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Strategic Sales Compensation: What Do Forward-Thinking Companies Need to Do?

You ask. We respond

As businesses reach out to global markets and a sluggish economy puts pressure on profits, more U.S. companies are turning their attention to sales force effectiveness. More than 170 participants tuned in to a Webcast presentation on October 14, 2008, featuring Deloitte Consulting LLP Principal Michael Herman, Deloitte’s National Sales Effectiveness service line leader, and Michael Vaccaro, Deloitte Consulting LLP senior manager, a member of the leadership team in Deloitte's Sales Force Effectiveness service line. The two discussed ways for human resource (HR) and sales professionals to assess and improve their sales incentive compensation programs, using results from a biennial Deloitte survey on sales compensation practices for discussion. The following are the presenters' responses to select questions submitted by participants during the Webcast.

Participant Questions

What role has HR traditionally played in sales compensation?
Responsibility for sales compensation usually crosses functions within a company. In the best of worlds, HR works in partnership with Finance, IT (information technology) and Sales to make sure the right behaviors are being motivated within the sales force, the right plan designs are in place, the right pay levels are targeted, the plan is attractive to the right talent, and that there is consistency throughout the company. The trick is to bring all these worlds together in a coordinated fashion to make sales compensation work.

In scenarios where HR has a more limited role, primary responsibilities usually center on market pay positioning, appropriate pay mix, sales incentive eligibility and plan terms and conditions.

Why the big difference between 2004 and 2006 on the Deloitte survey results?
In 2004, we conducted the survey at the onset of the last expansion. We were coming out of the Sarbanes-Oxley/Enron world then, so folks were still not as happy with the results they were getting. In 2006, the economy was in the midst of the expansion that was on a fairly predictable path upwards. We think that accounts for much of the improvement in the responses. Ironically, there didn't seem to be one big item that suddenly got a lot better in terms of cost, plan design or the like; in fact, some of the same concerns around the sales force meeting their goals, plan costs, and properly rewarding top performers, and simplicity were visible then, just as they are now. Mostly it seems like it was the mood of the time.

You said that setting quotas in 2009 will be an interesting exercise. Is that because you think they will be lower than expected or higher than achievable?
It has been at least five of six years since we've been this uncertain about where the marketplace will go. So we expect it will be more challenging this coming year to predict the market, and to reflect those predictions in sensible goals that will drive compensation. If the goals turn out to be wrong, then pay and productivity are going to be misaligned. Additionally, companies are going to have a perception issue within the sales force. If you set the expectation that quotas are going to go down, how do you deal with the implication that your sales force is going to get less pay? How can you continue to reward your top performers like you need to in order to retain them?

Additionally, where material costs are a significant part of overall cost, some industries will see swings that could favorably impact margin (assuming pricing holds), hence favorably impacting their earnings. One could argue quota setting (where quota is margin) should reflect these potential decreases in costs, too.

What are some third-party software applications that seem to be working well for incentive comp?
There are four applications out there that have received promising independent reviews from Gartner. One is called Oracle Incentive Compensation. The second comes from a fairly new company out of Canada called Varicent. Theirs is the first application to combine territories, quota, sales compensation and analytics in one suite. If you have an Excel background, you can actually design and change plans, make queries for reports and so on. The third is Callidus Software, which is a Gartner Best of Breed application. It has been in this space for a while and is moving more towards a hosted model. Of course, there are other applications that might make sense for a smaller organization, but these are the three big players according to Gartner.  Finally, Synygy is the fourth software company that received a “positive” rating from Gartner in their latest overview. Synygy’s business model mostly focuses on a subscription based hosted platform, which has been appealing to many pharmaceutical companies.

How do the technology solutions create flexibility as opposed to typical spreadsheets or Access databases, which can be very easy to modify?
Many of these systems are built specifically to manage compensation. So they offer a significant flexibility to the end user, and there's a richer engine behind the scenes that allows you to support more complex sales models, have more precise metrics in them (assuming good data is available) and manage them more effectively, especially when there is a large sales force involved with lots of moving parts to track. The systems also allow you to model changes before you make them to see what they will cost and who will be affected. This can eliminate the requirements for companies to “do heroic acts to accomplish everyday deeds” in sales compensation administration.

Are you seeing any difference in trends globally versus in the United States?
We are. It's mostly a matter of degree, however. Within the sales force, the U.S. seems to lead in terms of driving the newest practices around team selling and multiple sales models, for example. For instance, we also conducted the survey for the Canadian marketplace and found that many of the trends we saw in the U.S. occurred about two years later in Canada.

It also can depend on whether the company has its HQ (headquarters) in the U.S. or elsewhere. Many U.S. companies are taking more bold action to standardize their pay approach in global theaters; companies with HQs outside the U.S. tend to have a more decentralized and/or nonstandardized approach to pay that builds pay practices around regional and local pay practices and corporate cultures.

One other emerging trend is the continued high demand for "hunter" sales reps in emerging markets (e.g., Brazil, Russia, India, China), as U.S.-based companies are increasingly looking to global markets/emerging markets for growth.

In the Asia Pacific region, technology industry compensation for many roles that traditionally had lower amounts of leverage (base pay vs. at-risk) are now seeing a swing toward more leverage. For example, technically focused presales and postsales services roles are seeing their pay compositions go to more incentive-based pay and more bonus dollars than the typical levels associated with these roles. 

Another trend in global markets across regions versus the U.S. involves the treatment of compensation of the country manager or business unit manager role. This has traditionally been an executive role, second or third line manager (depending on country size), with a defined revenue goal and ownership of a profit and loss statement. The trend abroad has been to increase quantitative measures and metrics and lessen the measurement of qualitative measures such as KSOs and MBOs.

Do you have a sense for how companies tend to align the currency for setting quota targets, booking orders and paying commissions?
Typically this is handled in a pretty rudimentary way, either with a set exchange rate determined at the beginning of the measurement period, or with whatever market rate the company enjoys at the time of commission payment. The big issue is maintaining the right level of reward for the right level of effort across boundaries. You do not want to get caught over- or underpaying simply because of a currency move. So the way companies do it is to pick one of these policies and stick with it.

Any recommendation on administration? Centralized? Decentralized?
It depends on the company and its market strategy. We often find there are certain high-level elements — certain compensation philosophies, metrics, policies and rules — that can be standardized, while also leaving the local market the right amount of discretion to account for their own market conditions. So you can have plans that are standardized to a strategic and administrative level, while being reasonable in recognizing those differences among markets.

Do you have any insight in how to understand the impact of adding gross margin measures on selling less profitable products?
The fear is that having reps understand the gross margin of different products is going to drive them to sell only the highest margin products. Anecdotally, this seems to occur. Companies that want to ensure that a complete product line is offered with the same vigor often play fairly complex games to try to control for this behavior, such as selling on an average price or using a selling “points system.” But the real question is: Do you want your sales force responsible for driving profits? Is that their role? Do they carry out the activities in their job that are aligned with driving profits? How much control do reps really have over profitability?

Many companies like to emphasize the “quality” of revenue generated by sales. And margin is not always the best measure for this. There are more than 40 proxy measures for paying reps on profitability. Our point of view is that sales reps should be paid for profitability defined by either “cost to serve” or “pocket-margin.” This applies to all levels of products – including less profitable ones.

Please repeat the items to look for under the "P" (process) piece and the "O" (organization) piece.
Some of the individual elements of “S”, “P”, “O” and “T” are given in a sidebar within the survey itself.  Learn more.

You mentioned 3–8 percent spend on commissions was too much. Could you restate this to make sure we caught the point?
The 3–8 percent we referred to was the typical amount of commission error in over- or underpayment that studies show “leak” out of total compensation payout. So it's not the amount of commissions spent overall; it just represents the visible and invisible errors beyond the regular compensation.

Do we see a trend in outsourcing sales compensation administration?  Isn’t that risky?
We are seeing a slow trend in companies deciding that their sales compensation administration is burdensome and fraught with enough potential errors that turning pieces of the administrative job over to an experienced third party as part of a “hosted model” is attractive. A number of the sales compensation application providers are expecting this to become a bigger part of their business. Companies mitigate the risk by being strategic in determining the pieces of the administration process that they turn over to a third party, and which to keep in-house.

What plan elements do you see for sales roles with long sales cycles?  How do you keep reps engaged in tough times?
The potential problems with traditional compensation plans in long sales cycles are that sales may not happen during the measurement period, or that the size of sales are so large as to dwarf an average quota, making payouts “feast or famine” for the rep. Companies can address these by using plan metrics that drive the right behavior and activity in generating a sale – visits made to prospective clients, number of deals at certain checkpoints in the sales pipeline, whatever is seen as appropriate – or by moving to plans with low pay-at-risk or that are bonus-based.

For example, a handful of technology companies have implemented multiyear bonus plans (usually two year plans), where year one focuses more on the behaviors and activities and year two on the financial results.

As for tough times, we have recently gotten several inquiries around how a sales compensation plan be used to reward for improving cash flow, given the tightening credit situation.

In addition to metrics that align to the sales process and key behavioral and activity milestones, many firms are also increasingly dampening the effects of a long sales cycle by altering the performance periods of these sales representatives. An example of this involves allowing quarterly, interim sales targets that represent equal portions of what would be an annual sales goal. Cumulative goals then are rewarded incrementally at say, each quarter close, but such a plan only allows maximum incentive payout at the close of a four quarter period based on the revenue generated cumulatively that either meets the annual sales goal target or does not. These plans, while difficult to administer, represent for many firms a sound hedge against reps "taking their eyes off the ball," and the volatility associated with unpredictable selling cycles.

Do you have statistics on usage of base+commission plans vs. commission-only plans?
Our 2008 survey showed that base+commission is far more prevalent. Forty-eight percent of respondents used base+commission plans, while only 3 percent used commission-only plans.

Does survey data exist on how companies handle vacation/"banked” time when calculating compensation payouts (for example, when a rep is retiring)?
Unfortunately, I am not aware of any survey data on this element. Typically, this is a policy decision that is made as part of the terms and conditions of a sales compensation plan.

Related Content:
Archived Webcast:  Strategic Sales Compensation: What Do Forward-Thinking Companies Need to Do? 
Survey:  2008 Strategic Sales Compensation Survey
Resources:  Sales Force Effectiveness Framework
Overview:  Human Capital and  Total Rewards 

This publication contains general information only and is based on the experiences and research of Deloitte practitioners. Deloitte is not, by means of this publication, rendering business, financial, investment or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte, its affiliates and related entities shall not be responsible for any loss sustained by any person who relies on this publication.

As used in this document, “Deloitte” means Deloitte Consulting LLP, a subsidiary of Deloitte LLP. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries.

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