The way this question came to us was in the context of a business with new equipment sold at lower margins and higher volume, and used equipment sold at higher margins and lower volume. But the principles apply more broadly.
Presumably the high revenue new equipment sales are generating a reasonable margin, though perhaps at a lower percent. If the relative value of these two offerings is accurately reflected in the margin value generated (dollars/euros…), then Margin Value may be the single measure that combines them both and balances effort and rewards appropriately.
There are many reasons businesses give for not using Margin Value as a sales compensation measure.
However, there are many reasons businesses give for not using Margin Value as a sales compensation measure, including a reluctance to share margin information broadly and an inability to accurately measure margin at a sales person or order/contract level. In this case it may make sense to split the plan into two separate components with target incentive value assigned for New Equipment and Used Equipment separately, along with goals or quotas for each category. In addition it may be important to link the two measures so that a sales person cannot “win” by doing well on one and not the other. For example, there could be a requirement that in order to earn accelerated over-goal compensation rates on one of the measures, at least 90% of the annual goal has to be achieved on the other measure.
Our answer here is, “tightly and directly.” Here’s the chain:
- Business strategy
- Operating objectives for the coming year
- Expected contribution of the sales organization to achieving those objectives –> sales goals
- Sales roles with objectives aligned to achieve overall sales success –> key accountabilities by role
- Sales compensation plan measures and goals/quotas
So there’s a direct chain that goes from the business strategy all the way to the measures and objectives in the sales comp plans. If you can’t demonstrate these linkages, your sales compensation plans may not be doing all they can to support your business’s success.
Often sales people influence both the volume of sales and their relative profitability. Rewarding simultaneously for both puts the incentives in line with what’s best for the company.
Three effective ways to approach this:
- Make revenue the primary measure using a goal-based incentive (see this post for a clear explanation of how a bonus or goal-based incentive work), and add a profitability multiplier. For example, offer the opportunity to earn as much as an additional 20% (1.2 multiplier) at year-end if a stretch profitability goal is achieved, lose as much as 20% of total earnings (0.8 multiplier) if they are below an unacceptable level of profitability, or have no effect on their own earnings in-between (1.0 multiplier). This would be most appropriate if revenue is the most important focus for sales, with profitability in the also-important category. It would also be appropriate if profitability is difficult to measure at the individual level, but very accurate by business unit or in aggregate.
- Measure sales people only on gross margin or gross profit dollars, and drop revenue as a sales compensation plan measure. This would be appropriate if margin can be accurately tracked and reported by individual sales person. Here again, a goal-based incentive is probably the best choice.
- Use a matrix with revenue goal attainment on one axis and profitability goal attainment on the other. In the middle of the matrix (at goal on both), pay 100% of the target incentive. As both revenue and profitability increase, pay over-target earnings. Pay very little for below-goal performance on both. And pay in-between if they’re over on one measure and under-goal on the other. It’s a little tricky to design the matrix, but once you’ve got it, it’s very easy to understand and administer.