Wednesday, February 24, 2016

Commission Policies in the Automation and High Tech Electrical Industry

We are gathering information and building a list of frequently asked questions.  

I am often asked about commission structures within the Automation, Electrical Distribution Industry and other knowledge-based distributor operations (Power Transmission Distributors PTDA, Fluid Power Distributors FPDA and Industrial Distributors). Considering the frequency of the question (from potential salespeople, experienced seller, managers and others,) I feel it appropriate to post some thoughts on the practice. While this is not our typical kind of post, I wanted to create a forum for discussion.

Commissions based on Gross Margin are one of the most commonly used incentive practices on the channel side of the business. On the manufacturing side, many people are still paid based on their gross sales numbers. Often you will hear distributors refer to this practice as paying on “tonnage” because sales professionals compensated in this matter really aren’t required to worry about whether their company makes a profit or not. Distributors must produce gross margin to survive. Further, the gross margin does not flow straight to the bottom line. Instead, gross margin dollars pay for everything from the light bill, insurance and rent on to the cost of the distributor’s employees (which typically account for 60 percent of the total gross margin).

In nearly four decades of involvement in the industry (which includes service as a sales manager at a major manufacturer, C-Level executive in a regionally based distributor, President of the North American trade association dedicated to the automation channel (The Association for High Tech Distribution) and, over a decade, as a consultant to the industry,) I have seen literally hundreds of commission models. These range all the way from commissions accounting for only 10 percent of the salesman’s total compensation to structures which comprise 100 percent of the salesperson’s monetary package.

I typically recommend a compensation plan which is comprised of a base-salary and a commission. For the record, I find deep fault with both straight commission and straight base salary plans. The exact percentage must be fine-tuned based on the company and conditions in the seller’s territory.

The most common industry practices on payment of commission are:
• Monthly draws on commission which are settled at the end of each year.
These packages are designed to “smooth out” the monthly variations in commission amounts. Draws give the seller some consistency over the year, but often lead to conflict when the total commission for the year is not met and the seller ends up owing money from surplus commission draw.

• Commissions which are paid quarterly, semi-annually (every six months) or annually.
Most companies have discovered the accounting required to provide accurate monthly commission payments are too time consuming to justify payment on a monthly basis; hence the quarterly, semi-annual or annual payments.

As stated before, well over 90 percent of commission plans are paid based on Gross Margin generated by the sale.
Gross Margin is defined using the formula (Sell Price) – (Cost of Goods Sold)

This number does not include incentives to the distributor from manufacturers, buying group rebates, special buys, mark-ups on freight, special handling fees or other income generated by the sale.

Further, distributors do not typically pay commissions on the following:
• Sales made which are not paid in full by the customer due to disputes or other issue.
• Sales made which remain unpaid because of credit/collection issues by the distributor
• Sales made which are turned over to collection agencies.
• Sales which are paid well outside of the distributor’s terms (i.e. paid 60, 90 or more days after the normally extended terms.

Sales are not one time events
It is important to note, sales generated in this industry are not one time events. Instead, the distributor/customer sales cycle is a long continuing relationship where no sale is ever considered final. Distributors are called on to provide after-the-sale service for many years after payment is made and money has changed hands. The unwritten agreement with the customer can be summarized in this manner: If the distributor customer continues to grow the business relationship with the distributor, the distributor will extend follow-up services in perpetuity.

In Knowledge-based distribution commissions serve as a plan to compensate the salesperson for more than just “closing the order,” they also serve as payment for continued support. With this in mind, it is considered an industry norm to not pay commissions for salespeople who leave the company. For instance, when commissions are issued on February 15th for the quarter ending December 31st, and a salesperson resigns on February 1st, commissions are forfeited.

Conversely, it is not uncommon for distributor salespeople to benefit from the work done by their predecessor at the account. Most customers come with a level of “flow business” which once started continues on for many years. The new seller assumes the role of service champion and is rewarded with commissions on sales they had nothing to do with initially generating.

In the world of knowledge-based distribution, sellers are judged on their ability to not only close the sale but to provide the kind of service which causes the customer to buy more from their employer. Distributor salespeople are judged on their ability to grow the relationship as opposed to garnering one time orders.

As stated earlier, this post is in response to the dozen phone calls or emails we get from all levels of the distribution world each month and is by no means a full report on the state of commission (or commission rates) in our industry. Instead, we thought it appropriate to answer many of the common questions asked.

Here are a few random comments:

On Commission starting and end dates
• Typically distributor salespeople in our industry benefit from the past work of others at their accounts. This comes by way of business flow which was developed prior to their assignment to the accounts under their charge. Typically, new salespeople start with some commission based on the work of others.

• When salespeople leave other resources must be assigned to their accounts to maintain the service level at the accounts developed. These resources must be continued whether they are provided by a new salesperson or through resources such as inside sales, customer service, product specialists or others. It should be noted this practice extends not only through the ranks of distributors, but also applies to many other members of the supply chain: supply-partner manufacturers, manufacturer’s rep agencies and others.

• Policies on being currently employed in order to receive commissions have remained unchanged for many years. Recently, we spoke with a gentleman who resigned his post in the late 1960s. He indicated his commission plan was very similar to those of today. When thinking about leaving his (then) current employer, he waited until the week following the issuance of commission checks. He went on to form a company of his own and has no hard feelings on the potential commission left behind.

• Do policies like this favor the person who stays in position for a long time? I believe long duration salespeople do better in the distributor world because they learn more about their accounts and build layer after layer of flow business. This is typically good for seller and employer alike.

Why don’t distributors pay commission on sales volume?
• Typically, manufacturers pay a commission based on total sales volume. Some distributors call this being paid on tonnage. The average manufacturer salesperson is not privy to the internal cost of the product. Sell prices are very likely to be set by others. In addition, the margins for manufacturers is higher than distributors. Distributor salespeople often know their company’s cost of the product and are paid to capture as much gross margin as possible. For the sake of those outside the industry who may be reading this article, the typical distributor ends up with a profit before taxes and interest of between 2-4 percent. They are not working on a gigantic margin.

Different commission rates?
• Is it reasonable to have a different commission rate for various products sold within the distributor organization? Yes. Here is why: The cost associated with doing business with many supply-partners (some distributors have as many as 500) varies. Some provide incoming freight, some are easy to business with and others have mounds of paperwork associated with each order. Fluctuating the commission rate based on the type of product sold is common.

• Can a distributor have different commission rates based on the sales territory? Again, the answer is yes. Size and type of customer play a role in how easy or difficult it might be to create a relationship. Geography plays a part as well. The salesperson responsible for a large urban territory might may discover the sheer number of potential customers to be larger than the more rural based territory.

Commission rate changes?
• How often can commission rates be changed? Business is a fluid thing. Conditions ebb and flow. Product lines become obsolete. Economies rise then fall into recession. The one mistake either seller or employer make is to assume what works today will always work. While I am definitely not in favor of change for change sake, I do believe business conditions warrant changes in commission rates. As a rule of thumb, any commission plan which has not been tweaked for over five years is probably in need of some examination.

I am building a repository of questions, comments and background information around commission plans. I would invite your comments be they anonymous or sent via email and posted at this end.


Priyanka Sekar said...

Thanks for sharing this Informative content. Well explained. Got to learn new things from your Blog on SAP SD

Sahana said...

Thanks for sharing this Informative content. Well explained. Got to learn new things from your Blog on SAP