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What is contribution-based compensation? Contribution-based compensation is a time-tested approach
to sales force compensation that has been proven to offer significant
benefits. At the foundation of this strategy is the belief that the best
way to set up compensation plans is to tie them directly to the costs of
running the company. Sales representatives contribute their share towards
corporate expenses and profit. After their contribution is paid, they keep
most of the rest of the money they bring into the company. Firms that have
introduced this approach benefit in several ways:
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The opportunity to make an unlimited amount of money
provides a significant incentive to sales representatives. As a
result, they typically become more productive, so corporate revenue
increases. |
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It becomes easier to recruit new sales associates,
particularly top producers. Improved recruitment translates into
faster growth and increased market share. |
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A pre-defined level of profit is built into the plans,
ensuring long-term profitability, which adds value to the business and
enhances the firm's financial stability. |
Here's how it works...
Cover corporate expenses
The first goal of any company should be to make sure it can pay its bills.
Expenses come in two types: fixed and variable. To simplify a little,
fixed costs are expenses that do not increase as business increases.
Examples include office space, utilities and salaries for support staff
and management.
Variable costs are expenses that vary with the amount of
business you do. Commissions, telephone charges and manufacturing costs
are variable expenses. Variable costs are tied to revenue — if you don't
have any sales, for the most part, you don't have those expenses. But
whether or not you bring in any money, you still have to cover your fixed
expenses.
Fixed costs can be allocated equally among sales
associates, with each associate responsible for bringing enough revenue
into the company to cover his or her share.
Variable costs also need to be paid out of the revenue a
sales representative brings in. However, because those costs are tied to
sales, instead of allocating them equally, it makes more sense for each
representative to be responsible for the variable costs associated with
his or her sales.
Build in profit
The second goal of any company should be to make a profit. The best way to
ensure profitability is to add the desired amount of profit into the
expense allocation.
Profit can be treated as either a fixed or a variable
expense. If it is designed as a fixed expense, that puts an upper cap on
profit. So most companies prefer to define it as a variable expense. This
allows them to continue to benefit as revenue grows.
This approach is an unusual one — most businesses define
profit as what is left over after expenses? but treating profit as an
expense, and planning for it, is the most effective way to make sure the
company is profitable.
Allocate expenses among sales associates
The next step is to allocate the expenses fairly among the sales
representatives.
You need to make everyone responsible for contributing the
same amount. Anything else penalizes top producers and is a disincentive
to selling more. But, realistically, some people won't be able to bring in
that much.
We use a concept called the "fully productive
equivalent," which counts newer sales associates or low producers as
partial representatives rather than whole ones. So, for example, at an
office with 16 sales representatives, the fully productive equivalent may
be 13-1/4 representatives.
This method of accounting for the reduced contribution of
low producers brings a higher level of accuracy to the expense allocation.
Derive commission levels
The next step is to identify the correct placement of commission
levels.
Divide total expenses by the fully productive equivalent
number of sales associates. This is the breakeven point, or the amount of
money each sales associate needs to bring in to cover corporate expenses
and profit.
Then determine what percentage of each sale needs to be
held back to cover variable expenses. That provides the maximum a company
can afford to pay out once fixed expenses are covered.
Design plans
Once you have calculated the amount each representative must contribute
for corporate expenses and profit, along with the highest commission level
the company can afford to pay, you are ready to start designing
compensation plans.
One way to structure plans is to have the representative's
commission level start out low, because the company is keeping enough
money to pay both fixed and variable expenses. Once the company has taken
out enough money to pay fixed expenses, that contribution stops. The money
that was going to the company to pay fixed expenses now goes directly to
the sales representative. The sales representative will now typically
receive a substantially higher commission.
However, that method may not be appropriate for your sales
force. Using CompensationMaster's software, you can design any type of
compensation plan you want: salary plus bonus, 100% commission, high
split, retroactive, etc. You can build in any type of perquisites, any
type of benefits.
The software will tell you whether each plan you create
meets your profitability goals or if it will put you in the red. This
reduces the risk of implementing new commission structures, and allows you
to design compensation plans with confidence.
To learn more, schedule a demonstration
over the Internet.
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