Last Updated Oct 5, 2011 2:53 PM EDT
Applying an arbitrary constraint, like capping sales commissions or limiting the total amount a salesperson can earn in a year, often does more harm than good. But lots of businesses do, like this owner of a $20 million company:
"After a salesperson reaches $80,000 in earnings we apply a sliding scale to commission rates, and we cap any salesperson's total income at $95,000 per year," he told me.
"Why?" I asked.
"Because that's fair compensation for the job they do," he replied.
"Maybe so, but isn't that shortsighted?" I asked.
"Absolutely not," he said. "Shortsighted would be allowing salespeople to make more than our top executives."
"But if a salesperson sells more doesn't your company make more?"
"Yes..." he replied, "But there still should be limits to what salespeople can make."
No, there shouldn't. Not if their earnings are based on their performance.
Say you pay a 10% commission on sales. (How did you arrive at 10%? There are a number of ways to determine an appropriate commission rate, so assume you assessed fixed and variable costs, calculated and targeted margins, and decided what your business can afford to pay in commissions and still make a reasonable profit.)
A salesperson who does $500,000 in sales earns $50,000. You're satisfied with $500k in sales because it makes your operating budget work, but you'd really like $700k and are happy to pay $70k in commission.
Then a superstar does $900,000 in sales. You love the impact the $900k makes on your top line... but paying a salesperson $90k makes you feel a little queasy, especially if that amount is near (or over) what you make.
"Wait," you think, "I'm running this joint. I have the most responsibility. Why should she make the same or more than me?" Then you think some more. "Plus we simply can't afford to pay a salesperson $90k. That's crazy. We better cap total compensation... or better yet drop the commission rate to 3% after $700k in sales and 1% after $800k."
That's when you're being shortsighted.
Not only can you afford to pay a 10% rate on $900,000 in sales, in reality you can afford to pay more than 10%. Your fixed costs -- and some of your variable costs -- are no longer part of the equation because they are offset by the first $500k in sales. Incremental sales are more profitable because they are only offset by direct variable costs: product costs, shipping, sales commissions, etc. If your business nets 20% on $500k in sales it should net even higher margins on $900k in sales.
That's why you can afford to pay sales superstars more, not less. Too much is never enough when sales pay is based on performance.
Take an objective look at how your salespeople are compensated. Then remove arbitrary constraints, especially constraints based on emotion rather than objective analysis.
And don't tell me your business is somehow different, because in most cases it's not -- unless your compensation model is flawed to begin with. In almost every situation, the more your salespeople make the more your business makes.
Give salespeople the financial incentive to work as hard as they can to increase their pay and you'll grow your business too.
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