Sales Compensation: Bonuses, Commissions and Other Magic Formulas
Managing people can be difficult and not a lot of fun. Through the years, I have found that owners tend to look for a magic formula or financial equation that enables them to pay people without having to manage them. But I’ve been consulting for more than 30 years, and I have yet to encounter such a formula. Until then, we’ll have to stick with the usual means, including magic commission and bonuses — which are probably used by roofing and the home improvement industries more than in any of the other industries I work with.
Regardless of how you pay people, you have to pay them a competitive, livable wage. If not, they will go to work for someone else. Whatever system you develop, it must be fair to both the company and the individual. It also has to be legal, and follow federal and state wage and hour rules.
There is no research that shows paying a higher salary for cognitive tasks (skilled tasks that require thinking) improves performance. If I pay you more, will it make you smarter? Will your skills magically improve? The answer to both of these questions is no. There is research that shows how paying will increase production on non-cognitive tasks such as repetitive assembly-line work. Most salespeople and management skills require cognitive thinking.
The absolute best pay system is very simple: pay people well, hold them accountable, promote people who perform well and terminate people who do not. The greatest value of paying a commission or bonus is that you have to measure something to give the financial reward. Believe it or not, the measurement is more important than the actual financial reward.
For the past seven or eight years, I have been a speaker at the NRCA convention. Each and every one of those years a business owner approaches me, and he or she is paying more to a salesperson than the owner is making. Many of these industry formulas are based on outdated practices. Long gone are the days when you could use the financial formula to double the cost of the job, have a 50 percent margin and give a 10 percent commission to the salesperson. Why? Inflation. Shingle and other material prices have risen dramatically in the past five years. A job that costs $10,000 five years ago can now cost $15,000. What did a salesperson do to earn that 50 percent pay increase? Another fault with this formula is advertising expenses and how leads are generated. In the olden days, when salespeople were paid 10 percent, they were going door to door generating their own leads.
Let’s look at the absurdity of the 10 percent formula. If your average job size is $10,000 and the salesperson sells two jobs per week, he or she makes $2,000 per week, or $100,000 per year. A good salesperson will sell a minimum of one-third the jobs he or she looks at. So, the salesperson has to quote six jobs per week to sell two. If it takes two to six hours to sell each job, you are looking at an extremely high compensation rate for time put in. If a storm hits your area, you’re really going to be overpaying for the time worked.
So, what and how should a salesperson be compensated? Let’s get a rough idea and salary guidelines.
Start by calculating what you think is a fair annual salary for a salesperson in your area. This will vary according to area, your average job size and type of work, etc. Suppose you figure a low of $50,000 and a high of $90,000. Next, work backward and calculate how many estimates a salesperson needs to do per year and some of the minimum closing rates you would expect. Also, figure in how much project management time you expect. In some companies, the salesperson only sells, and others buy material and run the job. Play around with the numbers and come up with a minimum the person would need to do, the average and then the maximum. Use this and some common sense to determine a compensation structure that makes sense. I won’t and can’t do the math for you because every company is different. However, here are some guidelines to think about:
- Commissions and bonuses should be figured on what is paid to the company, not what is sold. If you don’t collect your money, the salesperson did not check out credit and other details.
- Commissions and bonuses should be determined on gross profit, not just sales. Yes, that is harder to calculate, but both the company and salespeople need to win. You say, “They have to sell from a price sheet.” OK, but if they are creative with a tight sales measurement and the jobs loses, so do they.
- You can have a commission vary according to the price of the job, but extremes of this mean you are a dishonest contractor. Some companies have systems where they want a certain amount and they split the remaining balance with the salesperson. Sorry, that is dishonest. Your price needs to include overhead and profit and, yes, you can add more profit to some jobs for risk. However, setting up a structure where salespeople can gouge customers is dishonest.
There is no magic math formula that takes the place of managing people. However, if you’re a commissioned and bonus-minded company, I know I will not change your mind. If you are ever laying on the hospital bed awaiting surgery, tell the doc that you’ll give him an extra 2 percent if he does a good job. See what kind of look you get. Employ professional people, manage them, pay them well if they do a good job and terminate them if they do not.