentive payment was determined by the appli- cation of the commission rate, expressed as dollars per percentage point of quota above 50%. As can be seen from Figure 2, the commission rate c is simply the slope of the curve given by the equa- tion for the compensation formula stated above:

c = 2(T - B) Q for .5Q ^ S g 1.5Q.

Remembering that sales S are expressed as a percentage of quota Q and that Q = 100, it can be seen that over the entire range for which commis- sions are paid:

2(T - B) T - B c = 150 - 50 ⁵⁰

It can also be seen from Figure 2 that the slope c decreases as B approaches T. As the slope grows smaller, so does the maximum possible income, P

Accordingly, it was possible, using c, to tell the salesman how much he would earn for each percent- age of quota attainment above 50%. Similarly, the salesman could estimate his own commission income at any point in time.

The group bonus represented the third source of income for the salesman. The bonus was a group

incentive based upon the total district's level of quota attainment. If district sales were less than 50% of quota, bonus payment was 5% of target income. For sales results equal to or greater than 50% of quota but less than 100% of quota, bonus payment was 6% of target income. A bonus of 7%

of target income was paid to the salesman if the district exceeded quota for the period.

Step 6: Pretest the compensation formula

Results to be expected from application of the formula were estimated by applying the formula to the historical performance of several individual salesmen and selected sales districts.

When results from the paper-and-pencil test were found to be satisfactory, the new compensation plan was implemented in one sales district. Both the salesmen and the sales manager in the test district accepted the program with enthusiasm.

A major increase in sales volume occurred after the new compensation plan was introduced. Al- though management was uncertain as to how much of the increase could be attributed to the com- pensation plan, it was believed that the plan had made a positive contribution to sales' results.

As might be expected, the results were carefully evaluated to determine any modifications necessary before extending the plan to other sales districts.

In Conclusion

Although the compensation plan outlined above may not be applicable in all sales operations, the general approach is useful in most sales situations.

The specific plan discussed has several advan- tages—including a provision for orderly growth in salesman compensation, a consideration of individ- ual preferences for salary as compared with com- mission, the provision for group incentives, and a high degree of flexibility for application at the local level.

A critical feature of this program is the impor- tance of the local sales manager's consultations with each salesman, to establish target income, base salary, and quota. And the success of the program depends in large part upon the administrative abili- ty of the field sales manager and his effective rela- tionships with his salesmen.

One warning: One of the most common errors in designing a compensation plan is to overburden the plan with objectives more appropriately assigned to other areas of sales management. After all, no compensation plan can overcome basic weaknesses in manpower development, quota and territory de- termination, and quality of supervision.