The Economics of Commissions Part 4 (Are there Other Options?)

Beth Carroll |Prosperio Group

In the first article, we looked at the various ways commissions can be calculated so that “costs are covered,” namely using a draw, a multiple of salary, or a threshold approach. In the second article, we looked at three different ways of scaling a commission rate relative to production: flat, retroactive, or progressive. We also discussed setting a fixed tier for production (e.g., $20,000) or a relative tier (75% of goal, where the goal is individualized based on a person’s book of business). The third article focused on using a matrix to simultaneously measure two different performance factors to determine a commission rate.

And yet, we are still not done with the options that exist for using a commission to pay incentive compensation. There are at least four more methods that readily come to mind, and each is used for very particular circumstances. The first will probably be familiar to many of you. It is called a “Declining Commission” and it is often used for larger deals, on an account-by-account basis, for hunter-type roles.

The idea here is that when an account is landed, a higher commission rate is paid for a period (usually 12 months) and then reduced for the next 12 months, and then reduced again. It is entirely up to your business model what the time horizon should be before the step-down, and how many steps there should be and if the final step is zero, or something north of zero. Keep in mind that any ongoing commission on business previously sold becomes an annuity and reduces the sales rep’s need to hunt for new business. So don’t be surprised if you have a substantial final step, or that after a few years your hunters have all become farmers and you are not getting new customers. An alternative to this approach is to use a “bank” which I wrote about in “How to Have your Sales Reps Really ‘Make Bank’” in the August 2019 edition of 3PL Perspectives.

When you start dealing with salespeople who are true consultative sellers, closing large deals with very long sales-cycles (think Managed Transportation, Warehousing, or Supply Chain Management), then it is not uncommon to see a deal-based commission. These start as straight commission plans, but the rate is modified based on specific characteristics of the deal, such as: anticipated profitability, payment terms, bundled services, etc. The better the deal the rep can put together, the higher the commission rate. The more concessions the rep gives, the lower the rate. It’s also quite common for these types of plans to payout in milestones spaced out over several years, as revenue or profit is recognized. Because of the long sales cycle, these plans are often paid quarterly or even semi-annually, and they tend to be very lumpy in terms of payment, with reps having really good years and really bad years depending on what has closed. To counter this reality, these roles have some of the highest base salaries in the industry.

The final primary method that can be used for calculating a commission is called a Personalized Commission Rate, but it is not really a commission. It is a goal-based incentive that has been turned into a commission because someone thinks it makes it easier for reps to do the math. Here’s how a PCR plan works.

When you start dealing with salespeople who are true consultative sellers, closing large deals with very long sales-cycles (think Managed Transportation, Warehousing, or Supply Chain Management), then it is not uncommon to see a deal-based commission.

Joe has a quota of $1m and Sally has a goal of $2m. They both will earn $20k if they reach their goal. This is a classic goal-based incentive plan, which makes a ton of sense if the sales opportunities Joe and Sally have are inherently unequal (Sally has New England, and Joe has South Dakota as territories). You could communicate this plan using a linear incentive table where 80% of quota pays 50% of the incentive, 100% pays 100%, and 120% pays 200%. You interpolate or use the slope of the line to find payouts between those major break points (it’s 2.5 to 1 between 80% of quota and 100%, and 5 to 1 between 100% and 120% of quota – change in Y / change in X). OR…you could convert the pay/performance relationship to a personalized commission rate. Joe’s baseline rate is now 2% ($20,000 / $1m) and Sally’s rate is 1% ($20,000 / $2m). You could pay this from the first dollar or you could scale it as I did with the linear table setting different rates based on what percentage of goal is attained (remember the discussion in article 2 about retroactive versus progressive rate tables).

I have been working with transportation companies now for 12 years and have yet to find one who uses a PCR plan. However; they are quite common in software and hardware sales environments where territory quota is the ruling determinant of pay.

There are a variety of secondary commission models, such as using a commission on a secondary measure as a “kicker” rate applied to a primary metric. This is, in essence, creating a modifier plan or mini-matrix. You can also use a combination of linear incentive with a commission rate above a certain percentage of quota attained. So, with Joe and Sally, you could pay them $20k when they each reached 100% of their quota (assuming some scaling below this), but then say they both get 2% of all sales above quota. This means Sally’s pay will escalate faster than Joe’s above quota because she will likely have a higher volume. They are quota-driven, to quota, and then volume-driven after quota.

While this concludes the series on commissions, I have already hinted at an entirely different world of incentive compensation possibilities by raising the notion of “goal-based incentives.” In this world, pay is not a direct function of volume, instead, it is a function of (you guessed it) goal attainment. There are several different ways pay can be delivered relative to goal: from a linear function, to a tiered structure, to MBOs/SSOs, and IPMs/KPIs, and even piece-rate plans. We will explore these incentive options in the next series: Going Beyond Commissions – Getting EXACTLY What you Pay For.

Beth Carroll is the founding partner of Prosperio Group, a business consulting firm that focuses on the strategic management of compensation for global transportation & logistics companies. Beth is based in Chicago, Illinois and has more than 20 years’ experience developing incentive compensation plans for companies across the globe in a variety of industries. Prosperio consultants have completed projects with more than 175 Transportation and Logistics companies. Beth can be reached at 815-302-1030 or via email at [email protected]

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