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Profit-First Approach to Sales Commissions

Sales commission structures have long played a critical role in the realm of sales, driving performance, and serving as a pivotal motivational tool. Yet, like everything else in business, these structures must evolve to stay relevant and effective. In this evolution, one principle should serve as a guide: focus more on the deal margin rather than deal revenue.

 

Understanding Sales Commission Structures

Sales commission structures refer to the framework of compensation that businesses use to reward their salespeople for successfully closing deals. The structure may take various forms, such as base salary plus commission, straight commission, or residual commission. Most companies built these structures around revenue targets, rewarding salespeople based on the sheer dollar value of the deals they close.

However, this traditional model, while effective in certain contexts, can often create a myopic focus on deal size, potentially leading to a neglect of other vital factors such as profitability, customer value, and long-term business sustainability.

 

Shifting the Focus: Margin over Revenue

A different, and often better, option is to build sales commission structures around deal margins. The ‘margin’ of a deal refers to its profitability—the revenue it brings in, minus the costs associated with the sale. Focusing on deal margins rather than revenues encourages salespeople to sell more profitably, aligning their efforts with the broader financial goals of the company.

Consider a scenario where a salesperson secures a substantial deal, but at a low margin, due to extensive discounts or expensive value-added services. While the deal adds to total revenue, it might contribute little to the company’s net profit; in fact, it might actually result in a financial loss. On the other hand, a smaller deal with a higher margin contributes favorably to the bottom line.

By prioritizing deal margins in commission structures, companies can motivate their salespeople to pursue the most profitable deals—not just the largest ones. This approach requires a nuanced understanding of product value, cost structure, and pricing strategy, fostering (and requiring) a more financially savvy sales force.

 

The Importance of Variability in Sales Commission Structures

Alongside a shift from revenue to margin, commission structures must also incorporate a degree of variability to adapt to unforeseen market shifts.

External factors, such as market conditions, competition, and customer preferences, constantly shift. A rigid, static commission structure can quickly become outdated, leaving sales people either demotivated by unreachable targets or overly comfortable (and complacent) with easily achievable ones.

Incorporating variability into commission structures can mitigate these issues. For example, a company might adjust commission rates based on market trends or strategic business priorities. Alternatively, it could introduce performance tiers, where higher deal margins result in higher commission percentages. This approach fosters a more agile and responsive sales force, ready to seize new opportunities as they arise.

 

Collaborative Development of Compensation Plans

An often-overlooked aspect of designing effective sales commission structures is the importance of developing these plans collaboratively with the sales team itself. Involving the sales team in this process helps ensure that the resulting plans are realistic, achievable, and motivating.

When salespeople are included in the process of setting their targets and commission structures, they gain a better understanding of the rationale behind these decisions. They are likely to perceive the targets as fair and achievable, which can increase their buy-in and motivation to achieve them.

Collaboration can take various forms. For example, managers might solicit feedback from salespeople about past compensation plans, seeking input on what worked and what didn’t. Leaders should also involve salespeople in discussions about the company’s strategic priorities and how these could be reflected in the commission structure. Alternatively, they could hold brainstorming sessions where salespeople propose and discuss potential compensation models.

Collaborative development of commission structures can foster a sense of ownership among salespeople over their targets. When they feel that they’ve had a hand in setting these targets, they’re likely to be more committed to achieving them. This often leads to improved sales performance and greater satisfaction among the sales team.

 

Recalibrating Targets: Keeping Sales Reps on Their Toes

A vital component of effective sales commission structures is the continuous evaluation and recalibration of sales targets. This practice keeps salespeople engaged, motivated, and focused on their goals.

Recalibrating targets doesn’t mean constantly moving the goalposts just to make life harder for sales reps. Rather, it’s about realigning objectives based on performance trends, market conditions, and business needs. If a salesperson consistently exceeds their targets, it might be a sign that their goals are too easy. If they constantly fall short, the targets might be too ambitious, or there could be other barriers to their performance.

Periodic review and recalibration of targets can thus help ensure that salespeople remain in the “sweet spot” of motivation—where their objectives are challenging but achievable, pushing them to perform at their best.

 

Balancing Individual and Team Performance

When optimizing sales commission structures, it’s crucial to strike a balance between individual and team performance. Traditional commission structures often focus solely on individual sales, which can inadvertently foster a competitive, rather than collaborative, sales environment. While healthy competition can drive performance, an overly competitive environment can lead to internal conflicts and hinder overall team performance.

A balanced commission structure should reward both individual achievements and team success. This can be accomplished by incorporating team-based bonuses or profit-sharing into the commission structure. For example, a portion of the commission could be tied to the team’s overall performance or the achievement of specific team goals. This approach encourages salespeople to work together, share knowledge, and support each other in achieving common objectives.

Team-based commission structures can also help align the sales team with the broader organizational goals. When the team’s success directly impacts individual earnings, salespeople are more likely to focus on the company’s strategic objectives in their sales efforts. This typically leads to a more cohesive sales strategy, improved customer relationships, and ultimately, increased profitability.

 

Incentivizing Long-Term Customer Relationships

In the pursuit of profitable deals, it’s essential not to overlook the value of long-term customer relationships. A sales commission structure that rewards not just the initial sale, but also the ongoing relationship with the customer, can be a powerful tool for building customer loyalty and ensuring repeat business.

One way to achieve this is by incorporating residual or recurring commissions into the commission structure. In this model, salespeople receive a commission not just for the initial sale, but also for subsequent purchases made by that same customer. This incentivizes salespeople to maintain relationships with their customers, provide excellent customer service, and actively seek opportunities for upselling and cross-selling.

Another approach is to offer bonuses or higher commission rates for renewals or long-term contracts. This encourages salespeople to focus on securing long-term commitments from customers, which can provide a steady stream of revenue for the company. CFO’s love this model because it helps improve the predictability of future revenue streams.

By incentivizing long-term customer relationships, companies can not only increase their profitability but also enhance their reputation, customer satisfaction, and market share.

 

Conclusion

Sales commission structures are powerful tools for driving performance and profitability. However, to leverage their full potential, businesses need to rethink traditional paradigms. By shifting the focus from deal revenue to deal margin, incorporating a degree of variability, collaboratively developing plans, periodically recalibrating targets, looking at both team and individual components, and focusing on long-term customer relationships, companies can create a more agile, responsive, and effective sales force.

For more useful articles on sales, read more to dive into how AI may transform Sales in 2023.

Here’s a quick summary of the points to focus on:

  • By placing an emphasis on deal margin, we incentivize sales teams to pursue not just the biggest deals, but the most profitable ones.
  • The incorporation of variability into commission structures allows for the necessary flexibility in an ever-changing market landscape.
  • A collaborative approach when setting plans is one of the best ways to ensure buy-in.
  • Recalibration of targets keeps salespeople engaged and motivated.
  • Emphasizing team and individual elements provides balance and an all-for-one, one-for-all environment.
  • Building in a recurring commission income stream emphasizes long-term commitment for both the customer and the rep.

The art of sales commission structuring is a fluid discipline. As with all areas of business, a one-size-fits-all approach is rarely the best solution. By tailoring your commission structures to prioritize these points you can ensure your sales team remains motivated, adaptable, and highly effective, driving sustained growth for your business. The future of sales commission is not just about revenue; it’s about margin, adaptability, sustainability, and strategic alignment.

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