In the results of the 1998 PMAA financial survey we conducted, there was a clear trend away from volume-based sales commissions to those based on gross margin. Marketers are becoming well-aware that volume may be good for refiners, but what they need is profit!
At Meridian, we are frequently asked by marketers moving to margin-based pay how to design the most effective sales commissions plan. The guidelines we are sharing with you this month were developed after reviewing and seeing the results of a multitude of compensation plans.
First, the most effective commission programs we see pay commissions based upon a percentage of a salesperson’s monthly gross margin. Administratively, check to be sure your GL software has the capability to provide margin reports by salesperson before offering up this type of commission program.
In addition, the most effective programs use an increasing percentage scale. Depending upon the use of base salary with commission, the percentage can be as low as 1% to as high as 15% of the monthly gross margin. For instance, a commission program with a substantial base salary might begin at 1% with incremental steps to 5%. The thresholds might be set at $20,000 increments.
For instance, a salesperson with gross margin for the month of less than $20,000 would be paid 1% of the total. Margin totaling $20,000 to $40,000 would be paid at 2%, etc.
The larger percentage should be applied to the entire margin for the month, not just the incremental amount above the first $20,000. This creates strong incentive for developing extra margin. So, with this example, a salesperson with $37,000 in gross margin for the month would earn $740 in commission. That same salesperson with $100,000 gross margin would earn 5% or $5,000 for the month, plus any base salary.
A plan without base pay is more likely to start at 10%, working up to a 15% threshold. With any gross margin commission, ensure that the margin used for pay purposes is after delivery or haul expense. Most marketers with internal hauling compute the margin using equivalent common carrier rates. Again, be sure your GL system has the capability to show you gross margin by salesperson after hauling.
Ideally, compensation should be paid on a cash-received basis, not at the time of sale. This encourages your sales team to sell to accounts that pay bills promptly. It also keeps you out of the administrative nightmare of charge backs on bad debts.
Although percentage-of-gross-margin systems are simple, they do not account for equipment expense. A $5,000 gross margin per year customer that requires a $1,000 tank investment has a lower net to your company than a customer not requiring a tank. The monthly amortized cost of provided equipment should be netted from gross margin (similar to hauling fees) before paying commissions. Equipment Tracker is an excellent resource to identify this expense, as well as keep track of your loaned equipment!
Finally, avoid the pitfall of paying higher commission percentages on new accounts than old accounts. This practice only encourages neglect of your most loyal customers which will cost you dearly in the long run.