If you are still paying your sales staff based on commissions you may want to reconsider. There’s another compensation method that will not only help them sell more but it will deliver greater profits to your bottom line. Here’s how.
There is something on an Income Statement called a Contribution Margin (CM). This is the amount left over after you take Sales Revenue and deduct Variable Costs. It can be expressed as a number or a ratio. The CM is what is left over to pay for your fixed costs and ultimately add (or deduct) to your bottom line.
An example is $100,000 in sales revenue and $60,000 in variable costs. You now have $40,000 to cover fixed expenses and the rest goes to Net Operating Income. Let’s say fixed expenses are $20,000. Now you have $20,000 toward Net Operating Income.
There are many neat things you can do with CM – you can even use it to predict how much you should sell to reach a desired target profit or how to adjust your variable/fixed costs to reach various financial goals.
Connecting the Dots
So back to sales staff. Let’s say you pay your staff based on sales and you have various services that you want them to sell. They will tend to sell the one that has the highest return for them. However, what if that service they are selling does not have the greatest contribution margin? It’s quite likely it may not due to the higher selling price affecting the contribution margin (lowering it) when offset by variable expenses. This lower contribution margin means LESS going to Net Operating Income (assuming fixed costs are the same for both services).
What to do? Pay your sales staff based on Contribution Margin instead of selling price. This accomplishes two things. The salesperson will want to sell the service that maximizes contribution margin and thus having a direct positive impact on your Net Operating Income. Everyone wins!
Contributing blogger Shane Ketterman is a network engineer by day and an MBA grad by night. He combines real-world experience with unique marketing and business views. The VAR Guy is updated multiple times daily. Don’t miss a single post. Subscribe to his newsletter, RSS feed, Twitter feed and Resource Center.
Shane, this is a very interesting topic and you make some good points. I agree that any sales rep will focus their selling efforts on whatever products or services pay them the most in commissions or bonuses – regardless of whether or not those products or services are most important to the company. Telling the rep to focus on the higher CM offerings alone will not drive them to do so. This all starts with the reps compensation plan. When developing a reps plan, here are three quick tips to take into consideration:
• First and foremost, make sure that the sales reps plan is in alignment with corporate objectives and strategy. Too many times I have seen reps make a lot of money while the company does not achieve its strategic goals. In this case, if the reps have multiple offerings to sell, I would provide more of an incentive for the reps to sell the higher CM products. You want their efforts laser focused on the solutions that best fulfill the strategy of the company.
• Keep it simple – limit the number of Measures or Goals to three. More than this will drive the rep to choose the few goals they make the most money on and forget the rest.
• Pay the reps as close to the point of deal closure as possible. This will keep them hungry and motivated to achieve their next level of commission or bonus.
We have a bunch of best practice sales comp information on our website: http://www.makanasolutions.com/incentive-compensation
Hi Larry – Thanks for the feedback! I agree with all three points. Compensating based on CM is a fairly general model that would definitely need to be fine-tuned for each company. I view it as a guideline and then it can be applied with the principles you laid out.
Another popular method is to compensate based on performance feedback from the customer instead of a any other factor.
I would surmise it really comes down to what benefits the VAR/MSP as well as the Customer and Sales professional. The Customer being the focal point.