The Wonderful World of Sales Commissions

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The Wonderful World of Sales Commissions

Congratulations, you have done it!!! Your business is taking off, and the demands on your time have taken you to the point where you no longer have the capacity to manage all aspects of your business, specifically adding top line revenue growth at a meaningful rate. To take your organization to the next level, you know it is time to bring in additional resources to focus on growing your revenue and ultimately your bottom line. This is a great problem to have, but for many small business owners a very scary problem, as you have no idea where to start or how to compensate these individuals or if it is even the right time for this hire. If you find yourself in a similar situation, here are some factors to consider when hiring for a sales role.

Before deciding to bring on additional resources to focus on sales you, as the small business owner, need to understand the financial impact this hire will have on your net income. Here are some questions to think through as you determine what the financial impact will be:

  • What is a reasonable target in additional sales you can expect from this individual? As an owner and expert in your business and your industry, you know what the supply is, and you know your customer base, and you know what customers have yet to be reached. How much of this can your additional resource tap into and grow your top line revenue?
  • What are your current gross margins? This is important to determine of this additional revenue, how much in additional gross profit will I generate? This will help you decide if you can afford to make this hire.
  • Will my gross margin be impacted by this additional revenue growth? Will margins improve as a result of the growth or will it have a negative impact on my overall gross margins? Will I need to consider additional resources in other areas of the business to support this revenue growth?

Once you have answered these questions and analyzed what impact this additional hire will have on your gross profit, you should be able to determine if it makes financial sense to bring on this additional resource. The goal at the end of the day is not to grow top line revenue but increase your bottom line and equity. For example, if you determine one additional salesperson in your organization can generate $75,000 of additional gross profit on a yearly basis, if the cost of that hire does not exceed $75,000 then you will be increasing your bottom line and equity, if not you should consider if it even makes sense to make this hire.

Now once you have determined it makes sense to hire on a salesperson in your organization, the next question to answer is how I am going to compensate them? This isn’t an easy answer and there is no one solution for every business. You first should think through how much you are willing to compensate this individual in total. The answer to this question should largely be driven by your first analysis where you determined the impact to gross margin this hire will have. Remember, you don’t want to compensate this hire above what their gross margin expectation is. After figuring this out, you next need to determine what compensation structure should you implement. This answer is largely dependent on your risk tolerance, but here are three common structures that a business can use when compensating their sale roles.

  • Fixed Salary with Variable Commission – this is probably the most common structure we see with our clients and is good for owners with a medium risk tolerance. You just need to determine what percentage should be fixed and what percentage is variable. You then will need to figure out should you use a flat commission percentage for all sales (i.e. 10% of all sales) or does it make more sense to use a sliding scale percentage (i.e. $0-$20,000 is 5%, $21,000 to $40,000 is 8%, etc.). Some businesses will even set a floor where no commission is paid until a certain target is met. For example, until you reach $40,000 in sales, no commission is paid, but after that either a flat percentage is utilized, or a sliding scale is used. Again, these decisions will ultimately be driven by your risk tolerance and what you think will be motivating to your sales team to maximize your net income.
  • All Variance Compensation – while not as common today, there are still organizations that implement this strategy and is geared to owners who have a very low risk tolerance. This structure takes all the risk off the table as you will never be in a position to compensate an employee who hasn’t produced any revenue for the organization. While in theory this sounds great, this practice can lead individuals to making any sale they can find, many of which can ultimately be negative for the organization.
  • All Fixed Compensation – again, not a common practice, but certain management theories talk about taking out the competition within the organization and one way to do that is to eliminate all commissions. This is especially true of organizations with multiple sales roles as in many instances due to competition, commissions can have a negative impact on the business for a variety of reasons. With his approach your total compensation would be paid as a salary.

Taking your organization to the next level, can be a very exciting time, but one that comes with many challenging and critical decisions. Determining if bringing on additional sales resources and the compensation plan for that role can be one of those challenges. If you find yourself in this situation, don’t worry, this is a common question we help many of our clients with and would be happy to work through the analysis with you.

As always, if you have any questions or would like to learn more, feel free to reach out to any of us at Mackey Advisors (859) 331-7755.

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