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Few ideas inflame passions faster than the suggestion that performance pay in sales be abolished.

It’s my contention, nonetheless, that in an ideal environment, commissions and bonuses are likely to be in conflict with the goal of the organization. Of course, traditional sales processes are not "ideal environments" and, as such, they serve as an illustration of the conditions under which performance pay is, in fact, appropriate!

Let’s begin, accordingly, with the case for performance pay.

The Case For Performance Pay

Let’s envisage a situation where performance pay definitely makes sense. The situation that springs to mind immediately is outsourcing, or more generally, the use of contractors.

If you have outsourced a task to a contractor, it makes sense to compensate that contractor on a per-piece (or results) basis. Because you are outsourcing, you have no control over the contractor’s production process (you can consider only inputs and outputs) and, consequently, it doesn’t make sense for you to gamble on something over which you have no control.

Most organizations understand this explicitly. This is why most contractors (including service providers) are under pressure to quote on a fixed-price, rather than a time-and-materials basis. 

Now, if you consider the structure of a typical sales process, you’ll realize that the relationship between the salesperson and the organization is more similar to contractor-client than it is to employer-employee:

  • Salespeople are responsible for the end-to-end sales process.
  • Management often has limited access to objective process data.
  • Salespeople perceive that they own customer relationships (and in many cases they do).

In this environment, it certainly does make sense to pay salespeople as you would a contractor.

But I maintain that the typical sales process is not an ideal sales environment. What we now have to consider is how the radically different environment I advocate impacts the case for performance pay.

The Ideal Sales Environment

In summary, the essential differences between a typical sales process and the process I advocate are as follows: 

  1. Salespeople are responsible only for conducting (sales) appointments.
  2. All other tasks (including the sequencing of those appointments) are allocated to a sales support function.
  3. Sales process management decisions are subordinated to the organization’s constraint.

If you consider the first two points above, it’s obvious that we are no longer outsourcing the sales process, in its totality, to the salesperson. In fact, we have simplified the role of the salesperson to the point where he performs only one task (appointments).

As well as increasing the productivity of the salesperson, the elimination of multitasking provides management with the ability to micromanage the salesperson. If a salesperson performs one simple task, over and over, management now has access to a statistically relevant quantity of objective data. This data stream is the critical feedback loop that enables a process of continual improvement.

Now that the salesperson can be measured and managed intelligently, the case for performance pay is no stronger for the salesperson than it is for any (and every) other employee.

Which, of course, raises a very interesting question: Wouldn’t it make sense to provide every employee with performance-based compensation? Our consideration of point three (above) exposes the first of two fatal flaws in this common argument.

Fatal Flaw #1: The Optimum Is Rarely the Maximum

If you consider most performance-based compensation programs, their operation is simple. Employees’ pay is linked (directly or indirectly) to their productivity. Accordingly, the harder an employee works, the more he earns. This approach assumes that incremental increases in employee productivity are necessarily good for the organization.

Sadly, this assumption is dead wrong. The fact is, in any process, incremental productivity improvements in only one resource will impact on that process’s output. (This critical resource is the process constraint.) Productivity improvements elsewhere will have either no positive impact, or even a negative impact, on process output. (I’m referring now to non-constrained resources.)

Consider a simple organizational process consisting of the following sequence of activities (each performed by a separate resource):

  • Promotion (the generation of sales opportunities).
  • Sales (the conversion of sales opportunities to orders).
  • Fulfillment (the fulfillment of these orders).

If you were managing this fictitious organization, would you exhort the people responsible for these resources to produce at their maximum possible rates? I hope not! Presumably you’d recognize that there is no benefit in Promotion producing sales opportunities that Sales can’t process. Similarly, there’s no benefit in Sales generating orders that Fulfillment can’t fulfill. To provide each of these individuals with a financial incentive to produce at maximum (individual) capacity will waste resources, unnecessarily inflate expenses, generate chaos, and damage customer service.

It’s for this reason that the third attribute of an ideal environment is that sales process management decisions are subordinated to the organization’s constraint. What this means is that the output of the various resources within our process should be synchronized with the maximum sustainable capacity of the process constraint. Performance pay is likely to have the exact opposite effect.

Fatal Flaw #2: Pay Does Not Drive Performance

At first glance, the assumption that people will work harder in the pursuit of a greater income looks innocent enough. After all, a donkey will chase a carrot, won’t he? Well he will, until he’s replete! From that point on, the donkey has no interest in the carrot whatsoever.

In our experience, team members’ desire for additional money subsides rapidly once they are earning what they believe to be a fair market rate (assuming, of course, that their basic needs are met by that level of income). Furthermore, team members value the security of a fixed income more than they value the possibility of a higher (variable) income.

But -- and I’m asked this question often -- don’t we want our employees to be entrepreneurial? The answer is no. We don’t. As suggested previously, we will destroy our organizations if we turn them into a loose cooperative of contractors -- all taking risks in the pursuit of a profit (this is, after all, the definition of "entrepreneur"). We want our organizations to be tightly synchronized, highly efficient, and totally predictable. The donkey-and-carrot method of compensation is at odds with this objective.

Market Rate Plus Some

Now I’m not suggesting that the elimination of commissions should result in a drop in your team members’ average rates of pay. In fact, I would expect the opposite to occur in many cases. But I am prepared to suggest that, along with performance pay, we should eliminate the notion that performance and pay should be directly linked.

A better method to apply to the calculation of salary is to estimate the replacement cost of an employee. This replacement cost should consist of the market rate for a person of comparable capability, plus a premium for the inevitable switching cost you would incur if you were to lose that team member. You’ll find that this method provides a simpler and more rational basis for setting and renegotiating salaries.

Obviously this method will result in an indirect link between productivity and salary (more productive employees will have a higher replacement cost). You’ll also find that the offer of a good fixed salary (in place of the promise of untold riches) will result in a greater number of better quality respondents to your employment advertisements -- particularly when you are recruiting salespeople.

A Caveat

It’s important to highlight that the elimination of performance pay is contingent upon the successful reengineering of the sales process. If your sales process (or any other process) is intelligently designed and objectively managed, the retirement of performance pay is likely to be a logical and painless eventuality. An attempt to reengineer a traditional sales process that begins with the heavy-handed suspension of performance pay is likely to have unpleasant consequences.

Editor's note: This post originally appeared on the Sales Process Engineering blog, and is republished here with permission.

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Originally published May 14, 2015 7:00:00 AM, updated February 01 2017

Topics:

Sales Compensation