Sales Compensation Plan – Why Pay a Base Salary?

Posted by David Wallace on October 26, 2009

In today’s economy, I see many postings by companies looking to hire sales professionals on straight commission. Their logic is that if a sales representative is good, the rep will have no problem “eating what they kill.” Straight-commission sales reps are inexpensive to bring on board, do not add to your company’s overhead, and are highly motivated to identify and close business.

Sounds too good to be true, huh? Well it is, because you usually “get what you pay for.” Let’s look closely at the logic of this argument.

Eat What You Kill

Many very successful sales representatives eat what they kill. They’ve developed a business within their territory which generates high commission payouts. For some, their commissions far exceed their base salary, if they even have one.

Even the most successful sales reps do not start their territories or careers with an established book of business. They build it. And it takes time, often years of patient effort, to build a revenue-producing territory. Plus, when you hire a sales rep with experience in a territory, the rep cannot immediately replicate his or her previous level of success. Two major obstacles cause initial lower sales production: the sales rep’s non-compete contract with his or her former employer and customers’ loyalty to their vendor companies, not their sales reps.

Non-Compete Agreements. Competitive companies limit their sales risk by requiring their reps to sign non-compete agreements. These agreements stipulate that if a sales rep leaves the company, the rep cannot sell a competitor’s products to their former customers for a specified period of time, usually one, two or three years.

Customer Loyalty. Unless the product is a price-driven commodity, customers are usually reluctant to switch vendors or service providers simply to follow a sales representative. They recognize the risks associated with switching vendors. Product quality, availability and customer service levels may not be comparable. They may also need to negotiate new contracts and pricing.

A successful sales rep who joins a new company, even one who remains in the same territory, must invest time with customers to rebuild relationships before significant sales are achieved. During this territory development period, the sales rep will need supplemental cash flow to survive.

Straight Commissions = Low Cost of Sales + Motivated Reps?

Here’s another false argument. Hiring straight commission sales reps can reduce your cost of sales and motivate reps. I’ve often heard business unit managers say, “Let’s hire reps at 100% commission. If they don’t work out, we’ll replace them and they haven’t cost us a penny.” Even at 100% commission, bringing new sales reps into a company involves expensive “hidden” costs:

  • Training – New sales reps need training on your company’s culture, products, processes and procedures. They need to learn your contract terms and pricing. They may need training on your preferred sales approach.
  • Benefits – Unless you are hiring an independent contractor, you may need to include your new sales reps in the company benefits plans.
  • Time – New sales representatives demand more time from your managers and executives while they learn your company and its systems.
  • Equipment – New sales reps need to be equipped with appropriate sales tools such as phones and computers.
  • Territory expenses – As new sales reps work their territories and visit headquarters, they may incur significant travel and entertainment expenses.
  • Customer satisfaction – New sales reps are visiting your customers and prospects. You want to make sure you have the right rep in place, delivering the right message, the right way. The cost of customer dissatisfaction can be enormous and ripple through to other customers and prospects.

Straight commission can provide tremendous motivation for sales reps who generate sufficient cash flow to meet their basic personal needs. However, sales reps who have not yet established their territories and are struggling to make ends meet can quickly become disillusioned. If your sales cycle is longer than a month or two, dissatisfied reps may leave for new job opportunities. Then your investment in that “no cost” sales representative is lost. Customer satisfaction may also decrease as customers perceive higher turnover within your sales team. Finally, the sales rep you spent time and money training may take your investment and go work for your competitor.

Base Salary + Commission – What’s the Optimal Mix?

The debate is ongoing about what percentage of total compensation should be base vs. commissions. Ideally, you want to pay enough base salary so that your sales rep doesn’t need to worry about meeting basic obligations such as food, rent/mortgage and car payments. But you want to avoid paying too much. You don’t want your rep to feel like he can live comfortably off the base salary.

In general, I try to target the base salary at about one-third of the total compensation (base + commissions) at 100% quota attainment. This ratio can vary based on the level of total on-target earnings (OTE) and the length of the sales cycle. When the OTE level is higher ($300K and above) or the sales cycle is short (less than one month), I may offer a maximum base salary of 25% of OTE. When OTE is lower or the sales cycle is long, I’ve seen base salaries offered as high as 75% of OTE.

When you set base salary as a higher percentage of OTE, this reduces the risk borne by the sales representative. Given this situation, I suggest reducing the commission rate paid as a percentage of revenue or margin.

Base Salary – What Should I Expect in Return?

No sales representative earns his or her base salary for just “showing up.” Your sales compensation plan needs to specify clearly the activities for which reps are paid a base salary. Here’s some language I’ve used in the past:

Base salary is paid for the timely and accurate completion of administrative and other tasks associated with the generation of business volumes, including:

  • Managing account relationships
  • Prospecting for new business
  • Ensuring profitability of deals
  • Competitive reporting
  • Forecasting business volumes
  • Negotiating master agreements
  • Assisting in the collection of accounts receivable
  • Expense reporting
  • Personal education/skill development
  • Completion of all required documentation

Draws Against Commissions – Why offer these?

As an alternative to base salary, you can offer draws against future commissions to address sales reps’ needs for start-up or short-term cash flow. A draw is a loan your company provides to a sales representative that is repaid by earned commissions. Draw amounts are usually negotiated with sales representatives for a defined start-up period when they are hired. The draw is designed to provide the sales representative with nominal cash flow while he or she is focused on developing the territory. For businesses with seasonal cycles, draws can also be used to provide reps with more consistent cash flow.

For more information, contact Wallace Management Group at (203) 834-0143 or email David Wallace.

© 2009, David P. Wallace

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