Sales Commissions - Based On Revenue Or Profits?

Sales commissions can be based on revenue or profits.

What do you do? What do you think is best?

Here's a contrast of the pros and cons for each:

Based on Revenue

Pros: Simple and immediate. If the sale is $100,000 and commission rate is 5%, pay $5,000, worst case when payment is received typically 30 to 90 days after.

Cons: Tolerates and even encourages over-selling and unrealistic expectations as sales person has no financial risk if sale becomes a problem. Can also blame engineering for not delivering.

Based on Profits

Pros: Ties sales person's compensation to company's overall bottom line. Disincentives lying / over promising.

Cons: Lengthy and significantly out of control of sales person. A project could take many months or a year for completion, to determine how profitable it was. More importantly, the failure could be on the execution / implementation side, something the sales person will argue they are neither responsible for nor have the time to oversee.

VOTE: What Do You Think?


About 8 years ago I was put on a commission plan as a sales engineer paid on profit at the close of the project. It sounded great, considering how weak the salary was (I especially realize this now). But a couple months after this plan went into effect, we had two of the biggest sales months in company history up to that point, substantially due to two projects which were $800k and $600k.

Awesome! I thought...til I realized that the first one was a four year project and the other wouldn't be done for about 18 months. After nine months on that plan and all of $700 in commission I asked for a different plan.

If salespeople fight for the flexibility to adjust pricing / profit margin to make sales, it just seems fair to me they are commissioned on profits. Otherwise, It is very possible to drive huge revenues but make no profit on any of it.

I guess a salesperson with small commission checks could rightfully blame engineering or installer guys for poor execution, but that smacks of an NFL Reciever trashing his QB for not throwing him the ball enough.

Prima-donnas move on, while others learn to play to the strength / success of the whole team.

TechnoAware's sales commissions are based on revenue.

Surely the Profit-based would be the most balanced choice for the Company, for the correct reasons you wrote: but I agree as well to what you wrote about the countereffects it has.. And surely it might open to annoying disagreements, misunderstandings, if not timely and clearly managed..

About the correctly mentioned overselling risks, I actually always think that the overselling is never only commercial's blame; if it "regularly" happens, it is also because of a certain corporate marketing policy supporting (or pretending not to see...) that.. I mean if an agent or a commercial is overselling a project, creating problems, costs, disappointments, loss of reputation to his/her Company, that Company can decide then to say "bye" to him/her and that's it.... And he/she should just know it....

When a Company trains its commercials and BDMs, the first thing that they could (if they want....) explain to them is their strict policy to tell, explain and sell only what's really feasible for them.. And they must be just convinced that it is always the best commercial strategy to earn more themselves, for a middle-long-term vision relationship. I mean for them and for the Company's marketing in general.

As I always say to our Agents and BDMs around the world, "I prefere to lose a project, but to gain 2 Partners!.."..

In this case, I think revenue-based commission is the most simple and clear to manage.

Cheers,

Simone

(TechnoAware)

When I was an integrator, for the video and intrusion side of the business, they paid the reps on % of gross margin. The other side of the business was EAS and benefit denial which paid on revenues.

There was a sliding scale that went as high as 10% if margin was over 45 pts. In theory this was supposed to "reward" the reps for margin. In reality the math didn't add up. Easy example is a $100K sale at 45 pts would be a $4,500 commission. At 5% of revenue in the same sale the commission is $5,000.

And No deal ever sold at 45 pts. - Most in a competitive environment went around 30 pts. or less. The other thing they did to the reps was on deals was not assign the margin % until after ops had secured the subs who would pull the wire / hang the cams. So a deal you may have "sold" at 30 pts. would come in at 28 if the sub didnt take $55 per hour.

The real hilarity was they told all the reps this was the "industry standard" and how almost all reps were paid. Now that I've been on the manufacturers side, I see that was total bullshit as almost all we work with are paid on revenues

The company I refer to was spun off by the parent company for pennies on the dollar

IMO, you have to compensate sales people based on things under their control, which leads to revenue-based commissions predominantly.

With that in mind, there is usually a max discount % that a sales person can extend to a customer, then they have to get upper level approval and so on.

Products should be priced and sold with a margin that enables a business to be profitable, or at least viable. Sales people shouldn't need to think about profitability, that is essentially baked into the product price. Much of what happens as it relates to profitability is out of the sales persons direct control.

What determines "profit"? Is that above the line raw markup on COGS, or bottom line "leftover cash" after all operational expenses are covered?

I don't recall ever hearing of a real successful profit-based comp structure in any normal company.

Good feedback. I would think it would relatively easier for a manufacturer to do profit, or at least projected gross margin commissions, than an integrator.

The rationale being that most manufacturers have a low labor component, limiting the amount of downside whereas, with integrators, labor overruns from poor designs, misrepresentations, etc. can expose them to huge financial risks.

John - is your question regarding integrators or manufacturers?

Both. I'd be interested in your experience on both sides and if they differ substantially across the two.

I can see how there would be a bunch of animosity towards the sales guy in a revenue based commissions model. This model completely removes the incentive to "get it right." It removes any responsibility for the sales person to ensure the project is profitable. Sign me up!

I can only speak for the few integrators that I have worked for, but I understand the profit based commissions model to be the most common, at least in my market. I have not heard of another integrator that pays based on revenue. Perhaps manufactures?

Sure, it takes some time to build up a sales bank due to the progression payout (pay when paid), but it also insulates the sales professional from the inevitable peaks and valleys of their funnel. It also promotes longevity - most commission plans are written such that when you leave the company (voluntarily or involuntarily) you lose any commissions that have not been paid.

Cheers!

Mike

All of the National Integrators I work with pay on Revenue.

All of them have a spreadsheet or sales tool they plug the components into, along with wire runs which then generates the labor estimate. This tool will also shopw margin for the job. All of these companies have a bottom line margin (usually 30%) the rep cannot go below without authorization from upper level management

That authorization usually comes with a reduced commission % as well

So revenue based until you start giving it away, then it becomes an ad-hoc mgmt calculation of revenue - profit lost?

No corresponding upside on extremely profitable deals, aka gouge bonus?

Rukmini -no upside for higher margin in revenue based model However, you have to remember that most deals now have multiple quotes even if they are not a formal RFP. This really eliminates most of the gouging that used to see. For the reps, some companies used to do accelerator plans which increases the commission % by couple points once the annual goal is met. I don't know if that's still used today

Well I can think of a major national player that you are not working with.

I'll respond by telling a story. A few years ago, I sold a 7-site project to the same end user. The total sale was close to $4M. There had been some "optimization" done at about that time, which basically meant getting rid of junior project managers, lead technicians, administrative persons, and so on. For the first six months or so, the project manager didn't show up to a single project meeting. I showed up to all of them. I directed subcontractors, coordinated with other trades, personally watched fiber being tested, and so on. I had no authority to do any of this, but I did it anyhow, because it needed to be done. When there was something I couldn't get done "unofficially," I'd walk into the project manager's office, and tell him what I needed, or deal with the admin, or whomever I needed something from. I felt like I deserved an honorary PMP certification for doing nothing officially, but getting it all done. The project rolled along fantastically, with me directing subcontractors and interfacing with the end user and other contract mechanisms, holding meetings, making sure everything went well. About the six month mark, the project manager showed up to a project meeting, without a notebook (I won't go on a diatribe as much as I'd like). The projects were expected to take 3-9 months to complete, depending on the site. The smaller sites were complete. I went to work for a different company. From what I've heard, talking to people still at the company, about three years after the projects began, the two large sites (accounting for about $1.7M) were not complete, and the company had basically walked off the site and left quite a bit of work undone. Everything was going smooth when I was there project managing things as a salesperson. Apparently they were not after I left.

I was paid on "expected profit." The way that works is that I put together a booking package, which includes all parts and pieces, the basic project plan, and so on. I ended up doing MS project schedules and other things after that, but the basics are parts and pieces, setting up turnover, and you're "supposed" to move on at that point and go sell other things. Based on this package, the project manager signs off saying that they agree that the project makes sense as presented. They're supposed to ask questions or concerns, do engineering with techs, VE everything, and so on.

The profit margins were good. I went to grad school for IT management. Everything was straight.

The job tanked, from what I hear. Not while I was there but after I left.

Word to the wise: Sending a tech to a job that is 1/4 of your entire branch's yearly quota for an hour, then calling them to do a service call on a convenience store is not a good idea.

To the original point, I believe sales persons should be paid on reasonable margins, and that the installation management team should have the ability to have a dialogue on this before accepting it. When the job is "booked," it can be a temporary thing, depending on your processes and systems, but within the first couple weeks after the PM has time to review, the costs should be normalized. The PM should agree to the normalization, as should the sales person and sales engineer (if they exist), and the GM or Director of PM (Or similar position) should review and sign off on the normalization.

You can hire a cat to manage a project, but that may not be the best idea. All key stakeholders internal to the company should agree that it will cost X amount of dollars (plus or minus 3%) to do the job. After that, it's on the PM and their boss to make sure the job is done. While I did a lot of things that weren't my job, that shouldn't be the norm.

Sales commission should be based on EXPECTED profits based on reasonable management, not actual profits. If you give a project manager, in the booking, a "whatever you need" fund for unexpected things, that is quite substantial, the salesperson shouldn't be punished if the project is poorly managed.

Related note: I've been a salesperson, sales engineer, and project manager. None of those categories should be punished when another category doesn't do their job.

Nick, great feedback.

To highlight one section of your comment:

"I was paid on "expected profit." The way that works is that I put together a booking package, which includes all parts and pieces, the basic project plan, and so on. I ended up doing MS project schedules and other things after that, but the basics are parts and pieces, setting up turnover, and you're "supposed" to move on at that point and go sell other things. Based on this package, the project manager signs off saying that they agree that the project makes sense as presented."

Most manufacturers pay on revenue, and integrators use GM in some way to determine the commission payments. Perhaps they pay a % of GP or there is a sliding scale where the % of revenue paid is dependent on the GM.

In general, I remonnend that manufacturers stay away from paying their sales people on profit - keep it simple and set the pricing and authorities to guarantee the right margins.

With integrators, it depends on their short term (1 - 3 year) goals. I always begin a sales compensation project by understanding their short term goals - top line revenue, recurring revenue, gross profit, etc? We'll tie the compensation plan back to the company goals.

Regardless, keep it simple and don't ever decide not to pay on a situation that was in the plan but the "sales person didn't do anything for it". You'll lose that sales person (which might be ok), but you'll also lose any other talented sales person - not paying commissions is one of the worst reputations to have in recruiting talent.

...it's also Illegal in Texas and obligates you to three times the commission that the pay plan would have paid.

It might be more complicated to implement but a 50/50 split makes the most sense to me. Base half of the commision on revenue and half on profit.