Redesigning sales compensation in merchant wholesaling 

Part 1 in a series by Scott Benfield

“Many wholesalers think if they change the comp plan, sales will magically go up. We call this talk miracle results for under-qualified sales managers.”  Wholesale executive

Many wholesalers are frustrated with the lack of punch in sales and profits delivered by compensation changes. Therefore, they’ve become disillusioned and some have given up hope that changing compensation plans is an effective ingredient to improve the business. The purpose of this series is to review wholesaler compensation today and to offer methods to redesign sales compensation systems.

Wholesaler sales compensation is woefully out of touch with the dynamics in the marketplace, channel cost structure, and financial goals of most companies. In short, only a complete redesign of compensation can effectively increase sales and profits. Of course, this means compensation will take on added complexity. However, a few simple rules and ideas provided in this series should serve most distribution executives well in their efforts to make changes in compensation.

Why sales compensation is out of touch
Compensation systems, in distribution, have been relatively stable for many years. The changing markets will demand changes in compensation as new and different models of outside sales need differing methods of payment. 

On the whole, distribution compensation systems are out of touch because:
• Compensation often doesn’t support the strategic goals of the firm.
• Compensation causes as many bad behaviors as it does good behaviors.
• Compensation doesn’t address channel cost and efficiency issues demanded by customers.
• Compensation doesn’t always consider seller tenure, product dynamics, and segment dynamics as drivers of compensation design

This series will explore these problems in separate installments and will offer several compensation models to consider. This first installment offers a brief rationale for the out-of-touch argument and insight to future subjects.

Compensation doesn’t support strategic goals of the firm
This series will concentrate less on base salary issues and more on pay-at-risk (PAR). Pay-at-risk, often named bonus or variable compensation, is used to motivate or reward a particular behavior(s). Too often, PAR is not congruent with a firm’s strategic goals. At-risk pay should reward results and actions or learned skills to get results. Many executives simply pay for sales and profit growth without defining the behavior to achieve that growth. When this happens (and it does quite often) it causes unanticipated surprises, including unprofitable and sometimes unacceptable means used to justify the ends of the pay at risk.

An example is the growing problem of salespeople giving away services to consummate the product sale. Many salespeople promise value-added services on top of mature products to differentiate their offerings. They promise account-specific inventory, specialized delivery and payment terms to customers to sell the product. Since salespeople are compensated on margin dollars, the cost of these services is not reflected in their pay-at-risk measurement, and the services inflate operating expenses. The company may sell more at lower pre-tax profits since service costs balloon from sales-driven service promises. Part of the solution to the problem is addressing the issue in the compensation system.

One way to guard against over servicing is to identify which services are part of the standard product sale and which are not. Link non-standard services to pay-at-risk. If salespeople use non-standard services to gain the sale, their pay decreases, making them less inclined to give them away.

Sales managers should identify key success factors for the job at hand and place them in management by objective (MBO) or other performance management systems. Rewarding salespeople for accomplishing these objectives should lead to higher sales as they master the success factors.

Many salespeople believe their objective is to get results by any means. Often, the means they use to get the top-line sale leads to poor bottom-line profits from loosely defined and controlled behaviors not linked to pay-at-risk.

Balancing compensation
Benfield Consulting’s surveys of merchant wholesalers find that 75 percent or more of pay-at-risk is based on one measure, gross margin dollars. Using a single measure compensation system doesn’t guard against destructive behavior. In our previous example, giving away valuable services to consummate the product sale is an unbalanced system that rewards destructive behavior. Why? 

Salespeople often give away services to differentiate their offering. These “free” services then inflate operating expenses, which depresses before-tax income. The problem can be alleviated, as explained in the previous section, by identifying and controlling services that salespeople abuse. Part of the solution is creating a balanced compensation system.

Balancing refers to using offsetting or countervailing measures to balance the outcome of a set of behaviors. For instance, since salespeople are paid on margin dollars, they are not charged with increased service costs or the increase in operating expenses. Consider that gross margin dollars can be balanced, in a matrix, with margin percent. As margin dollars go up and the margin percent goes down, the commissions would be lower to guard against price cutting and giving away services.

Another area for balancing margin dollars with margin percent is in limiting price cutting. Weak salespeople are prone to cut price and drive up margin dollars, only to leave corporate shareholders with low earnings. Again, developing a matrix that offsets margin dollars with margin percent on sales can alleviate the problem. In short, the countervailing measure of margin percent balances the single measure of margin dollars.

You can balance compensation plans using any number of methods. For example, you can balance top-line sales with earnings before interest and taxes (EBIT), and margin dollars with margin percent and EBIT. Or, if your salespeople are ignoring key success factors and assignments, balance those negative actions by rewarding salespeople when they accomplish clearly defined objectives.

Single-measure compensation plans are not self-policing control systems. A control system needs inherent checks and balances to safeguard against destructive behavior. In essence, a compensation system should control behavior through offsetting measures that balance efforts to maximize results.

This series will examine several different compensation systems. All of the models will have two or more measures to give balance to the plan. For now, consider that if you have a single-measure compensation system, it likely is unbalanced and you are getting behavior that you don’t want.

Compensation doesn’t address channel cost efficiencies
When a customer’s purchases level off, the salesperson assigned to the account becomes more expensive because the incremental margin from the account moves at a slower rate than the sales call frequency. Generally speaking, research on distribution sales costs suggests a need for reduced capacity in sales forces in the near future.1 As distributors trim sales forces to fit customer demands for a more efficient channel, they’ll need to change compensation plans to direct salespeople to incremental opportunities vs. defensive selling.

Defensive selling is when the sales effort at an account does not show incremental sales and margin growth greater than inflation. It is common in larger accounts where, in traditional compensation plans, salespeople have a significant portion of margin dollars at stake. Because salespeople want to protect their “pot of gold,” their sales effort turns defensive and not offensive. Plus, their call plans typically target the largest accounts, not necessarily the accounts with the most recent gain in incremental growth. Finally, according to research in large accounts, many want total purchase cost reductions including a reduction in sales effort to increase savings in the channel.

These dynamics will force a change in compensation systems to recognize the need for incremental gain at growth accounts. In single-measure margin dollar compensation systems, all margin dollars are the same. Many salespeople confuse large account holdings with growth, when in actuality they are slow to no-growth accounts. Because of their size, a defensive sales posture sets in. Future compensation plans must recognize accounts with a recent history of growth and will differentiate the reward for sales to these accounts compared to stable, large accounts. For instance, instead of paying 25 percent of margin dollars for all revenues, sales managers may want to compensate a higher percentage, say 30 percent for growth accounts and 20 percent for low to no-growth accounts.

Also, margin dollar compensation systems cause many salespeople to horde small accounts, which deliver negative activity profits. Compensation systems must identify account thresholds and limit payouts on small accounts that don’t offer significant growth in a year or two. Again, the overriding problem is that all margin dollars are not the same, and well-designed compensation programs send the salesperson to areas where incremental gain is most probable. In turn, this will lower channel costs and give distribution the productivity it needs.

Compensation doesn’t consider product, 
segment and salesperson dynamics
The one-size-fits-all compensation systems based on margin dollars don’t fit the differing dynamics of salesperson ability, product life cycle, and the strategic importance of different segments.

Salespeople differ in tenure, education, and mastery of product application. Most sales managers change base salaries to recognize these differences, but give little attention to the balance between pay-at-risk and base salary. For instance, experienced salespeople that are long-time employees require higher salaries and low to medium pay-at-risk. Why? It takes a higher base salary to attract experienced people, and experienced salespeople are less likely to put a large portion of their compensation at risk because they have a greater need for steady income. In short, experienced salespeople are at a stage of life with high expenses and low risk tolerance.

Technical ability and advanced education also call for higher base salaries and more lucrative pay at risk. Because technical salespeople are often in high demand, those who can produce command high salaries. That’s why a high base salary and a high pay-at-risk are common in these instances. Salespeople who act as consultants and manage large account relationships are the most common recipients of high base/high pay-at-risk salaries.

The dynamics of the product life cycle also influence compensation. For salespeople who primarily sell mature or declining products, salaries tend to be lower than those who sell new products with new technologies. Often, salespeople work under identical compensation plans regardless of the products they specialize in. As a result, the mismatch creates friction and unnecessary loss of salespeople. With new product technology that may take a long time to develop, it makes no sense to offer a low base salary/high pay-at-risk package. Why? The salesperson reaches the payout only after spending considerable time developing a user base for the product. Most will starve and quit before investing several years of missionary sales to get the product sold. It makes more sense to develop a high base/low pay-at-risk package until the product becomes well known to an established user base.

It’s necessary to understand the mix of products salespeople are responsible for in order to design an appropriate compensation package. The typical geographic territory isn’t useful when developing a compensation package specific to a salesperson or product. Geographic territories try to maximize efficiency by reducing the driving time between calls. Geographic territories too often mute the product/seller ability/segment dynamics that influence the design of the sale position. While all territories have a geographic component, sales managers increasingly realize the “splat” strategy of throwing salespeople in geographic territories (they go splat upon impact) is inefficient and ineffective.

Segment dynamics also play a part in designing the compensation plan. Reward salespeople for sales to accounts in segments that are growing and that have strategic importance.  Limit pay-at-risk for sales to accounts in segments of little importance. You can also address segment needs by developing a segment-based sales force, but you’d also need to change compensation to recognize the growth and profit dynamics of the segment.

Increasingly, sales managers are realizing the need to have varying compensation plans and solicitation methods by segments. Those who work with a segment logic are largely rewarded with better sales and profits with less effort.

Future topics
Future installments in this series of articles on Redesigning Sales Compensation in Merchant Wholesaling will explore the need for new and varied models of compensation. The drivers of the new compensation models will be market needs and the strategic thrust of management. The dominance of margin dollar compensation coupled with the one-size-fits-all geographic territory doesn’t sufficiently differentiate the sales effort for varied segment and customer needs. Only by challenging today’s compensation systems can sales managers deliver the productivity customers demand and still produce the top-line growth demanded by shareholders.

Our next installment will discuss the Performance Cycle and its influence in designing the compensation plan.

Scott Benfield is a consultant for merchant wholesalers in business-to-business markets. He is the author of three books and dozens of articles on industrial marketing and sales. He can be reached at or .

1 See Benfield Consulting Articles at www.progressivedistributor.com, “The Quest for Productivity, Valuing the Outside Sales Effort.”

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