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Compensation Systems: Sales Commissions

post # 495 — January 28, 2008 — a Managing post

What’s the latest view on paying sales commissions in professional organizations?

I’m generally not a fan, because paying a commission:

  1. Fails to distinguish between revenue and profit. It can reward bringing in work that the organization loses money on (or at least makes less money than other alternative uses of its scarce resources.)
  2. Fails to distinguish between on-strategy and off-strategy work. The organization ends up with an “if it moves, shoot it” mentality.
  3. Over-rewards the person who makes the final sale (the transaction), and under-rewards activities (for example, seminars, articles, speeches) that “court” the audience and lead them into conversations that result in sales. Consequently, it encourages an impatience that may backfire in building business.
  4. Encourages salespeople to think of their own rewards (the commission) rather than truly helping the client, and hence creates an uncaring market image that may backfire.
  5. By overstressing individual commissions, can prevent the cooperative teamwork necessary to execute a full coordinated marketing program. Instead, the sales efforts are no more than the (weakened) sum of a lot of individual efforts, none of which has the impact to make a big difference.

In spite of these concerns, sales commissions are still common in a lot of professional businesses. In some, such as real estate brokerage or headhunting, it’s at the core of how individuals are paid (X% of all revenue generated to the individual, the remainder to the firm.)

And, as firms (in, say, law and accounting) try to get their junior professionals involved in generating business, I see them experimenting with paying those juniors a percentage of what they generate.

What do you think about all this? Are sales commission systems good in a professional business context? If not, why are they common?

10 Comments

Stephen Downes said:

As a customer, I avoid firms that pay commissions as much as possible. Commissions distort the quality of service I receive. In the same light, I steer away from piece-work. As a purchaser, I always want the ability to balance quanity with various other factors: relevance, usability, quality, etc.

posted on January 28, 2008

McGill said:

We pay for introductions, not sales. So, if one of our staff introduces us to someone who subsequently becomes a client, that consultant will retain a percentage bonus of any profits from the client’s first project or six months of business (whichever is greater). This way we reward the person who delivers real value.

posted on January 28, 2008

Port Orange Homes For Sale said:

It’s kinda like a referral fee then right. If I have someone who wants to buy in your area and refer them then I get a percentage for that referral fee.

posted on January 28, 2008

Brad Farris said:

I see a lot of folks who have a bonus paid when their new business reaches a threshold. In other words, we need X new business to reach our plan for the year. We divide it up amongst the princpals so that each of us has a “quota” and then tie some individual bonus to attainment of that individual goal. I also see staff receiving a bonus based on the whole company reaching their goal, so that their contributions are rewarded, but not tied to specific business.

Usually there are other components of the bonus, both for staff and principals, but new business is significant.

If they are taking “bad” business (off-target or unprofitable) then it is the managment team’s job to refocus those efforts. I try to make the numbers as transparent as possible so that there are not a lot of hard feelings when this happens.

I mostly work with smaller firms (20 – 50 professionals) with a small number of practice groups (1 – 3). I can see how this would get more difficult with more professionals or pratice groups.

posted on January 28, 2008

John Caddell said:

David, there’s one reason and one reason alone these pay schemes persist: the desire not to pay for something until you have a guaranteed return to underwrite it.

If I structure a person’s compensation with a high variable component, if he fails, I pay less. If he succeeds, I pay more (sometimes a lot more). Taken to an extreme, I hire 1,000,000 on 100% commission, then whoever gets the sale I pay. The others get nothing. I have complete market coverage but I only pay for results!

This of course has all the undesired consequences you put into your post.

Regards, John

posted on January 28, 2008

Glen Cooper said:

Dear David:

I own Maine’s largest business brokerage company. Of course, we’re commission-based. Everything you said, however, is true about the side effects, even though I like to think we still give extraordinary service. We brag that we have developed “systems, teamwork and a track record” over our 27-year history to help our exclusive business selling clients get their businesses sold.

For us, one of the differences is that we teach David Maister! I have read your 1993 book and just read your new one, Strategy & the Fat Smoker. I am the new teacher for the “Professional Practice Management” course for the International Business Brokers Association. We use you and Michael Gerber (the E-Myth) as foundational authors for the course.

If you are ever in Maine, please call ahead. A free lobster lunch for you and your wife awaits you! Our office is on the waterfront in Portland. I’d love to meet you sometime.

Glen Cooper, CBI, CBA, BVAL

President, Maine Business Brokers

Portland, Maine

posted on January 28, 2008

Ken Hedberg said:

In addition to the factors cited by the other commenters, I have found that many consulting professionals and their organizations go through extensive periods with inadequate deal flow and the consequent lower backlog than healthy. They assume that inadequate business development activity is the most likely cause of weak backlog. Then they decide that if they want results, they must offer direct incentives for those results (i.e., commissions). Seems logical.

The flaws only start with the five factors you cite, David.

One: In my experience, a strong and continually earned reputation usually will generate lots of referrals and repeat business, independent of the level or skill of the marketing and selling activities. Intervening questions – Is the quality level of service sufficiently high? Does the firm have a sufficiently strong reputation among those in the profession? Interestingly, these are often the toughest direct competitors. If your organization has a strong reputation for quality service, professional excellence, and innovation among your competitors, it will contribute mightily to referral and repeat business.

Two: I distinguish between marketing programs and direct business development. You highlight seminars, articles, speeches, etc. as critical components of professional services marketing programs. Agreed. In addition, for many professional services firms, the process of responding to a specific opportunity is an entirely different set of activities, focused on uncovering true needs, crafting alternative solution designs, competitively pricing the work, presenting with compelling impact, and negotiating a win-win decision with the client. Again, in my experience, teamwork is much more critical in these direct business generation activities than even in the marketing program. Individual commissions fail to recognize the multiple contributions to an effective business generation process.

Three: In many cases, large projects (and/or large revenue streams from clients with interrelated work) are either a natural outgrowth of a successful professional services practice and/or a strategic objective of the organization. Commission based compensation swings far too widely, from feast to famine and back, to serve as an effective reward system.

Four: many of us face sell cycles that average six to twelve months, or even longer. When coupled with long delivery cycles in many professional services businesses, the business rhythm extends well beyond any normal fiscal period. This timing mismatch encourages short-term behavior out of synch with the business or relationship cycle by commissioned staff.

I could go on and on. Suffice it to say that I agree with David – directly variable commissions get in the way of optimal organization performance in many professional service organizations. Leaders fall back on them because of flawed assumptions and a genuine desire to address systematically weak business development.

posted on January 29, 2008

Julien Dionne said:

David, I agree with you that paying a commission, in the context of a professional organization, can lead to the issues you listed. That’s why the organization will have to design their incentive plans carefully to achieve the desired results – reward only profitable, on-strategy work in a fair manner and have a good mix of individual vs group rewards as well as taking into consideration client feedback. P.S. TAG!

posted on January 31, 2008

Michael Webb said:

Not everyone is good at or motivated to do the things the sales role requires. If you are like most people, it requires a self-awareness, and may require the will to do things you are not comfortable with or motivated to do, especially at first. For example,

  • preparing yourself for meetings with prospects (is 15 minutes enough? is an hour too much?),
  • focusing on the prospect’s interest’s and perspective rather than your own, and be serious about it rather than fake
  • seeking out clever and creative ways to engage them (can be difficult in some cases), and
  • taking the trouble to remember things about them, and use that information in the next interaction.

All these require discipline and effort. You can make yourself more effective with practice. Further, since there may be little or no payoff in the short term, it can be difficult for an outsider to know if the salesperson is really working at it, or slacking off (although prospects might be able to detect a lack of sincerity).

Although I don’t dispute the criticisms you’ve made for commissions (in fact there are even more problems with them, which I’ll mention momentarily), having been a commissioned salesperson for many years in my career, I do believe that one benefit of commissions is that they help motivate certain people, in the right context, to work harder and more creatively. If my pay won’t vary from the next person, why go the extra mile to land the extra client? Why step away from Sunday night television to practice my lines for Monday morning’s appointment?

One problem businesses have, which they try to cover up by using commissions, is that they really don’t know what it takes to convert prospects to customers. They fear paying for nothing, and believe commissions are away of paying for results, instead. Yet as markets, cultures, and technologies change, this eliminates their control of their own destiny.

My point is that a business needs to be very clear about the way it engages its potential customers, how it develops a relationship by helping them realize their problems, and how it earns their trust. The series of actions people in the company take, when combined with their prospect’s responses to those actions, are what comprise “the sales process.”

Within that framework of clarity, there will be selling tasks that produce obvious variation, depending on the skill and the will of the person doing the helping (or “selling”). Examples might be:

  • how many interested people did you cultivate at a conference,
  • how many qualified attendees do you secure for a seminar, and
  • how many companies agreed to initial on-site workshops or evaluations?

Being more or less effective at these specific kinds of tasks ties obviously to the company’s fortunes, and obviously requires personal discipline and energy to accomplish well.

I’m no compensation expert, but I believe these situations argue for variability in one’s compensation, at the least (to reward efficacious behavior), and since the ultimate proof of efficacy is in the revenue, commissions can be a sensible approach.

posted on February 4, 2008

Tom said:

I think it really depends on the industry you are dealing with, but in general I’m a big believer in commissions.

But this has to be backed up with teambuilding activities. Sales teams are dynamic organisms that need to be constantly worked on.

Also, in many industries it is necessary to offer commissions in order to attract top sales people.

posted on February 2, 2010