CONTRIBUTION-BASED COMPENSATION

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:

	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.
	It becomes easier to recruit new sales associates, particularly top producers. Improved recruitment translates into faster growth and increased market share.
	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.