In a recent webinar on sales compensation, we polled the audience, asking about the biggest issues facing sales compensation professionals today. Out of several hundred responses, consideration of moving the sales force away from revenue toward paying on profit was one of the top issues faced by more than four in 10 participants. In this post, we will help you think through whether you should consider shifting the metric in your incentive plan to pay on profit.
Should you pay on profit?
The first question to ask is whether shifting the metric to profitability is a strategic priority for your organization. For some companies, they are not (yet) focused on their margins—they are focused on growing as quickly as possible or growing share at all costs. Strategic goals like these are likely at odds with switching your primary sales compensation metric to profit (from revenue or sales). However, companies whose strategic goals include increasing their average selling price or improving the overall profitability of their product mix should consider shifting the primary incentive compensation metric to profit.
If paying on profit or margins is indeed a strategic goal, it still doesn’t mean it is a metric that should be in the salesperson’s sales incentive plan. We need to ensure that salespeople control profit. The primary ways salespeople control profitability of their territories is by:
- Controlling the price. If salespeople can grant price discounts to the customers, then consider switching the metric from revenue to margin. This is often the top reason companies seek to switch to paying on profit—to prevent salespeople from immediately dropping to the bottom of the allowable discount range to ensure they secure the deal.
- Controlling the costs. This may seem like an odd category to include, but in many industries, salespeople can control the costs by how many deal “freebies” are given away. For example, while salespeople don’t control the cost of goods sold, they can inflate the costs of service by giving away free shipping, expedited shipping, free service upgrades, etc. If this is the case, and these elements are trackable in some sort of margin metric, then consider switching away from revenue.
- Impacting the product mix. If salespeople are selling products that have widely different margin percentages and the organization wants to drive them to sell the higher-profit-margin items, switching the metric to gross margin will help encourage them to focus on the more profitable products.
Can you pay on profit?
Assuming at least one of the conditions above is true, then a case could be made to pay salespeople on profit. The next question is, can we actually do it? There are two important aspects to whether you can pay on profit: the ability to measure profit at a territory level, and the willingness to share gross profit details with salespeople.
Many organizations have either never tried, or simply can’t, measure territory- or account-level profitability. Their systems were simply not designed to measure and report gross margin at that level. In this case, investigate what it would take to develop the systems, data and processes to measure and report margin at a territory level.
- Willingness to report
Even when the system is in place to measure and report on profitability at an account or territory level, some companies are unwilling to communicate their margins to salespeople. They consider their margin information highly confidential and may not want salespeople (and their customers) to know their margins. In this case, companies measure on margin “proxies” that impact the gross margin without divulging the actual gross margin percentages to the sales force.
Paying on profit
The 2008-2010 global financial crisis forced many companies to evaluate whether they should switch their primary sales compensation metric from revenue to profit. It is important to first determine whether salespeople have adequate influence over profit to consider placing it in the incentive plan. If so, the measurement systems should be evaluated to ensure they can measure and report on territory-level gross margins. Finally, if you are switching your sales compensation metric to margin, it is best practice to measure and report on the new metric for three to six months prior to compensating on the metric to allow the salespeople to become accustomed to the metric and also to work out any bugs with the calculation.