Handle with care

UNIVERSITY COLLEGE DUBLIN:Companies need to manage their salespeople, not just pay them. Commission and bonuses are good motivators but there must be checks and balances in place. Salespeople should be rewarded for building relationships with customers, getting repeat business and keeping margins up too If salespeople discount heavily to get higher sales, the company can end up incurring a net loss

PAYING COMMISSION to salespeople is a motivational tool as old as trade itself. The principle is simple: the more the person sells, the more he or she gets paid. Everybody wins, in theory at least. The company wins because it is selling more. Salespeople win because they are getting paid more. The customers win because they are getting the products they want.

It's not quite as simple as that, however, according to Dr Susi Geiger, a senior lecturer at Michael Smurfit Graduate School of Business at University College Dublin. "The second you introduce variable compensation, you introduce self-interest and that is not necessarily good for a company or its customers," she says.

The blunt instrument of commission can encourage poor behaviour among salespeople and can be counter-productive in the long run, according to Geiger. But what could be wrong with higher sales? Well, quite a lot it turns out.

"If the commission is based on turnover rather than gross margin, additional sales are not necessarily good for a company," she explains. "For example, if a salesperson discounts heavily to get higher sales, the company can end up incurring a loss on the sale when all costs are taken into account."

There is also the issue of "channel stuffing" in which the salesperson gets retailers or wholesalers to take additional product for promotions and with promises of favours in the future. "This results in an oversupply into those channels and depressed sales in subsequent periods," she says.

Possibly the biggest issue with variable compensation is the fact that it drives people to figure out ways to work the system to their own best advantage rather than working for the company's benefit, she explains. "The people who go into sales are typically those who like risk, who are self-motivated and are comfortable with the concept of variable earnings," says Geiger. In other words, they are people who are naturally good at exploiting any system to their advantage.

The concept of variable compensation is attractive to companies because it enables them to shift a large proportion of the risk onto their sales staff. In a recession particularly, the tendency is to pay sales staff very low basic salaries with high commissions and bonuses.

"This, the common wisdom goes, has the desirable effect for the firm of offloading the risk of slow sales onto the sales person by lowering the fixed costs the company has to bear," Geiger explains. "In addition, companies often build in 'accelerators' into their variable compensation schemes. These offer higher rates of commission for sales above certain thresholds over given periods such as financial quarters. Again, common wisdom suggests that this sorts 'the men from the mice' by helping star performers to earn a multiple of the wages of weaker sellers, getting rid of underperformers and making salaries competitive for those few stars among the sales force."

Both of these common assumptions can be dangerous for a company. "Increasing the variable part of the compensation package focuses salespeople's minds, to be sure but it focuses them on those behaviours that maximise their own gain, and not necessarily that of the company," says Geiger.

When a manager tells salespeople to book revenue, he should also remind them to protect margins, use discounts carefully, avoid channel stuffing, engage in after-sales service, listen to the customers and nurture existing relationships within and outside the customer base, she explains.

"By paying salespeople a base starvation wage and letting them scramble to make up the rest of their salary, you are creating hungry salespeople - with all the consequences this may have for your customer relationships, especially at a time where they may badly resent being oversold to," she adds. Put simply, the interests of the customer become secondary to the need to maximise sales and this has natural implications for long term relationships with those customers. Accelerators cause further problems.

"Accelerators cause salespeople to stuff sales into good sales periods to reach the thresholds where they get paid higher commission or bonuses," she says. "They are a disincentive to selling during poor sales periods when the thresholds won't be reached anyway. This has the effect of increasing the overall cost of sales for the company."

Depending on the industry concerned, anything from 5 to 40 per cent of a company's revenues can be taken up in selling costs so this can be very expensive indeed. It also causes problems in areas such as production where staff may be laid off for periods when sales and demand are particularly low.

So, is there an optimal sales compensation package, one that allows salespeople to manage their own efforts and earn accordingly, but that also protects company interests?

"Companies should think very carefully about what they signal to their salespeople when devising or revising the compensation structure," Geiger says.

"Compensation directly and dramatically drives sales behaviours, much more so than any other management tool. Increase your variable compensation and you are telling salespeople to sell at all costs, even at the cost of customer relationships.

"Companies need to manage their salespeople, not just pay them. Variable pay is a good motivator but it needs checks and balances.

"There need to be rewards for repeat business, for customer relationship management and there need to be direct links to gross margin. The buzz word now is consultative selling, where salespeople work closely with customers to meet their needs. Compensation packages need to allow the space for that to happen."