I’ve chosen to close Part One of this book with a frontal assault on the juiciest bovine of all: the unassailable belief that salespeople should be paid commissions. And while I’m at it, I’ll take aim at bonuses, targets and other artificial management stimulants.

A litmus test

This discussion is important for two reasons.

First, commissions and their bedfellows will definitely handicap the performance of the reengineered sales environment I’ve gone to great lengths to describe.

Second, this discussion will force us to confront the significant implications of Sales Process Engineering: both locally and organization wide.

If you are brave enough to follow in the footsteps of our quiet revolutionaries it’s critical that you truly appreciate the essence of SPE. It’s not enough to believe that SPE will work; you must also understand – at the most fundamental level – exactly why it will work. (And if you don’t, it almost certainly won’t!)

So, I’m proposing that you use the (emotionally-charged) question of salespeople’s commissions as a kind of litmus test. If, by the end of this chapter, you are comfortable that there is no place for commissions in a reengineered sales environment, it’s safe for you to proceed.

If, however, this conclusion still does not sit comfortably with you, it makes more sense to treat this book as an exercise in creative thinking (and leave your sales function well alone).

When commissions make sense

At its most fundamental level, SPE involves the transitioning of the responsibility for sales from autonomous agents to a centrally-coordinated team.

When sales actually is performed by autonomous agents, it does makes sense to pay these agents on a commission basis (a percentage of the revenue they generate).

So, if we imagine a computer hardware manufacturer that sells desktop and notebook computers to consumers, via big-box retailers; it’s clear that these arms-length retailers should be paid on a commission basis.

And, if we think about this example, we can identify two conditions that accord well with commission-based pay:

1. These retail agents sell from stock – meaning that there is no requirement for them to interact with the hardware manufacturer on a transaction-by-transaction basis (which certainly would not be the case in an engineer-to-order environment)
2. These retail agents are truly autonomous – they march to their own drumbeats (and they own the relationship with the ultimate customer)

But what happens to the case for commission-based pay when these conditions are not in place?

As we discussed in Chapter 2, when we transition from a make-to-stock to an engineer-to-order environment, the case for autonomy becomes weaker. Increasingly, the performance of the organization as a whole becomes more a function of the quality of integration between sales and production.

And, because autonomy and teamwork are polar opposites, as the case for autonomy becomes weaker, we reach a point where we have to make a clean switch from one to the other (there’s simply no such thing as an autonomous team member!).

The wrong question

We now arrive at the critical question. We should not begin this discussion by asking: does commission make sense? Rather, we should ask: should we sell via autonomous agents or via a centrally-coordinated team?

Once we answer this question, our position on commissions becomes obvious.

Commissions: the case against

In order to understand why, let’s briefly revisit the history of manufacturing.

There was a time (before the industrial revolution) when almost all labor was paid on a piece-rate. Piece-rate pay is the manufacturing equivalent of commission. Rather than being paid in units of time, a piece-rate worker is paid in units of output. (A sewer, for example, might receive 20c for each garment processed.)

Today, however, piece-rate pay is almost extinct. (And, I suspect by now, you have a good idea why!)

What happened is that management discovered that, as the complexity of the environment increased, there was a critical threshold beyond which scheduling decisions had to be made centrally.

Of course, beyond this threshold, piece-rate pay had to be eliminated because it drove workers to work as fast as possible and not to subordinate to the schedule. (Remember, because of the combination of dependency and variability you never maximize the output of a system by maximizing the rate-of-work of each system resource.)

Commissions (or any kind of performance pay) are inappropriate in the reengineered sales environments described in this book for exactly the same reason that piece-rate pay is now inappropriate in manufacturing environments.

And this conclusion does not just apply to the sales function in isolation. As we discussed in Chapter 4, in many organizations it is not healthy for sales to be the organizational constraint. So, in these cases, irrespective of the structure of the sales function, the organization as a whole will perform better when sales is not operating at 100% utilization.

I wish this could be my last word on that subject. However, there’s a number of persistent objections to my position that we must first put to bed:

1. Ours is a mixed environment: salespeople are not fully autonomous – meaning that a mix of salary and commission is justified
2. Even if we don’t need the compensation plan to determine salespeople’s rate of work, we still need performance pay to maximize salespeople’s quality of work (in other words, without commissions, what would motivate salespeople to actually sell?)
3. Commissions enable us to mitigate against the uncertain nature of salespeople’s performance and keep costs under control
4. The theory may make sense, but good salespeople will simply not be prepared to work in an environment without commissions

The fallacy of a mixed environment

I’ve heard many executives argue that it’s beneficial for their salespeople to be partly autonomous. But I’ve never heard anyone argue that it’s beneficial for salespeople to be partly team members.

Perhaps it’s because the latter phrasing exposes the folly of this position!

I’ve already stressed that it is impossible for salespeople to be team members and autonomous agents at the same time. However, an astute reader might argue that this is possible in theory (if not in practice).

Your salespeople can be capable team members and operate autonomously if (and only if) the rest of the organization has the capacity to subordinate to individual salespeople.

At first glance, this condition may not appear to be particularly onerous. However, when we consider the enormous variability in salespeople’s output, we recognize that effective subordination would require a huge amount of redundancy in customer service, engineering and production. (Remember, we’re considering true sales here, not repeat transactions.)

The fact that this is commercially unrealistic in most organization tends not to stop management from pursuing a mixed sales environment. And, the consequences are as unpleasant as they are predictable:

1. Management encourages salespeople to operate autonomously
2. Salespeople proceed from the assumption that more sales is always better (the tacit assumption is that the rest of the organization can keep up)
3. On average, the sales team as a whole sells less than the organization has the capacity to produce
4. However, because new accounts are won infrequently (after all, salespeople spend the greater majority of their time processing transactions), the load on the rest of the organization is irregular
5. On the (not infrequent) occasions that customer service, engineering or production does not have the capacity to honor commitments made by salespeople, on-time performance tends to be compromised (although, the commitments that have been made to new accounts are often met, at the expense of existing ones)
6. Periodically, management attempts to improve the financial performance of the organization with additional incentives and special promotions
7. These incentives tend to increase the lumpiness of the deal flow – meaning that, over time, peak sales increase, at the expense of average sales

The bottom-line is that contradictions cannot persist indefinitely. Your salespeople cannot be both autonomous agents and team members. They cannot be responsible only for sales outcomes and simultaneously be expected to attend sales meetings and maintain the organization’s CRM. And customers cannot belong to both salespeople and to your organization.

Commissions and the quality of work

If salespeople don’t have the opportunity to earn commission, then why would they sell?

I wish I had a dollar for every time I’ve been asked this question by an incredulous executive. You would think the onus should be on the defender of performance pay to present an argument.

After all, receptionists answer the phone when it rings, in spite of the fact that they receive no incremental pay. Your financial controller does a good job of paying bills on time, in spite of the fact that they receive no rebate on each check signed. And even senior executives perform important tasks, absent special incentives (I’m assuming that no one is paying you to read this book!).

Why should salespeople differ from almost every other worker on the planet?

The answer to the question four paragraphs above is simple: absent the opportunity to earn a commission, salespeople will still sell because they are salespeople. (Just as receptionists answer the phone because they are receptionists.)

I often wonder if those executives who ask that question are really enquiring into the motivation of their team members or if they are providing an (unsolicited) insight into their own pathology!

In Drive, his excellent best-seller, Daniel Pink presents a powerful case against performance pay. His conclusion – backed-up by many experiments from the social sciences – is that external rewards retard the performance of knowledge workers and have a positive effect only in situations where workers are performing mindless, repetitive tasks.

In other words, if your team members are responsible for activities any more complex than licking stamps, the work itself is their reward.

Interestingly, Pink’s conclusion points to an interesting defense of performance pay in the traditional sales environment. Consider these two points:

1. In most environments the volume of sales appointments has a far greater influence on sales output than the qualitative performance of the salesperson
2. In almost all environments, salespeople generate their own appointments as a result of mindless and repetitive prospecting activities (internet research, cold calling, etc)

With these points in mind, commissions may be defensible in traditional sales environments, not because they motivate salespeople to sell, but because they motivate them to prospect!

Of course, in our case, this argument is moot because we are definitely going to free salespeople of the requirement to generate their own sales meetings.

Commissions as a hedge against non-performance

The obvious problem with the argument that performance pay provides management with a hedge against the costs associated with salespeople’s non-performance is that the same argument could be applied to everyone in the organization.

But, then sales is a special case for a couple of reasons:

1. The performance of salespeople is highly variable
2. It is easy to isolate the contribution that a salesperson makes (this would not be so easy in the case of a line worker)

As we’ll discuss shortly, SPE inverts these two reasons:

1. The output of the sales function ceases to be highly variable
2. While it’s easy to measure the capability of a salesperson, it is difficult (if not impossible) to isolate the contribution that person’s activity make to the organization as a whole

First, however, let’s consider the wider (and more terrifying) implications of performance pay.

Management abdicates

We’ve discussed earlier that you cannot manage an autonomous agent (these two concepts are antagonistic). Performance pay makes this contradiction explicit! In other words, when a significant component of a salesperson’s pay is performance based, management has formally abdicated its responsibility for sales.

In so doing, management has telegraphed to salespeople that selling is optional! It is now up to individual salespeople whether or not they generate sales – and in what quantity.

If a salesperson is capable of selling, the real cost of their non-performance is not their salary, it’s the profits that the organization does not earn when production is sitting idle!

If a salesperson is not capable of selling, the real cost of their non-performance is still not their salary, it’s the sales opportunities that are lost that could have been won if they were attended to by a more capable individual.

Variability diminished

If sales appointments are the primary driver of sales (and it’s rare that they are not), we can significantly reduce the variability of sales by:

1. Fixing the volume of sales appointments (the same number of appointments, week after week)
2. Increasing the volume of appointments (as the appointment volume increases, the variability of the entire sales function reduces)

Of course, our standard model does this by ensuring that salespeople do nothing other than sales appointments and by ensuring that each salesperson performs ten-times the volume of appointments they would perform in a typical sales environment.

Capability

Many of our silent revolutionaries report an increase in salespeople’s capability. There are three contributing factors here:

1. Predictably, when organizations reduce the size of their sales teams, they retain their more capable salespeople
2. When salespeople do nothing other than sell – four appointments a day, five days a week – they get good at it (or they rapidly conclude that sales is not the right career for them)
3. With control over salespeople – and with accurate and current data – sales management finds it easy to institute a process of ongoing improvement

Salespeople’s position on commissions

If there’s one thing I’ve learned in the last 10 years or so, it’s that sales managers are uniformly terrible at predicting their salespeople’s reaction to our standard model.

Almost without exception, sales managers predict outrage from their team members – perhaps even a mass exodus of talent! And the one component of our model sales managers predict will be the most offensive is the elimination of commissions.

In reality, salespeople’s reaction to this proposition tends to be shocking for exactly the opposite reason. It’s shocking how comfortable salespeople are to give up both their autonomy and their variable compensation plan!

The reason salespeople tend to be so compliant is very simple.

Salespeople (contrary to popular opinion) do not live in a parallel universe. They are a part of the same dysfunctional reality that is causing the rest of the organization (including management) so much pain.

Salespeople may have different theories about the source of their particular set of issues – and they may propose different initiatives as a remedy to these issues – but, when presented with the evidence, salespeople recognize (often faster than management) that a significant number of sales problems, production problems and management problems can be tracked back to the same root cause (their autonomous mode of operation).

And make no mistake; salespeople have more than their fair share of complaints:

1. They hate the volume of clerical and customer-service work that prevents them from engaging meaningfully with potential and existing customers
2. They don’t enjoy spending their evenings in hotels entering data in the CRM, generating expense reports and writing proposals
3. The resent the continual conflict over the allocation of commissions (particularly when accounts span multiple territories)
4. They hate having to advise clients that their promises will not be met – and they resent the fact that they have to live with the continuous uncertainty over production performance
5. They don’t enjoy the underlying – and constant – conflict in their relationships with production, customer service engineering, management and even finance

It may be true that salespeople are in love with the notion of the salesperson as a lone crusader, but salespeople are also realists. They quickly recognize that, on balance, the proposed environment will be infinitely more rewarding to work in.

Sure, they sacrifice their autonomy but, so what? They each get a dedicated executive assistant (sales coordinator) who will free them to do nothing but sell.

And sure, they have to transition from commission to a salary but, what of it? Salespeople understand that the dynamics of the environment in which they operate rob them of the financial upside they signed-on for. And, the truth be known, salespeople have never been entirely comfortable with the notion that they are innately lazy: prepared only to do the right thing on the promise of an incremental financial inducement.

The new compensation plan

So, it’s out with commissions and in with a new compensation plan.

But there’s not much to the new plan. The idea is simple: we pay people what they are worth (perhaps a little more).

And that’s it!

In practice, you should pay salespeople enough to ensure that compensation is no longer a regular topic of conversation – and then insist that they perform the activities required for the organization to achieve its objectives.

So here, from management’s perspective, is the fundamental difference between the two compensation plans:

With performance pay, we make optimal performance optional – and then we attempt to exert control through a compensation plan that underlines salespeople’s autonomy with every pay check!

With salaries, we take the discussion of money off the table. Salespeople willingly subordinate to a central schedule. And they perform necessary activities because they are asked to (and, because those activities are congruent with both salespeople’s job descriptions and the reasonable interests of the organization).

This new plan, then, is not even new: it’s exactly the same plan we use to compensate everyone else in the organization!

And when it comes to calculating salespeople’s salaries, there are no surprises here either. As with all employees, there are two considerations:

1. Replacement cost (how much would you have to pay for another person with a comparable set of capabilities?)
2. Asking price (how much will you have to pay the current candidate to ensure that the compensation plan is no longer a regular topic of conversation?)

It should go without saying that it would be foolish to propose that salespeople (or any team members, for that matter) take a cut in pay when you transition to this new model.

Most of our silent revolutionaries shift their salespeople to a salary that is equal to, or slightly greater than, their average total earnings (typically judged over a three-year period).

If you think about it, both parties are getting a terrific deal here.

1. Salespeople are receiving a not-insignificant pay rise. Obviously the potential to earn a figure is worth nowhere as much as the same figure, guaranteed.
2. Management is increasing the volume of effective work performed by each salesperson by ten times. To achieve the same increase in a typical sales environment, management would have to add nine more salespeople for every one they currently employ! In the new model, the cost is limited to an incremental increase in the salesperson’s compensation and the cost of a sales coordinator.

The other artificial management stimulants

This debate about commissions is like Hydra (the many-headed monster). You successfully lop-off one head and another appears.

I fear that, even if I’ve done a reasonable job of convincing you that there’s no place for commissions in the reengineered environment, your very next question might be: but, what about bonuses.

My observation is that bonus plans have a couple of problems:

1. Because the bonus is remote from the positive behaviors that drive the desired outcome, the first installment of a bonus is a pleasant surprise and subsequent installments are viewed as entitlements
2. Bonuses suggest to team members that they are responsible for outcomes when, in fact, managers should own this responsibility – accordingly, they tend to dis-empower managers

It is certainly true that some degree of variability is required where compensation is concerned. However, my position is that standard salaries provide the necessary flexibility. As your team members become more capable, their market value increases, meaning that you are obliged to grant them pay rises when (or ideally before) they request them.

I suggest that there is absolutely nothing wrong with the traditional contract between employers and employees. Employees want to be able to perform rewarding work in a secure environment. If they were really seeking uncertainty and boundless riches they would not have signed-on to be employees in the first place.

The other stimulants (targets and quotas) are problematic for the same reasons as commissions and bonuses. They tend to suggest that team members own outcomes.

In a team environment, the team cannot own the responsibility for anything! There is no collective consciousness – only a group of individuals. It is critical, therefore, that the manager owns the responsibility for the desired outcome and that team members own the responsibility only for the activities assigned to them.

Here, a military example is illuminating. Imagine, rather than allocating discrete responsibilities to each of his units a commander were simply to assemble all his troops and exhort them to take Berlin!

Reinventing management

On the subject of management, it’s important to recognize that the transition to a reengineered sales environment is extremely difficult for sales managers.

As a result of this transition, sales managers find themselves in a position where down is up and up is down. If sales managers were to refer to a list they had compiled before the transition of everything they know for sure about sales, almost every statement on that list will now be false.

Consequently, it is not sufficient to reengineer the general sales environment. You must also rebuild from scratch the sales manager’s method of operation.

* * * *

You now have a sound understanding of the theory that underpins Sales Process Engineering. Part Two of this book will show you how to convert all this theory into practice.

Hi Justin

Just wanted to ask if you’ve designed a way of managing the sales budget of a company.  In other words, how to review if the salespeople are meeting the budget or not.  Most companies are affected by the end-of-the-month syndrome, and at the same time, salespeople – once they meet that month’s budget – are not interested in selling more.  They’d rather stay still and avoid cannibalizing next month’s sales.

Thanks
Alejandro

 Here’s my response:

Alejandro

Good to hear from you!

Here are the two steps we take to eliminate these problems:

Eliminate monthly budgets – in favor of a T/cu type measure (Throughput per appointment-slot-consumed).

Eliminate commissions. Pay people what they are worth and make performance compulsory.

Justin

Alejandro’s question was a reminder of just how dysfunctional most sales functions really are. His email set me thinking: why have managers (us) historically designed the sales environment this way.  (Presumably, it’s not because we’re daft, or ill-intentioned.)  Among the assumptions that underpin the design of the sales function, there must be some that are false … what are they?

Three fallacious assumptions

Here are some assumptions that I suspect will fail to emerge unscathed from an exposure to reality.  Feel free to critique my selection, or suggest your own.

Salespeople should be responsible for sales. Really? In how many organizations do salespeople actually have significant control over sales? What percentage of your transactions are the result of your salespeople:

1. Originating their own opportunities (as opposed to responding to an inbound enquiry)?
2. Prosecuting these opportunities single handed, without assistance from engineering, estimating or management?

If salespeople aren’t responsible for generating the greater majority of sales (all by themselves), wouldn’t it make more sense to hold them responsible for just the activities that they actually do perform?

Of course, in our model, we have salespeople performing only business-development meetings – nothing else.  (Marketing originates opportunities, project leaders design solutions, etc). This means that they are accountable for only what they do in these meetings.  “Sales” is management’s responsibility.  Just like “production” is the responsibility of your production manager – not a lathe operator or a claims processor.

Monthly is a sensible measurement frequency for sales. It’s true that we calculate our profitability monthly. But does it follow that all internal processes should also be measured just once every 30 days.  Consider your on-time-delivery performance, for example: should you stop and calculate this just once a month? Of course not. It should be calculated for every delivery.

We calculate profitability monthly because profitability is the consequence of a number of events that occur at different frequencies (and out of synchronization with one another). A more frequent calculation would probably generate less information, not more.

If the responsibility of the salesperson is to maximize the velocity of sales opportunities (and, yes, it should be) – and, if the salesperson’s effort is expended in discrete packets called appointments – why wouldn’t we calculate the progress of each opportunity, relative to each appointment?

As with on-time-delivery performance, you may choose to view the resulting number in the form of a rolling average, but that doesn’t alter the fact that the relevant time-horizon for the activity in question is an appointment slot, not a month.

Commissions drive positive behaviors.  I had lunch with a director of a large (publicly listed) technology company in Sydney the other day. After hearing my position on salespeople and commissions, he asked about the negative consequences of eliminating commissions (replacing them with salaries).

I answered his question – as I usually do – with my own question. I asked him if he could first detail the positive behaviors, exhibited by salespeople, that he would be comfortable to attribute to the existing commission plan.

As usual, this question (an innocent one, I’m sure you’ll agree!) was met with a silence you could cut with a knife. He admitted that there were no positive behaviors – only negative ones! And he concluded, of his own volition, that it was probably more appropriate to try and find a justification for the existence of the commission plan than it was to look for a reason to not eliminate it.

As I’ve suggested before, if sales are important for your firm, I suggest that you identify the critical behaviors that contribute to sales, and then make them compulsory (commissions signal to salespeople that these behaviors are optional).

Please comment.

As the economy slows, it’s likely that your firm’s order flow will slow too.

But, does it really need to?

For you to answer this question in the affirmative, two conditions need to be in place:

1. Your share-of-market needs to be considerable
2. Your sales function needs to be operating at (or close to) optimal efficiency

So, think about it. Do these conditions hold true for your organization?

I suspect not. It’s likely that your marketshare is much less than 50%. And it’s highly unlikely that your sales function is operating at anywhere near optimal efficiency.

To validate my second claim, have your sales manager examine your salespeople’s calendars and determine the number of true business-development appointments performed by your salespeople last week (it should be 15-20 each).

If these conditions do not hold for your organization, the implication is exciting. In theory, at least, it will be possible for you to maintain your order flow in these tough times, provided that:

1. You can improve the performance of your sales function to the point where you can secure enough new accounts to compensate for any contraction in sales
2. You can do this without increasing your marketshare to unrealistic levels

An action plan (five simple steps)

With this encouraging thought in mind, let’s consider an action plan for coping with these tough economic times.

Step one is to estimate how many appointments (in aggregate) you believe it is possible to generate for your sales team each week.

Remember, that the number of appointments you can generate is primarily a function of the appeal of your market proposition. A client of ours in Kentucky just eliminated a problem with appointment-setting by writing to clients offering them $500’s worth of free merchandise. This offer was commercially viable because the value of new accounts was high and because the firm had under-utilized fulfilment capacity. This appealing proposition caused the number of prospects who accepted appointments when offered to increase from less than 1:20 to more than 1:3!

Step two is to determine the optimal size of your sales team. This is simply the number of appointments you can generate each week, divided by 20 (each salesperson’s future capacity).

Step three is to figure out how to remove all activities from salespeople, other than field-based, face-to-face, business-development appointments.

So, activities that must be re-routed elsewhere include opportunity generation (promotions), appointment setting and calendar management, solution-design and proposal generation, customer service and all fulfilment-related tasks.

Step four is to reconfigure your resourcing model. It’s likely that you will discover that you need far fewer salespeople (even considering your increased appointment numbers) and more sales-support personnel.

Our approach to resourcing is to provide each salesperson with a dedicated sales coordinator (who manages opportunities and plans his or her calendar) and then route all other activities to a promotions person, customer-service personnel and technical experts who provide salespeople with field support.

In most cases it is possible to accomplish this reconfiguration with a negligible (if any) increase in operating expenses.

Step five is to eliminate bonuses and commissions.

If you’ve been waiting for the right time to eliminate this caustic practice, a down economy is such an opportunity.

While performance pay makes sense in environments where salespeople are truly autonomous, these environments are few and far between.

As organizations transition to make-to-order (or engineer-to-order environments), the requirement for tight integration between sales and fulfilment becomes critical.

Tight integration necessitates team work, and performance pay for individuals destroys the integrity of teams.

Furthermore, performance pay:

1. Signals that optimal performance is optional
2. Causes your sales function to become more costly as it operates more efficiently

The bottom line

Typically, when we implement these five steps in organizations, we increase each salesperson’s activity level by 10 times. However, in most cases, we also reduce the size of the sales team.

A typical net result would be twice the volume of true business-development appointments, with minimal change in operating expenses.

If your current marketshare provides you with room for growth, this is a strategy worth considering in these slower times.

We recently published a document detailing three common scenarios: the application of SPE to different sized firms and it’s implications for sales activity and operating expenses.  If you don’t currently have a copy of this document, send me an e-mail (justin.roffmarsh@ballistix.com) with "Scenarios" in the subject line.

First time in Latin America.  First time presenting via a translator (it worked effortlessly).  And first time I’ve tipped more than $1,000 in a restaurant!  (1,000 pesos equals just $US0.50.)

But there was one experience yesterday that I’m well and truly used to: the reaction of workshop delegates when they determined that we recommend eliminating commissions and paying salespeople salaries.

I didn’t present our position on this explicitly — after all, it’s a secondary consideration, not the primary that everyone assumes it to be.  But our position was inferred and it didn’t take long for delegates to put two and two together.  So when one delegate eventually summoned up the courage to have me confirm that this is, in fact, our position, the room descended into pandemonium.  (A very noisy, animated, ‘Spanish’ kind of pandemonium!)

I want to share with you the three points of clarification I made last night, relative to this issue.

(Oh, and by the way, if you don’t know, I’m currently in Bogotá, Columbia, presenting at the first regional (Latin American) TOC conference (TOCICO)).

Here are those three points of clarification:

1. As I mentioned above, the salesperson’s compensation is not a primary consideration of SPE.  The key question is: does it make sense for sales to be performed by autonomous agents or by team members?  How you compensate your salespeople is a natural consequence of your answer to this question.  And this issue is not peculiar to sales.  If you have  a plumbing contractor visit to fix a leaking tap, you will compensate this person on a piece rate (commission).  However, if you have a large facility, with enough plumbing work to necessitate employing a full-time plumber, you will almost certainly convert this person from piece-rate to a fixed rate of pay (salary).
2. In line with point (1) above, you cannot and should not convert existing salespeople in a traditional sales environment from commission to salary and expect an improvement in performance.  You must first — if you deem it appropriate — change your basis of engagement with your salesperson (they must willingly give up their autonomy and become a part of a tightly integrated team).  Second, you must replace your laissez-fair approach to management with a formal management structure — a structure that gives you control over the activities performed by salespeople and (of course) visibility of the relationship between those activities and the results they generate.
3. Point three is a bit of a reality check.  The reality is, if you put a salesperson on commission, you have given that person permission not to make sales!  In other words, you’re telegraphing to that person that the consequences of him producing less his optimal output is simply an incremental reduction in his take-home pay.  Why would you do this?  Why would you make it optional for salespeople to sell?  What is the (opportunity) cost to your organization of those prospects who aren’t visited and those contracts that aren’t signed simply because your salesperson is comfortable to earn (say) $100k a year (as opposed to $115k).

If you had a plumber on salary, you would not make it optional for this person to fix leaking taps.  It would be an expectation.  If he chose not to, he would be risking his entire salary — not just the potential to earn an extra dollar or two.

If sales are important to your organization, why would it make sense to treat your salesperson any differently.

Performance should not be optional.

The case for performance pay

Let’s envisage a situation where performance pay definitely makes sense. The situation that springsto mind immediately is outsourcing — or more generally — the use of contractors. If you have outsourced a task to a contractor, it makes sense to compensate that contractor on a per-piece (or results) basis. Because you are outsourcing, you have no control over the contractor’s production process (you can consider only inputsand outputs) and, as a consequence, it doesn’t make sense for you to gamble on something over which you have no control. Most organisations understand this explicitly.  This is why most contractors (including service providers) are under pressure to quote on a fixed-price — rather than a time-and-materials — basis. Now, if you consider the structure of a typical sales process (as discussed in the preceding article), you’ll realise that the relationship between the salesperson and the organisation is more similar to a contractor-clientthan it is to an employer-employee relationship:

1. Salespeople are responsible for the end-to-end sales process.
2. Management has limited (if any) access to objective process data.
3. Salespeople perceive that they own customer relationships (and in many cases they do!)

In this environment, it certainly does make sense to pay salespeople as you would a contractor. But, as you well know, we maintain that this isnot an ideal environment. What we now have to consider is how the radically different environment we advocate impacts on the case for performance pay.

The ideal environment

In summary, the essential differences between a typical sales process, and the process we advocate are as follows:

1.  Salespeople are responsible only for the conduct of (sales) appointments.
2. All other tasks (including the sequencing of salespeople’s appointments) are allocated to a sales support function.
3. Sales process management decisions are subordinated to the organisation’s constraint.

If you consider the first two points above, it’s obvious that we are no longer outsourcing the sales process, in its totality, to the salesperson. In fact, we have simplified the role of the salesperson to the point where he performs only one task (appointments*).  As well as increasing (massively) the productivity of the salesperson, the elimination of multitasking provides management with the ability to micro-manage the salesperson. The thing is, if a salesperson performs one simple task, over and over, management now has access to a statistically relevant quantity of objective data. This data-stream is the critical feedback loop that enables a process of continual improvement. Now that the salesperson can be measured and managed intelligently, the case for performance pay is no stronger for the salesperson than it is for any (and every) other employee. Which, of course, raises a very interesting question: wouldn’t it make sense to provide every employee with performance-based compensation? Our consideration of point three (above) exposes the first of two fatal flaws in this common argument.

Fatal flaw one: the optimum is rarely the maximum

If you consider most performance-based compensation programs, their operation is simple.  Employees’ pay is linked (directly or indirectly) to their productivity. Accordingly, the harder an employee works, the more he earns. This approach assumes that incremental increases in employee productivity are necessarily good for the organisation. Sadly, this assumption is dead wrong.  The fact is, in any process, incremental productivity improvements in only one resource will impact on that process’s output.  (This critical resource is the process constraint.) Productivity improvements elsewhere will have either no positive impact, or even a negative impact, on process output.  (I’m referring now to non-constrained resources.) Consider a simple organisational process consisting of the following sequence of activities (each performed by a separate resource):

1. Promotion (the generation of sales opportunities).
2. Sales (the conversion of sales opportunities to orders).
3. Fulfilment (the fulfilment of these orders).

If you were managing this fictitious organisation, would you be likely to exhort the people responsible for these resources to produce at their maximum possible rates? I hope not! Presumably you’d recognise that there is no benefit in Promotion producing sales opportunities that Sales can’t process.  And, similarly, there’s no benefit in Sales generating orders that Fulfilment can’t fulfil. To provide each of these individuals with a financial incentive to produce at maximum (individual) capacity will waste resources, unnecessarily inflate expenses, generate chaos and damage customer service. It’s for this reason that the third attribute of an ideal environment (above) is that sales process management decisions are subordinated to the organisation’s constraint. What this means is that the output of the various resources within our process should be synchronised with the maximum sustainable capacity of the process constraint. Performance pay is likely to have the exact opposite effect.

Linking global rewards to global objectives

Now, if you think about it, the flawed assumption that incremental increases in employee productivity are necessarily good for the organisation does not have to ring the death knoll for performance pay. It’s possible to envisage a compensation program that links local rewards to global optima. For example, you could:

1. Only reward team members at the process constraint for incremental increases in output.
2. Compensate team members at non-constrained resources for maintaining optimal (rather than maximal) output.

Now, this (smarter) approach to performance pay overcomes the sub-optimisation* problem.  It does, however, introduce two questionable assumptions of its own — and it fails to address the second fatal flaw in the argument for performance pay! Let’s consider the two assumptions first. The first is that the process constraint will stay in the one location.  If it moves (and from time to time it will), it will be necessary to reconfigure your compensation program.  You will inevitably find yourself having to explain to team members at the prior constraint that they must now satisfy themselves with a lower rate of pay (this is particularly challenging when the team members involved are salespeople!). The second assumption is that it is beneficial for team members at the constraint to strive for maximum output.  The reality is that what you want is not maximum output but maximum sustainable output.  While it sounds like a heroic endeavour, the pursuit of ’stretch goals’ increases volatility and decreases average output.* It’s time now to unveil performance pay’s mostinsidious flaw: the assumption that pay drives performance.

Fatal flaw two: pay does not drive performance

At first glance, the assumption that people will work harder in the pursuit of a greater income looks innocent enough. After all, a donkey will chase a carrot, won’t he? Well he will, until he’s replete!  From that point on, the donkey has no interest in the carrot whatsoever. In our experience, team members’ desire for additional money subsides rapidly once they are earning what they believe to be a fair market rate (assuming, of course, that their basic needs are met by that level of income). Furthermore, team members value the security of a fixed income more than they value the possibility of a higher (variable) income. But — and I’m asked this question often — don’t we want our employees to be entrepreneurial? The answer is ’no’.  We don’t.  As suggested previously, we will destroy our organisations if we turn them into a loose cooperative of contractors — all taking risks in the pursuit of a profit (this is, after all, the definition of ’entrepreneur’). We want our organisations to be tightly synchronised, highly efficient and totally predictable.  The donkey-and-carrot method of compensation is totally at odds with this objective.

Market rate plus some

Now I’m not suggesting that the elimination of commissions should result in a drop in your team members’ average rates of pay. In fact, I would expect the opposite to occur in many cases. But I am prepared to suggest that, along with performance pay, we should eliminate the notion that performance and pay should be directly linked. A better method to apply to the calculation of salary is to estimate the replacement cost of an employee. This replacement cost should consist of the market rate for a person of comparable capability, plus a premium for the inevitable switching cost you would incur if you were to lose that team member. You’ll find that this method provides a simpler and more rational basis for setting and renegotiating salaries.  Obviously this method will result in an indirect link between productivity and salary (more productive employees will have a higher replacement cost). You’ll also find that the offer of a good fixed salary (in place of the promise of untold riches) will result in a greater number of better quality respondents to your employment advertisements; particularly when you are recruiting salespeople!

A caveat

It’s important to highlight that the elimination of performance pay is contingent upon the successful reengineering of the sales process. If your sales process (or any other process) is intelligently designed and objectively managed, the retirement of performance pay is likely to be a logical and painless eventuality. An attempt to reengineer a traditional sales process that begins with the  heavy-handed suspension of performance pay is likely to have unpleasant consequences.