By John Pfrimmer
Monetary incentives will drive behavior and will cause predictable results. If the rewards are significantly leveraged, that behavior will bring out the best or worst performance for the overall business. Sales people are usually self-starters and ego driven employees but monetary reward is often how they measure their own success or failure and how they feel appreciated. Beyond incentives, left to their own judgement, salespeople will usually try to effectively serve a customer by selling products or services that they think the customer wants and at a price that they think should be reasonable and deliver mutual benefit to both the customer and employer. The problem is their perception of what profit level they think “reasonable” really is.
Creating an incentive plan to encourage a sales team to achieve a company’s goals is not difficult. However, translating business goals into a sales team’s metrics and incentives and explaining it to them is a challenge. This is further complicated if there is a misaligned legacy incentive program already in place. Then a reorganization or culture change is also required to effectively align the sales incentives with the overall business goals and gain acceptance. The plan also needs to be simple and easily translatable from performance to reward. That usually means singularly focused rather than an elaborate formula that cannot be linked to any single transaction.
THE LINK BETWEEN INDIVIDUAL PERFORMANCE AND COMPANY PERFORMANCE
Most sales organizations are offered some sort of guaranteed salary plus an individual commission on achieving a revenue target. In some cases the sales team has some influence over selling price or “off invoice” discounts. This type of plan can lead to achieving revenue targets without achieving net income targets and sometimes even encourages price and margin erosion. It could even unwittingly lead a company into participating in or promoting a price war. It may also lead the sales team to sub optimize or limit the total scope or offerings to the customer to only those product and services that the individual salesman can control or close with the least complicated and shortest cycle time from offering to reward. An individual sales person may not realize benefits from a larger more complex sale even if it enlarges the per cent of customer spend and it would most likely complicate the individual sales person’s ability to get the order. A higher price or profit may also reduce the sales person’s chance of winning the deal so a sales person may lobby on behalf of the customer for the lowest acceptable net price to improve his order win rate.
A reasonable profit in a sales person’s eyes might simply be what he or she feels a reasonable markup is. I repeatedly have heard anywhere from 5% to 20% over the standard cost. When going much higher than that, many sales people may believe that the markup or profit level is onerous and will lessen their chance of winning the order. That perception comes from their own personal expectations as individual shoppers. What many sales people do not realize is that a 20% markup rarely even covers the selling costs let alone all indirect costs. Most of the time, these levels are dilutive or even negative OI. The business may also have a minimum expectation of 10-25% operating income after “all costs are considered. How many sales people even know their transactional contributions to the bottom line and how their margin production compares to their peers let alone the business goals? A first step is to shift the sales person’s expectation from a minimum markup threshold that is “reasonable” that may produce zero OI to a level at or above that margin level that will deliver the business’s Operating Income target. Then every strategic discounted order must be covered by an order that exceeds the target. This will be an eye opening epiphany to many sales people who have some control over “markup price levels”. If a sales team has no control over price or knowledge of costs, then revenue or quantity sold becomes a more feasible basis for their incentive plan. Modifying their incentive plan structure will obviously accelerate adoption of their new target price levels.
Cost based pricing is rarely the best approach to pricing because it does not allow for maximum willingness to pay or contextual pricing opportunities. It is often used by young or struggling companies that lack market price knowledge or a value proposition. It may then be used to define a walk away price but it left no room for negotiation. Once we change the incentives to margin $ maximization, the trend for upward average price per unit improvement is almost a certainty. That price and margin improvement adds to top line revenue too whether unit sales go up or not. Historical win/loss data at various price points is a more accurate basis to define market price potential.
KEY CONSIDERATIONS WHEN IMPLEMENTING
We should not underestimate a sales team’s ability to drive higher prices and margins for the business when incentivized to do so. However, unintended consequences of any incentive plan are also essential considerations in putting our plan together. That means more Operating Income “dollars” as opposed to just profit %. Incentives focused on Profit % could actually deliver rewards to the sales force while eroding revenue and OI $s for the business. A properly designed incentive plan will allow a sales person to achieve a target level of profitable dollars with price efficiency. That means escalating price to maximum willingness to pay for an individual customer or transaction. That allows the sales person to take into account and articulate the value offered and benefit to the customer. That value selling mindset at the highest allowable price instead of the lowest acceptable price only occurs when the sales incentive plan is correctly structured. Creativity naturally grows on the part of the sales team to identify and quantify tailored value to the customer when their rewards for doing so produce leveraged benefits to their wallet. That leverage can also be extended to create behaviors that grow the scope of the offering to a more complex or bundled sale possible provided that bundling is rewarded. A profit or price improvement reward structured program will also stimulate increased feedback from sales to marketing regarding competitive offerings, market price levels and innovation, value or cost improvement needs.
When creating an incentive plan that might be able to drive profit improvement and growth, we must first baseline our organizational capabilities and existing structure. Some of those key considerations are:
- Is profitability a strategic goal?
- Can profit or price be controlled by sales people?
- Can you measure at least Gross Margin at the sales person transactional level?
- Do you mind sharing profitability or cost information with sales people?
- Can sales people influence price, discounts or concessions?
- Can sales articulate every product’s and the company’s value?
- Is it OK to drive the sales of higher margin mix products most?
- Are there additional sales people overlapping the same customers?
- How is the existing incentive plan performing and can we logically translate historical revenues into average price or margin performance?
- What is the “opportunity to cash” cycle time and when are the sales people currently rewarded in that cycle?
- Is our product the price, cost or value leader or follower? How do we know?
After answering these questions we can determine the feasibility and advisability of developing a more appropriate incentive plan. Historical trend data will help us with the proof of concept and predictability. When we revise the compensation plan we will need to also consider “off invoice” discounts and “costs to serve” in the margin waterfall, e.g. shipping, cash discounts, restocking and returns, customer service, marketing incentives, rebates, promotions and selling costs, etc. Many seemingly profitable transactions turn unprofitable simply because of downstream discounts. The most effective incentive program will seek to have the salesman rewarded for managing all the variables under his control to deliver the maximum price or profit to the company.
Some considerations the compensation plan must consider are:
- Measurable individual and relative performance levels of each sales person by transaction, customer and product type in revenue, cost and margin.
- Direct relationship with plan and business performance targets
- Line of sight visibility – metric target should be apparent and reportable
- Timeliness – monthly if possible, order verses sale?
- Simplicity – Primary driver and easily identified, avoid conflicting goals e.g. revenue verses margin
- Accuracy – Credibility and morale
- Individual incentives are usually more productive but sometimes overlaps and team selling must be encouraged
Flipping a switch to change the compensation plan in mid-year is usually difficult and often times met with distrust. It should only be done in an emergency and in conjunction with an effective culture change and communication plan. Ideally we could demonstrate how the “new plan” could produce even more upside reward for the sales team. The good news is profit growth aligned incentive plans are self-correcting. Rewards for unprofitable sales go away and individuals who cannot or will not produce profitable sales will be less of a burden to the company’s cost structure. A mid-year phase in incremental bonus or reward program can be designed that only rewards upside profit performance improvement over plan and prior year. It becomes completely self-funded by the upside leverage. It will also be very useful in changing the culture and expectations of the organization.
About the Author
John Pfrimmer worked for GE 27 years. He started as a Field Service Engineer and progressed into management roles with P&L and Sales leadership responsibility over several failing businesses in GE Power Systems. He successfully turned those failing businesses around and was subsequently promoted to General Manager over the $150MM Industrial Repairs Business. Following similar success, John was appointed Commercial Director and Global Sales Leader over the entire $1Bil Energy Services Global Repair Department. Leveraging his 6 Sigma training he was able to lead the department to achieving 10% CAGR growth and over $500MM of operating income improvement from price productivity in 5 years.
Leveraging that success, John then accepted the position of Corporate Pricing Director for the $13Bil HD Supply Company. He began a new pricing initiative and in less than 2 years generated over $100MM of OI improvement directly attributable to product price and sales force productivity improvements in the first 3 of the 13 HD Supply Business Units.
John was then recruited by the $1Bil Tyco Global Fire Products Business as VP of Pricing and Commercial Operations. While in that role he generated over $700MM of OI improvement in 6 years from targeted product price improvements and developed commercial support processes and sales incentive plans to enable positive leveraged market growth. The business grew by 10% per year while improving from 14% OI to 25% OI to become one of the most profitable businesses in Tyco. John was then promoted to VP of Pricing for all of TYCO where he continued to drive price productivity and commercial process improvement the ultimately deliver $1.5 Bil of incremental operating income from price productivity. Following Tyco’s recent merger with Johnson Controls and just before his retirement in 2017, John continued in his VP of Pricing role to successfully “fix” the pricing and profitability of a couple of struggling JCI businesses which are beginning to thrive now. In every business pricing engagement, John was able to deliver between 100 and 500 of basis points improvement per year.
John has an Electrical Engineering Degree, and MBA. He is a certified 6 Sigma Master Black Belt with special skills in “Design for Six Sigma” (DFSS) commercial process creation and improvement. He is also a retired Navy Captain and aviator with over 30 years of active duty and reserve service.
