Archive for the ‘Compensation Costs’ Category

Sales Compensation Plan Designs – Cost of Sales vs. Cost of Labor Models

Tuesday, May 9th, 2017

By Clinton Gott, Principal

One of the most common and significant topics during sales compensation design engagements focuses on the right mechanic to use – whether to use a Cost of Sales or Cost of Labor model. In simplest form, Cost of Sales models use absolute commission designs while Cost of Labor models tend to use quota-based plan mechanics. A Cost of Sales model offers a set commission percentage against the volume results generated. Meanwhile, a Cost of Labor model attempts to deliver market appropriate pay levels aligned to a job’s worth in the market for delivering an expected level of production. There is of course a lot more to this story, and deciding on the right approach is an essential design question.

Cost of Sales Model

As mentioned, the Cost of Sales Model implies using an absolute commission mechanic. For example, a salesperson may receive 10% of each dollar of revenue generated. Typically, such designs may start with some expectation of performance so the commission rate can be set to deliver some approximate income level. For example, if a company believes a typical salesperson should generate $1,000,000 in revenue and wants to pay them approximately $100,000 in variable pay, then the rate would be the 10% mentioned above. In some cases, the absolute commission rate is simply selected based on some dollar amount a company is willing to share with a salesperson, in effect to offer someone a “cut” of the deals one drives. These designs are simple, not particularly elegant, and can fairly be described as “old school”. They are generally used for specific cases including:

  • When a company first opens its doors – classic startup plan and that sometimes continues through the high growth phase.
  • If a company is not confident or able to identify expected productivity expectations, also known as quotas or goals.
  • When most salespeople have similar territory opportunities and thus earning opportunities.
  • More transactional environments often with shorter sales cycle times.
  • Salesperson rather than company “owns” the customer.

In most cases, companies using a Cost of Sales variable incentive model will still offer some kind of base pay – very few sales environments are truly 100% commission. Quite often though, this Cost of Sales model will eventually start to show its age and begin to break:

  • Startup companies often move from SMB customers to Enterprise sales – that often means much larger deal sizes resulting in much larger incentive payouts. Earnings can begin to dwarf the market cost of the sales talent needed. A common story occurs the first time a sales rep makes more than a C-level executive, design questions will start to crop up. This issue can bubble up even more quickly if C-level resources are also helping to create and close the new massive Enterprise deals – “why should the sales rep get all that commission for the deal I drove?” becomes a familiar refrain.
  • Salespeople will sometimes build up a book of business that is large enough to sustain a comfortable wage year over year. Growth can often start to stall in these instances if the extra incentive doesn’t feel significant enough to reward for the extra sales efforts.
  • Adding products or services often leads to more complex sales environments requiring added sales resources including sales specialists, technical specialists, and inside sales. The initial absolute commission rate is no longer cost appropriate, but reducing a legacy commission rate usually goes over like a lead balloon. You’ll soon hear, “What happened to my 10%?!”
  • Without clear quotas and incentives directly tied to quotas, leadership may feel disconnected from a clear vision on how the overall corporate goal will be achieved.

Those and other issues almost always arise, leaving companies looking for a solution to drive growth in a more reasoned, exciting, and cost effective manner. Enter the Cost of Labor model.

Cost of Labor Model

The Cost of Labor model attempts to offer a market appropriate total pay level to salespeople who achieve fair and reasonable productivity expectations, again often called quotas or goals. The market level is usually identified as Target Total Compensation (TTC) and is a combination of Base Pay and Target Incentive, the balance of which is represented in the Pay Mix, e.g., 50/50 means half in base and half in expected variable pay. When a salesperson hits his or her quota, that person earns one’s individual Target Incentive amount. There are a plethora of design nuances to consider, such as when incentives should start being paid (threshold) and what happens for above quota results (usually some acceleration). We can leave those details for another day, but companies usually find Cost of Labor quota-based models are useful in many cases:

  • More moderate to low growth stages where every dollar of growth can be more challenging and feel more important – acceleration above goal creates the growth energy needed.
  • Need to protect and penetrate a base of current accounts in addition to acquiring new ones.
  • Unequal volume potential in assigned territories or books of accounts – can lead to unequitable earnings opportunity from winning the “territory lottery”.
  • Complexity requiring multiple sales participants versus “lone cowboy” market makers.
  • Companies have a better understanding of the levels of productivity that can be expected from the salespeople – the data and process for setting goals exists.
  • A desire to have clear accountability for who is responsible for delivering a part of the total organizational goal.

It is extremely important to clarify that Cost of Labor models are no less exciting or energy-filled than Cost of Sales models. If anything, a well-designed quota-based plan can create more energy, both including enough downside risk (the “stick”) and upside urgency (the “carrot”). Offering the right level of upside by way of the acceleration rate is absolutely essential, and that topic alone deserves its own study and consideration.

In some sales environments and with some stakeholders, you may find nostalgic feelings for the “good old days” of absolute commission plans. Or some may hold on to an ideology that absolute commission plans are simply “the right way to pay” and will best drive growth. Case after case though shows that in most instances, goal-based plans actually drive better results and create more fair payouts than traditional absolute commission models. We published one such example in Workspan where we piloted quota-based plan designs vs. legacy commission designs in a relatively flat growth environment; those on the quota-based plan drove revenue 3% higher than those on absolute commission. The new goal-based plan design was considered a stunning success.

Earlier I used the phrase “fair and reasonable productivity expectations”, which is almost always the most challenging part of quota-based plan designs. Establishing a clear methodology, ideally that improves over time, is at the foundation of doing high quality quota setting. Few companies feel particularly good at quota setting yet just about all of them do it, certainly at the topline level and quite often down to territories or accounts. There are a number of best practices that we can share at another opportunity.

In terms of plan designs, I often say to my clients that, “There are no fundamentally bad plan designs, but there is a time and place to use each type of design”.  Admittedly, that may be a bit generous to some of the plan designs we’ve seen out there, but most are developed from some point of reason by someone trying to do the right thing or to solve a business issue. When it comes to using Cost of Sales or Cost of Labor models, here too there is a time and place for each option. In most cases though, companies will benefit by eventually evolving to well-reasoned and carefully crafted quota-based plans.

For more information, please contact us at info@bettersalescomp.com.

Four Sales Compensation Lessons from Wells Fargo

Thursday, October 27th, 2016

By Clinton Gott, Better Sales Comp Consultants

Millions of fake customer accounts. 5,300 rank-and-file employees terminated. $190M in federal regulatory fines. Fraudulent behavior apparently dating back years. The recent headlines about Wells Fargo have been scathing. Even without the full details, it seems obvious quite a few infractions were committed by the sales organization and leadership team at Wells Fargo. In the pursuit to find blame, fingers seem squarely and subjectively pointed at the sales compensation program, whether fair or not. What is objectively clear is that companies are concerned, as questions about sales compensation plan risks and requests for risk assessments have taken a pronounced spike. Our clients have been asking Better Sales Comp Consultants for our perspectives, and we have identified four important lessons relating to the fiasco at Wells Fargo.

1. Plan Designs – seek balance and follow best practices

Plan designs themselves are not usually the primary cause of plan risks, whether in terms of unexpected compensation costs or the likelihood of unethical behavior. However, one symptom of poor plan designs is often a desperate and frustrated sales environment.  One particularly relevant topic in this situation concerns inadequate base pay with overly aggressive pay mixes.

In talking to contacts familiar with the Wells Fargo sales comp plans, there was very little base pay and very aggressive pay mixes. If all or most of pay is being delivered in variable pay, the sales energy and urgency can move from healthy and energetic to desperate and dangerous. A very aggressive pay mix particularly with low overall pay levels means results don’t just cause tension or belt-tightening but can compromise one’s ability to put food on the table and a roof over one’s head. Salespeople should be motivated and hungry rather than starved and reckless if sales results don’t break well in any given day, week, or even month. A reasonable pay mix in alignment with best practices can help create the right balance.

Plan measures are also a relevant topic area, as the “Great Eight” cross-selling metric has been repeatedly cited as a driver of this situation at Wells Fargo. First, the goal of eight, allegedly selected because it rhymed with great, seems whimsical at best; we hope that’s more an urban legend than a true goal-setting methodology. But the cross-selling objective isn’t necessarily a wrong or illicit one. Companies often want to drive strategic sales and increase the penetration from certain products. The real issue here is the opportunity to cheat that seemed to exist in this high transaction B2C sales environment and that such behavior was seemingly condoned, which we’ll explore later. But don’t necessarily blame the cross-selling measure itself for the events at Wells Fargo, as product penetration and growth strategies can be strategically effective and do not inherently inflate risk.

BSC Advice – offer a reasonable fixed portion of pay and include sales personnel in a performance management program. Create the right foundational environment while offering exciting and optimistic variable incentives that will foster a healthy sales culture with positive sales energy.

2. Goal Setting – get real about unrealistic stretch goals

Few supporting programs can create more desperation than overly aggressive goal setting. If goals appear unattainable, even with hard work and high performance, then one shouldn’t be surprised if cheating becomes a “go to” move. Some misguided sales leaders say that the best way to increase performance is to increase quotas, while most folks know there is more to this story. A better expression perhaps is the best way to increase cheating, demoralize salespeople, and eventually create turnover is to stretch quotas excessively. We’ve observed overly-hedged quotas becoming more prevalent and more pronounced during the tepid recovery after the 2008 collapse. A recent BSC/WorldatWork quota study suggests about half of companies over-allocate quotas and the most ideal range is only 5-10% down to the frontline salespeople; that amount seems like a fair hedge and allows for some flexibility in making deployment and account decisions. Anything more will likely lead to fewer than 50% of reps achieving goal, a sales culture of losing, and a much higher likelihood of risky behavior.

In the case of Wells Fargo, it appeared that not only were goals stretched but over-zealous sales managers would over-emphasize goals and results as often as every two hours. One can easily imagine a dark and anxiety-laden environment, more like a boiler room than a sales office meant to optimize customer interactions and drive related sales outcomes. It’s an outdated model, prone to risky behavior. Further, this approach likely falls extremely flat with coveted Millennials or really anyone who understands the two-sided coin of sales and service.

BSC Advice – use quota over-allocation thoughtfully. Attempt to limit total hedge to no more than 5-10%. Stay focused on a positive performance culture and avoid the boiler room drama.

3. Corporate Governance and Oversight – mitigate risk and protect your business

With all the negative attention on the financial services sector from 2008 and other times, it’s both easy and hard to imagine this kind of fraudulent activity would pop up once again at a bank. Skeptics may say it’s in the industry’s DNA, and one would think lessons should be learned from prior misconduct. Some may feel that pushing past the envelope will again pass with few repercussions. The depth and breadth of the Wells Fargo fraud is clearly not just a frontline sales rep issue. Management likely had to encourage it or at least have been willing to look the other way.

Companies should ensure the right governance rules and oversight processes exist. Define who is responsible for what, and hold them accountable. I’ve had clients with audit groups who sampled and reviewed plan payouts and deal details to ensure appropriate conduct and ethical behavior, not just to do the right thing but to minimize corporate and shareholder risk. At Wells Fargo, it’s hard to believe the fallout from years of fraudulent accounts and burned customers didn’t escalate to someone somewhere, but there should have been a person or group looking for abuse and mitigating risk. As a consultant, I’ve joined my project sponsors for interactions with internal audit groups. While they haven’t always seemed necessary, I’ll look at them in a much different light now. Wells Fargo’s fraudulent behavior should alter perspectives and will likely cast a longer shadow than some currently anticipate.

BSC Advice – take corporate governance seriously, as not just “the right thing to do” but for the health of your business. Invest in appropriate audit resources to support that mission.

4. Zero Tolerance Policy – foster ethical behavior as a mission critical activity

Companies should have a zero tolerance possible for unethical behavior. This should apply to all levels. Ethics should be part of the dialogue around all business behavior… yes, even in the rough and tumble world of sales. It should be pillar of a company’s mission statement.

There were rumors about Wells Fargo whistle blowers receiving the kind of treatment one should least encourage – ignored, shunned, and at worst, terminated. Leadership needs to create the right culture, and it should trickle down to every level. The ideal outcome is a culture of both high ethics and high performance from an elite organization.

BSC Advice – focus on ethical behavior in your mission statement, in leadership communications, and as part of your performance management culture.

In conclusion, sales compensation plans and programs can be a great way to align salespeople and company results, excite sellers, and drive optimal performance. It’s easy to point blame at the plan design or even goal setting at Wells Fargo, and those elements should be carefully considered. But one should raise the focus up a notch. Focus on the leaders, the messages being sent, and the corporate culture that enabled this situation. Hopefully, with the right controls, a culture of ethical performance, and both appropriate plan designs and goal-setting methodologies, other companies can learn from the many lessons of the Wells Fargo crisis.

Q4 Crunch Time – How to Create Winning Sales Compensation Plans

Wednesday, September 7th, 2016

By Clinton Gott, Co-Founding Principal

Fourth quarter and the clock’s ticking. The pressure’s on to create and roll out better sales comp plans in early January. It may not be an easy, but the right game plan will ensure a winning outcome. Focus on the following activities and questions, and you’ll earn MVP honors in the effort to drive better sales performance!

Define and Confirm Your Sales Strategy for the New Year

Is your organization introducing new products? Are you targeting particular sectors or account tiers for growth? Do you have a targeted emphasis on penetration, acquisition, or retention? You are likely targeting a range of sales strategies and preparing for an effective plan design effort means understanding what the organization is trying to achieve.

Define and Confirm Your Sales Roles and Responsibilities

To have effective sales compensation plans, you have to have effective sales job definition. If targeting a new product, can your core sales team sell it or will you need product or technical specialists to support the effort? If looking for growth in new accounts, do you have a defined hunter role or will your salespeople need to both hunt and farm? Overall, do you know how each role is supporting your sales strategy, and then how your current incumbents and potential hires slot to those roles? Organizations often want to jump to the details of their sales compensation designs without fully understanding what the sales roles will be asked to do.

Assess the Performance of Your Current Plans

Effective sales compensation plan assessments should include both qualitative input and quantitative analyses. You should seek input from the various leaders in sales, finance, sales operations, and human resources. Systems/IT may have input to share if plan administration, data, and reporting have been hot topics. We also recommend gathering input from the field, either through your sales managers, formal project-based interviews, and/or an online engagement study. Every sales organization has a unique character and various stakeholder personalities involved; understanding how well the plans focus and motivate the salespeople is a critical area for exploration.

As the year winds down, you should also analyze the plan’s performance and test the return on your sales compensation spend. How have people achieved against targets? What does the pay-and-performance relationship look like? Does the plan offer the necessary downside risk and upside opportunity? These analyses and others should combine with the qualitative input to form the story of your sales incentive program’s performance, identify change objectives, and point to areas for potential improvement.

Generate New Plan Ideas and Engage With a Design Team

We recommend pulling together critical and well-informed stakeholders from sales, finance, human resources, and sales operations to define plan needs, consider potential solutions, and eventually make plan recommendations for the new year. This can take the form of a two or three in-depth meetings. For each perceived need, the team should identify solutions from the world of sales compensation best practices and weigh the pros and cons. Ideally, those best practices should come not just from things you’ve done before or how your direct competitors allegedly do things, but you can and should look more broadly to leverage best practices across the many sales organizations and industries that exist.

Consider the options within the context of your unique corporate culture and organizational needs. You should look at the plans specifically for each unique sales role and address appropriate questions. Do you have the right pay levels for the talent needed and does the pay mix create the right risk/reward relationship? Do the plan measures support your sales strategy and can they be effectively measured? Are the plan mechanics simple and motivational? Is there enough upside and acceleration? Are there particular crediting challenges or details to define? How will sales goals be set and communicated? Overall, are your new plans aligned to your compensation philosophies, will the reps understand them, and will they drive each salesperson to achieve optimal performance?

Perform Cost Modeling to Test the Plans

Before taking recommendations all the way to final plans, you should perform scenario-based cost modeling. How will the plans perform and payout in a bad year, an average year, and a good year? How do the costs of the new plan compare to the prior plan at the macro-level and at the individual level? Which particular reps will win or lose, and is this displacement acceptable or does it put you at risk? What does the compensation cost of sales (CCOS) look like under different scenarios and do the economics of the new plan designs make sense? If not, you may need some fine-tuning before moving on to truly final plan designs.

Prepare Communication Materials and Define Your Communication Approach

This is a very important final step but one that often gets overlooked or shortchanged. Be sure to leave enough time for it! Create rollout presentations that communicate the what, why, and how of the new plan designs. What are the new plans? Why are we making changes? Be sure to connect the changes back to sales strategies. How did we make the changes? Be sure to share the process and the involvement of (hopefully) well-respected design team members. Make sure the salespeople know they matter and be sure to focus on how they’ll maximize earnings under the new plans.

Sell them on the plans – do not just communicate them. Be sure to have clear plan documents and even plan calculators to aid in understanding. For the rollout approach, wait until the upcoming year starts so you do not distract them at the end of the current year. Once the year begins, we recommend a business leader or sales leader perform the initial rollout presentation either at an in-person sales conference or via a webinar. Then task the sales managers to hold one-on-one sessions with their salespeople to sell the plan, answer questions, and generally do their job as coaches and motivators. Be sure to provide a path back to human resources or sales operations if a salesperson has additional questions and to help support the sales manager efforts.

Get to It!

Believe it or not, most organizations can perform the above steps over a focused 8 to 10 week process. It takes prioritization and the ability to involve the right people. In some cases, outside expertise can help drive the process or provide the sales compensation insights to help an organization navigate the various decision points along the way. The sales compensation program is an important enabler of your organization’s sales performance. Even though the year-end is fast approaching, there is still time to ensure your sales compensation program is well-positioned to drive your sales success in the upcoming year. Use the right game plan and you’ll knock down the winning shot every time!

BSC’s Inaugural Quota Practices Study

Saturday, May 11th, 2013

Quota-setting. If that phrase causes a twinge of pain, you are not alone! Over our many years of working with sales organizations, quota-setting has been a topic that causes consistent concerns across both the sales force and those concerned with their performance. The stakeholders we talk to often label it as the most challenging issue when describing their key sales effectiveness and compensation pain points.

Recently, we partnered with WorldatWork to conduct a comprehensive study on quota-setting practices that included over 80 leading companies across a wide range of industries. Only 21% of respondents rated their quota setting process as “very effective” or “effective”, so clearly, there is room for improvement. Of equal concern, only 25% of companies felt their quota-setting accuracy was “very accurate” or “accurate”. And maybe worst of all, we found that many companies were still doing things “the same old way” in terms of tools, processes, and data inputs. Yet there is good news as well; companies express a desire and intention to invest strategically and tactically to find better solutions for this important topic.

You can find all the latest trends and learn more about how you compare by downloading our executive summary report here: Quota Practices Study – Executive Summary from BSC & WorldatWork

And for the full report, please email us at info@bettersalescomp.com.

Introduction to Compensation Cost of Sales (CCOS)

Monday, May 6th, 2013

By Ted Briggs

After almost 25 years of consulting with leading companies on sales effectiveness and sales compensation, I’ve come to the conclusion that other than calling every sales compensation plan “commissions”, the most misunderstood and mis-applied concept in sales compensation is CCOS, compensation cost of sales. In this blog, we will examine what is CCOS and why should a company look internally rather than externally when using this important metric.

What is CCOS and Why Should a Company Look Internally rather than Externally?

Before providing a definition of Compensation Cost of Sales (CCOS), let me first tell you a familiar story. Whether it comes from an email question to our firm, or a question in an initial client meeting, we are frequently asked: “What’s the average commission rate in our industry?” as if it’s a test of our knowledge and expertise, or some attempt to defend a company’s current plans against some internal attack that their plans are too rich. My favorite answer is “2.4%”, said with much certainty and a wry smile or emoticon if electronic. I often want to reply as Marisa Tomei responded in her Oscar winning performance in “My Cousin Vinny”…”That’s a b&%%$#!+ question.”

Naturally, commission rates vary widely even in similar industries, as well as within a single company, as roles vary (e.g., major or global account roles versus territory or inside sales roles). This is because compensation levels and base salary to incentive ratios typically vary by role, as do the range of expected sales volumes. Try creating an average rate by company, more or less across companies, and you quickly realize how unimportant that comparison actually is. Try selling the comparison to your sales leaders and you’ll be pushed back farther than you may be able to able to recover.

The question companies really seek to ask is how much am I spending on my sales force versus other companies. This too is a challenging concept. Cost of Selling studies are rife with definitional inconsistencies as to what categories of cost to include (sales office building leases, overhead allocation, etc.) as well as whether the denominator should be actual current period revenue, or sales bookings.

Ultimately, the one comparable ratio becomes CCOS, which looks at what current period compensation (base and variable) is as a percentage of current period revenue. This measure is really a productivity measure answering: how much of every dollar do I have to spend to get a dollar of revenue? Naturally, in some businesses, total bookings, or even total gross margins (especially in distribution) may be a better denominator, but for most product based companies, revenue is the best metric. Of critical importance is to use a real financial measure, rather than sales crediting, which can be a distinctly different currency due to modifications in deal values and multiple sales crediting.

CCOS = [Total Salaries Paid + Total Incentives]/Total Revenue

Once calculated, the question becomes how to get data to compare it to. Absent having a benevolent consultant conduct one for free, you can charter a study with comparable companies. But once you get the data, what do you do? Let’s say you find that you are in the 70th percentile of spend….what do you do?

Do you cut pay, increase quotas, or reduce accelerators? Probably not! Assume you’re in the low 30th percentile of spend…now what? Raise pay, add salespeople?

Actually, what you need to do is look internal… deeply internal, and look over time to see trends. A total company CCOS rate is like an average of averages, and an average productivity measure gives you nothing with which to analyze and improve. First, you need to look at the detail, segment by segment, as well as region by region. Here, you can identify where you are performing most effectively, and least effectively. Next, you should look at not just last year, or this year’s target; include two years ago, so that you can see a trend. Which segments or regions are improving. This data gives you a chance to look for root causes of increased or decreased effectiveness.

One other cut of CCOS we like to see is new hires versus sellers with at least a year of experience. This can help you examine your investment in incremental headcount growth, and not apply the same treatment to all sellers. This can keep you from burdening legacy employees with extra quota to try and afford new talent.

One last thing to examine is a look at relative performance of each of your segments and regions versus your market. By defining and reviewing the growth rate with the CCOS trends, you can identify where results and effectiveness are best aligned, and of course, where they are not. This can help you understand your relative achievement versus the competition or broad market, and how effective your spend is in reaching those performance levels. The following table shows examples and some conclusions you might make.

This can help you focus your sales management efforts on coaching, training or even talent recruitment to try to drive incremental results. You can also do root cause analysis to see if there are competitive factors hurting or helping you in those specific segments or regions. Lastly, it can help you develop segment specific sales compensation plans and targets that better suit the environment in which the sellers are actually performing, and can better drive their motivation to succeed.