The next time one of your sales reps comes in after landing a big sale, will you be left wondering how much money you lost on the deal?
You’re in business to make a profit. Yet if you’re still paying your salespeople based on the volume instead of the profitability of the deals they generate, you’re doing so at the sake of your bottom line.
Sending your sales team out to hit the streets without a specific profit directive is as bad an idea as if a football team were to run a sideline-to-sideline play that didn’t gain any yards. What’s the point?
Perhaps your company falls into one of these common categories of why compensation isn’t tied to deal profitability:
- Your supplier measures your performance based on unit sales, and that cascades down into your own sales offering
- You don’t know your COGS (cost of goods sold) or COS (cost of sales), because you figure it’s too hard to measure
- It’s harder to train your people on the basis of maximizing profits than revenue, and may require changing your compensation plan
- Your competitors have convinced you that you’re selling a commodity
- You believe you have nothing unique to add to your offering to add value (and profits)
- You allow too much variability or special pricing on a deal
- You don’t have the right CFO to keep you in check
- You’re afraid to raise your prices
- You figure “we haven’t run out of money yetÃ¢Ã¢¬Ã¦”
Any one of those reasons could be the choke point for you. Unfortunately, it can happen very easily. Consider the case of a sporting-goods company I know that asked the manufacturer for exclusivity on a new product line, and in return was asked to maximize unit volume. Sounds reasonable, doesn’t it? Yet the deal meant this company had to sell a huge volume of this product year after year, just to retain its precious “exclusive rights.” And the deal itself completely ignored profitability.
The firm’s sales reps, armed with the lowest-priced product in the market, did a great job, and sold tons of inventory. But the company constantly suffered cash-flow issues.
When its senior executives sat down to discuss this problem, someone asked, “How can our competitors even stay in business? They barely sell any of these compared to us!” But quick math around the boardroom table revealed that the competition only had to sell one unit for every three this company did to make the same profit. In other words, this company was working three times as hard for the same result. The owner was paying three times as much in wages per dollar of profit, devoting more floor space and a larger line of credit to stocking that much inventory and so on.
Even so, the owner resisted change. Like so many other business managers, he found it hard to move past the customary focus on selling as much as possible and figure out what it might take to shift to a focus on profitability. “How will we tell our sales team that we have to raise our prices that high, and not have them all quit?” he asked.
A fair point. But how does a farmer explain to his neighbour that his cow ate the other guy’s cabbage? “Hey neighbour, my cow ate your cabbage. Sorry about that.” Just tell them!
In the end, the owner bit the bullet, and was glad he did. He ended up paying his reps more per deal at a newer, more profitable price. After some explaining and a few weeks’ trial, he didn’t lose a single rep, and his profits (not units sold) went up. It turns out the exclusivity wasn’t such a big deal after all.
It comes down to having the discipline to look at your profit numbers and base your decisions on them. When I was a student-painting franchisee during university, one thing the franchisor taught me was to do a job-by-job analysis after the job was done and I’d been paid. Wow, did I ever learn about profitability versus unit sales from that!
I also learned that it’s not as hard as you might think to convert from a volume-based sales-compensation plan to a profit-based one. True, you’ll need to sell the concept to your team, and make sure you don’t cross any legal/HR boundaries. You might need to amend your employment contracts, and you should be careful to treat past and “in process” deals fairly and pay all commissions. And if you suddenly realize that you’re losing money on current deals, it’s unethical to penalize your reps for working in a system that you created. On the other hand, once you know your profit per sale, you might even find that you can pay your reps more.
Wondering where to start? List all your COS items, such as wages, office-rent allocation, benefits, phone, car, mileage, training etc. Commission is probably a variable. Then look at how many units a salesperson sells in the same period. Based on their total sales, how much total profit do you make from them? Divide the profit into their total units sold and you have gross profit per item.
By the time you get this far, you’ll have already asked, “Are my reps making me money?” If not, don’t be too quick to blame them. After all, you set the price they’re selling at. But have a look at profit per deal. Are you leaving money on the table?
Where I live, there is a specialty custom stereo retailer who understands this profit game really well. Since it allows its sales reps (and customers) some pricing flexibility, it wanted a pricing structure that would permit some leeway without requiring the owner to look at every deal before approving it.
He therefore adds his target profit to his costs before he shares pricing with his team. He calls this his wholesale list price. So if he buys a product from his supplier for $10, he presents it to his team internally at a $13 wholesale cost.
He also gives his team pricing flexibility with a minimum and maximum markup percentage. So he instructs them to sell it in the range of $28 to $32. The salesperson is paid a very generous 10% commission for selling at the high end of the profit range, 5% for selling at the low end, and 0% for selling below $28. Incidentally, selling a product at the high end of the range gives the reps bragging rights among the team.
At first glance, you might be asking: what’s the difference? The retailer still makes a sale and pays a commission. But look at the difference in profit.
If a rep sells the item for $28, at the low end of the target, the retailer would pay $1.40 in commission. This would deliver a profit of $13.60 (i.e., $28 less the $10 paid to the wholesaler, his $3 internal markup and $1.40 in commission). Not bad. But compare it with his profit if the rep sells the item for $32. In that case, the profit would be $15.80 (i.e., $32 less $10 to the wholesaler, the $3 internal markup and $3.20 for commission). The rep is happy, making more than twice the commissionÃ¢Ã¢¬Ã¢¬the reward for hustling hard to sell the item the higher price. And the retailer makes $2.20 more in profit on the sale, a nice payoff for the time spent designing this pricing and commission structure.
This kind of result doesn’t come about by accident. Profits have a way of getting away from us if we don’t focus sharply on them. The bottom-line question you need to ask yourself is about the bottom line itself. Are you in business to make money? If so, then why wouldn’t you design your sales compensation to deliver that?