The question – “What is the best incentive plan for reps?” – always generates heated debate amongst execs (and reps!), because of the many existing drawbacks. After the debate, however, “commission plans” ― centered on either sales or margin dollars ― are often only tweaked, or left unchanged. Why the heat, noise and yet persistent status quo? I think you’re asking the wrong question to solve the wrong problem, due to:
- dated, unspoken, marketing life-cycle assumptions; and,
- lack of net-profitability tools that reveal big channel-activity waste between distributors and both their customers and suppliers.
In mature, consolidating industries, better comp plans come when you vary and tune them to different pools of customers. There’s no longer a one-plan-fits-all-reps solution just as there aren’t solutions for: a national, affordable, health plan for all citizens that won’t bankrupt the country; or a one-size-fits-all public school system that will serve all kids whose one common aspect is biological age. Big, seemingly insolvable “problems” must be broken into smaller strategically sensible problems so that end-user-centric solutions can be designed. We can’t individually do much about our national healthcare and public school messes, but you can immediately make some effective changes in both our territory and compensation designs. Let’s dig deeper into my assumptions about your assumptions by reviewing the ten possible compensation-plan drawbacks your system might currently have. Do you have any of them? If so, how measurably critical are they ― really? What are the root causes for why they exist? What are our underlying (usually-unspoken and somewhat-dated) assumptions and deficient measuring tools that have let the problems exist and grow?
POSSIBLE COMP-PLAN DRAWBACKS:
- We pay the same commission rate to a rep who’s only maintaining an established margin dollar flow from an established account as to a rep who wins profitable new sales (from new or existing accounts). Some of these cash-cow customers may be so loyal to the company that any rep could do the same maintenance function if given the chance. And the account could still have more upside potential. But the rep who’s making big income from the account is afraid to “rock the boat” by pushing for more. Or, they ignorantly may believe that they’re getting all (or the lion’s share) of the business and don’t want to be “greedy”. If profitable penetration work is under-rewarded and easy maintenance selling is over-rewarded, then creative digging power from mature reps in mature territories will fade away. Reps working for best-service-value firms who got lucky with established account inheritance can become: too well fed; too set in their ways; and less energetic with age and declining, empty-nest, income needs.
- How much key account upside potential is being ignored by complacent vets? Make a list of your top five or ten opportunities.
- How do you move to plans that pay more to creative and aggressive “hunters” for generating positive increases in real customer profits (not empty or losing margin dollars)?
- How do you pay less for high empathy, low-ego-drive “farmers” who can sufficiently maintain core accounts which the team cracked and continues to support with extra services?
- In mature firms in mature channels, all of the best (upside potential) accounts have long been assigned to veteran reps who often inherited them by being at the right place at the right time. Commission plans that over-compensate vets for core accounts will also encourage reps to milk the accounts as they head into (unannounced) partial retirement ― if the company will let them.
- What are the top few “harvest” jobs currently going on within the firm’s customer portfolio?
- Because of #2, promising younger reps are left to pursue “training territory” accounts. These small, remote and/or non-growing accounts no longer have the margin-dollar-per-order potential to cover traditional wholesale service costs, even before sales comp costs are included. (When I do the math in distributor workshops, we always find that accounts need to generate at least $400 in monthly gross profit to financially support an outside sales rep1.)
- Should you have trainees pursue small, historically-not-growing-with-no-promise-to-do-so accounts with a service model that guarantees losses?
- What’s a better service model that you can create to profitably serve the chronic small-order small accounts you’ve accumulated over the years?
- How can you attract and keep better next-generation reps who won’t want to wait a lifetime to inherit what’s left of harvested, gravy-train territories?
- You cannot easily reassign accounts amongst reps, or move chronically small ones to the house without creating compensation issues with vets ― even when an account is not thrilled with their assigned rep. For a look-in-the-mirror test: how many factory reps calling on your company are actually worth seeing? Are they working to help grow your profits? Are they worth their cost, as built into your purchase prices? Then, in a similar line of logic, how many of your best customers feel the same about your reps?
- So, why can’t you have only super-reps call on: core accounts, target accounts and super-loser accounts?
- What new comp plan(s) would allow this?
- Because of problems 1-4, the upside incentive that “gross-profit-based commission” is supposed to provide doesn’t work for:
- well-fed, slowing-down vets;
- hungry, energetic rookies with no access to viable, profitable upside account potential; or for:
- reps who were never money-motivated to begin with.
- Here are some questions to consider:
- Are you guilty of projecting our own money-motivation emotions on all reps?
- If reps were truly money-motivated, wouldn’t they have self-selected themselves into some form of more lucrative selling?
- How many of your reps rose to their present station because they knew someone in your industry to get a lower-level job and didn’t say no to promotions and being paid more money by some plan?
- More specifically, how many former inside sales reps, who valued pleasing the customer over asking for anything more from an account that “might rock the boat” are currently outside sales reps?
- Or conversely, how many reps are guilty of too much ego-drive and incentive greed, but too little empathy so that you see customers pushing back?
- Rep turnover in distribution channels is suspiciously low versus cold call environments ― what does this suggest about stress levels, compensation levels and trends? Is there:
- low-stress, high-maintenance, repeat selling to customers who’ve become friends?
- good pay that is indexed to the inflation in the product line; the growth rate of the industry; and the quality of the service horse that they’re riding?
- Not all margin dollars from all accounts are equally profitable. When distributors get good net-profitability numbers for customers, they’re stunned to discover that supposedly “good” accounts earning “good” commissions for reps are actually big losers for the company. The money-losing reality is frequently hidden due to a lack of good account-level profitability analysis, which could be easily rectified if it could be identified. With the dysfunctional account generating good commission levels, there’s actually a perverse incentive for the rep to protect the status quo.
- Why should the company keep paying reps to go after both new and old business for which the Cost to Serve exceeds the margin dollars?
- Why should the company maintain a plan that encourages reps to resist transforming big losers to big winners (especially when both the company and the customer would typically benefit)?
- Why not pay incentives for “improvement in net profit per customer”?
- If your incentives are like most distributors, you may find that you’re actually paying your reps to advocate for: looser credit; just-in-case special stock; more hot-shot services (without any fees for service). With Gross Profit incentive plans, reducing company profits and ballooning the balance sheet helps reps win more commissionable income. If you paid reps on all-costs-in, net profitability for customers, then they’d be in total alignment with company management. They’d also be keen to work with super-losing accounts to consolidate heretofore unseen activity costs on both sides of the relationship.
- Most reps may have some accounts that are more loyal to the rep than to the company. The big anxiety is that if you confront a rep about any of problems 1-7 above, they might defect to a competitor and take their loyal business with them. How can you quantify and then minimize this risk before any confrontational, intervention moves? (Do new plans in baby steps, not big, universal leaps.)
- How many specific accounts might defect to what degree and odds?
- How much net profit (not margin dollars) do the very, loyal accounts currently generate? What if their best accounts are actually big money losers? (Let them go?) Or winners? (Don’t change?) The true, net profit stories will guide each case, especially if you remember that “volume is vanity, profit is sanity” and free cash-flow is best of all.
- If you team sell the key profitable customers thoroughly before creating a confrontational moment, could estimated defection-scenario losses be reduced along with our anxiety about implementing necessary changes? By how much? Risk anxiety, when measured and pre-managed is always much less than you fear.
SOLVING THE PROBLEM:
- Dysfunctional commission plans have been in the way of best customers’ supply-chain, process improvement agendas in many channels since Sam Walton helped to jump-start a trend in 1988. He announced back then that Wal-Mart would no longer see or pay for reps’ commissions, which, for Arkansasreps, were skyrocketing. Wal-Mart would, instead, do business only with suppliers that were willing to assign management-led teams to co-creating with Wal-Mart an “integrated, automated replenishment system”. 2 The rep associations protested vehemently, with no success. And, the trend to improve inter-business buy-sell processes to both lower total procurement costs and improve the consistency of fill-rates, up-time and on-time productivity metrics is still spreading through all distribution channels.
- When you eventually work with key accounts on supply chain opportunities – proactively or reactively ― how should the rep be re-compensated for their different role in a team-to-team relationship?
- At the other extreme, why should you pay a rep a standard commission rate on sales or margin for bid business which happens to come from their territory? Don’t you need different levels of incentives for different levels of service intensity if you want a shot at winning net-profitable business from buyers with a wide range of service needs?
- If reps are incented by a percent of the customer’s net profits, then they will have to think about supply-chain activity costs at least on your side of the fence if not also on the customer’s. Isn’t that a higher-level of value-added thinking in line with best customers’ supply-chain ambitions? Sales rep “product knowledge” ― on 90% of our sales volume that have become commodities ― is not as valued by experienced repeat buyers as it was at the beginning of product life-cycles. Being a catalyst for buy-sell process improvements is the next-level value-added opportunity.
- Paying incentives on product sales or gross margin dollars reinforces selling products at almost any price, because all incremental margin dollars are profitable to the rep even if after total service costs are deducted, the company loses money. Getting last look to meet the price in de facto reverse auctions by the customer puts no value on the reps own, individual value, but they still get income. If a rep were to be paid on net profitability of the customer, don’t you think that:
- They would work harder to justify “last-look plus a point for my own value-added to your (the customer’s) bottom line”? And: “Price?! Why stop there, why don’t you work together to reduce ALL elements of total procurement cost and boost on-premise availability productivity metrics. All you have to do is re-tune our shared buy-sell processes.” 3
- Many of the status quo, coasting reps will fear and resist management and team members interacting more deeply with (their/your) three types of key accounts: most profitable; most unprofitable (to transform them); and most potentially profitable target accounts, because:
- The accounts may become more loyal to the company which will undermine the rep’s “magic act”, over-compensation benefits and defection-threat power.
- The team will most likely uncover and develop even more volume discrediting past rep claims that: “We are already getting all of the business”. (The best reps don’t know ― yet― that there are new territory and incentive strategies that you can co-create with them that will allow them to be part of the positive changes to create more value for customers, more profits for the firm and more compensation for them!)
WHAT BIGGER PATTERNS ARE BEHIND THESE DRAWBACK DOTS?
In an executive round-table discussion, if every participant is like one of the blind experts trying to describe an elephant by touching only one part of it, then there will be a lot of debate and talking past one another. If, instead, they would discuss:
- all of the issues above; combined with
- where their industry (the elephant) is on the life-cycle map; and
- referred to the powerful insights from net profit customer analysis
Then, quick, strong agreements would be:
- Straight commission plans lock you into a static past preventing you from implementing the necessary changes that a maturing channel requires..
- In a mature, consolidating channel, there is no one universal plan that can be applied to all reps and customer types.
- Customer net profit analysis is a key tool for rethinking:
- Which customers should be targeted with new and better service models?
- How many reps are needed to cover accounts with sufficient profit to fund the cost of the reps?
- How to re-educate and re-compensate reps with incentives being geared to win-win-win (company-rep-customer) supply chain economics, instead of trying to just push more product volume to any and all customers whether they are profitable or not.
HOW SHOULD WE MOVE FORWARD ON REP COMPENSATION?
The short answer is ― “it depends” ― every distribution channel and distributor location is different. Some firms may be in the early part of a product category life-cycle. If a company is a start-up with exclusive supply lines to sell goods that are the equivalent of videotapes for newly opening video rental stores in 1980, then “old school” thinking may work like it did in the Oklahoma land rush. Hire more reps on straight commission to get there sooner with all cold calling on just-opening, independent, entrepreneurial video-rental dealers. If your channel has matured and consolidated at all levels as it has for today’s DVD distributors, then a straight-commission, do-it-all rep will not be in the mix for the national contracts with Wall-Mart, Best Buy, Blockbuster, etc. If your channel is mature and consolidating and biggest most aggressive customers have “VPs of Supply Chain” (not “purchasing”), then general guidelines that will apply are:
- More growth in bottom line profits will come from selling fewer consolidating customers more deeply on an integrated win-win, buy-sell process basis.
- You don’t need more reps to go after smaller and more remote accounts for which the total service costs are increasingly greater than the decreasing margin flow that the accounts have. Smaller accounts need to be sold, instead, through a different service model centered around:
- cash-n-carry, “wholetail” outlets;
- telemarketing; and/or
- catalog and web-orders.
- When you have customer net profitability analysis, tracking and compensation reports, you’ll have the informational insights to: 4
- rethink your territory sales model―only A-sized accounts get the best caliber rep included.
- decrease the number reps―keeping and upgrading the best with supply-chain skills.
- re-tool your compensation to reward growth in account net profit, rather than maintenance of gross profit. You may set different percentages and targets for accounts where different service-intensity is warranted.
- use as a holistic, change-management tool, my “Kinetic Chain of Profit Power” which lays out the necessary preliminary steps that lead up to an effective and successful incentive plan implementation.5
- implement change by experimenting in well-measured, incremental steps. “Think Big, Act Small, and Fail Forward Brilliantly” with precision, net-profit tools.6
© Merrifield Consulting Group, Inc., Article 4.13
D. Bruce Merrifield, Jr.
- Do the math requested in article 4.11 at www.merrifield.com! ↩
- WMT wanted, furthermore, one final dead-net price that stripped out the overhead costs for: entertainment, rebates, the design and running of channel-loading, promotional programs. They wanted an everyday lowest cost to provide everyday low prices to provide everyday high fill-rates. Boom-bust, channel loading programs: didn’t create any new demand; taught customers to shop sale prices rather than brand; and the lumpy sales and brand-hopping hurt the ability to do reliable demand forecasting and steady volume flow. ↩
- For an entire training guide on the “how-to’s of buy-sell process improvement” see Ex. 59 at www.merrifield.com. ↩
- AND ANY DISTRIBUTOR CAN FAST AND AFFORDABLY FROM WAYPOINT ANALYTICS. For more info, webinars and management team demos go to www.waypointanalytics.info and www.quantumprofitmanagement.com. ↩
- See Ex. 16 and Article 2.1 at merrifield.com. Also, module 5.10 in my DVD “high performance” program. ↩
- More on “think big, act small” see Article 2.34 and slide show #22 at www.merrifield.com. ↩