Chapter Fifteen
Sales Force Compensation
Instructions for the Professor:
Overview:
The purpose of this exercise is to help students understand the various sales force compensation options. The exercise begins with three scenarios in which students are challenged to identify the most appropriate compensation plan based on the nature of the selling task. Next, students are asked to calculate the level of compensation for three different combination compensation plans, and make a recommendation as to which they would implement given a particular sales forecast. Finally, students are challenged to evaluate a more realistic scenario in which the rate of commission associated with each combination plan influences the level of sales volume and as a result, revenues. Each portion of the combination sales compensation plan analysis is accompanied by multiple graphs.
Concept Review:
Successfully managing the personal selling effort requires a motivated sales force. While trips, prizes and other nonmonetary rewards are commonly used as incentives, the type of compensation plan used by the company is the primary method of financially motivating and rewarding the sales force for their efforts.
Straight salary compensation plans pay salespeople a fixed salary per week, month or year. A straight salary compensation plan is an excellent choice for jobs that require a great deal of account servicing or missionary selling to existing accounts. However, straight salary compensation plans provide little incentive for the sales representative to solicit new business and open new accounts. While the plan is easy for the sales manager to administer, sales representatives compensated via straight salary typically require more supervision by their manager to make certain that the assigned tasks are being done. Straight commission compensation plans tie the salesperson’s earnings directly to the sales volume generated. Typically, sales representatives earn a percentage of their overall dollar sales volume. While this system successfully motivates the sales force to open new accounts and maximize unit sales, sales representatives may neglect the account servicing and follow-up aspects of the selling process, or aggressively push customers to make purchases they don’t need, actions that ultimately lead to dissatisfaction on the part of the customer. However, since selling costs are directly tied to the revenues generated, many small firms initially rely upon a straight commission plan as they build their business. Combination plans which incorporate salary, commission, and/or bonuses for exceeding quota represent the preferred method of sales force combination for the vast majority of firms in the United States.
Using the Exercise:
Initial Screen:
1.This screen introduces the three selling scenarios that form the first portion of the exercise. For each scenario, students will be asked to identify the most appropriate compensation plan.
After the initial animation sequence is complete, the professor clicks anywhere on the screen to transition to the first scenario.
Pharmaceutical Missionary Selling Scenario Screen:
- The screen pertaining to the pharmaceutical selling scenario appears.
The professor reads the pharmaceutical selling task scenario to the class.
The professor then challenges students to identify the most appropriate compensation plan based on the scenario.
The professor reads the alternative answers to the class.
The professor clicks on the letter associated with the answer that corresponds to the student’s response.
If the wrong response is given, a buzzer will sound and the letter associated with the incorrect answer will turn red. For details related to right and wrong answers, refer to the ANSWERS AND EXPLANATION section below.
The selection process is repeated until the correct answer is chosen. When this happens a cash register “ch-ching” sound will be heard. The slide will then automatically transition to the next screen.
Long-Distance Reselling and Copy Machine Scenario Screens:
- The process described in step 2 is repeated for the two remaining selling scenarios.
Summary Screen:
- This screen matches each of the selling scenarios with the most appropriate compensation plan.
Clicking the “NEXT” button located in the lower right-hand corner of the screen continues to the second portion of the exercise
The professor also has the option of skipping the compensation plan decision problem(s) by clicking the “X” icon in the upper right hand corner of the screen to end the exercise.
Compensation Calculation Screen
- The next screen describes a scenario and asks students to select a specific combination plan from among three alternatives. The initial scenario assumes that identical sales volume will result from each of the alternative combination plans being considered. To select the optimal compensation plan, students should calculate the cost of each alternative at the projected level of sales and select the plan that is least expensive for the company to implement.
The professor reads the scenario statements to the class.
When students have had adequate time to calculate their response, clicking on the “NEXT” button will reveal a graph of the compensation cost associated with each alternative.
Compensation Calculation Graph
- The purpose of this screen is to visually illustrate the overall cost of each compensation alternative at a stated volume level. The proportion of each plan’s cost that is attributed to the salary and commission components is also illustrated.
When the professor is finished discussing the screen, clicking the “NEXT” button will transition to the next screen.
Compensation Plan Comparison Graph
- The purpose of this screen is to visually illustrate how the overall cost of compensation plans featuring different commission rates and base salary components vary with volume. In particular, it is worth noting that plans featuring heavy base salary components are typically the most expensive at low sales volume levels, while those featuring low base salaries but higher commission rates are more expensive at higher levels of volume.
When the professor is finished discussing the screen, clicking the “NEXT” button will transition to the final portion of the exercise.
The professor also has the option of skipping the final compensation plan decision problem by clicking the “X” icon in the upper right hand corner of the screen to end the exercise.
Compensation Calculation Screen
- The final exercise portrays a more realistic scenario in which higher commission rates provide stronger incentives to generate sales volume. To select the optimal compensation plan, students should again begin by calculating the cost of each alternative at the projected level of sales. However, students should recognize that the net revenue gained under each compensation plan should be used to make the final decision, rather than just the costs associated with each plan.
The professor may or may not wish to “hint” to students that their consideration should be made on the basis of net revenue (total revenue less selling compensation plan expenses in this example).
When students have had adequate time to calculate their response, clicking on the “NEXT” button will reveal a graph of the compensation cost associated with each alternative.
Compensation Calculation Graph
- The purpose of this screen is to visually illustrate the overall cost of compensation at the forecast level of sales volume for each alternative. The proportion of each plan’s cost that is attributed to the salary and commission components is also illustrated.
When the professor is finished discussing the screen, clicking the “NEXT” button will transition to the next screen.
Final Screen -- Revenue Graph
- The final screen visually illustrates the overall revenue at the forecast level of sales volume for each alternative. The proportion of total revenue used to cover expenses, as well as the level of net revenue is also illustrated for each alternative. It should probably be mentioned that only sales compensation costs are considered in this example. Costs of goods sold, and other costs that must be deducted to reach net profit, are not considered.
While the expense portion associated with each alternative appears to be identical in the graph, such is not the case. Refer to the following table for details:
Option AOption BOption C
Expenses Portion62,50053,00050,500
When the professor is finished discussing the screen, clicking the “X” icon in the upper-right hand corner of the screen will end the exercise.
Answers and Explanations
PHARMACEUTICAL SCREEN
Correct Answer: STRAIGHT SALARY
Pharmaceutical selling to physicians is considered to be missionary selling as the primary job of the sales representative is to educate the physician, answer questions, and leave samples for the physician’s use. While such activities encourage the physician to write prescriptions, a commission element in the compensation plan could be considered inappropriate because the sales representative does not take orders directly from physicians.
In “real life”, some pharmaceutical sales representatives are compensated using a salary plus bonus plan. However, it is doubtful that the typical undergraduate will know this. However, if this is brought up, the following may be worthy of discussion.
While pharmacies do not release detailed sales data listing the number of specific drug prescriptions scripted by individual physicians, general sales volume information by drug is available from pharmacies located within the representatives’ territory. These figures are used to estimate the volume of sales that can be indirectly attributed to the efforts of particular sales representative. Bonus payments may be earned when the sales representative exceeds quota.
Some students may question why these same sales figures are inappropriate for use on a commission basis. Basically, this system of sales measurement is too imprecise to be used for commission sales. For example, pharmacies located near the boundary of adjacent territories may very well fill orders written by physicians practicing in BOTH adjacent territories; neither the physician nor the sales representative has any control over where a patient chooses to fill his or her prescription.
LONG-DISTANCE RESELLING SCREEN
Correct Answer: STRAIGHT COMMISSION
Several factors described in this scenario argue in favor of a straight commission compensation system. The small size of the firm indicates that the firm may be more inclined to favor a compensation system that minimizes selling costs when sales volume is low; straight commission is the most obvious method of cost containment that fits this criteria. Furthermore, the “product” is one that requires little if any after the sale support, training, or customer service. A salary component is often used to reward sales representatives for engaging in non-selling tasks but makes less sense for situations in which little account service is needed. Finally, the product being sold is somewhat “perishable” – if the business does not resell their minutes within a specified time period, they bear the cost of paying for the service whether it is used or not. The need to maximize sales volume in this fashion may also argue in favor a straight commission system. It is probably worth noting that in “real-life”, a straight commission plan is the least popular form of compensation in use today.
COPY MACHINE SCREEN
Correct Answer: Combination Plan
Most sales jobs require some form of follow-up, user training, support, or customer service. The salary component of the compensation plan helps to motivate and reward sales representatives in the performance of these tasks. Combination plans represent the most common form of sales compensation plan and are appropriate in a wide variety of industries and selling situations, as they present the sales manager with the maximum flexibility in directing the efforts of the sales force.
ANNUAL SALES COMPENSATION COST SCREEN
CORRECT ANSWER:
Option A -- $10,000 base salary plus 6% commission per case
Given company projections that each of the alternative compensation plans will result in sales of 15,000 cases (and thus identical levels of sales revenue), option A minimizes the selling cost expense to the company. The compensation cost for each alternative is computed using the following formula:
Base Salary + [(Commission Rate x Price per case) x Cases Sold]
Or
Option A: $10,000 + [(.06 x $ 35.00) x 15,000] = $ 41,500
Option B: $25,000 + [(.04 x $ 35.00) x 15,000] = $ 46,000
Option C: $40,000 + [(.02 x $ 35.00) x 15,000] = $ 50,500
ANNUAL SALES COMPENSATION COST SCREEN #2
CORRECT ANSWER:
Option A -- $10,000 base salary plus 6% commission per case
Variable commission rates are typically associated with different level of sales volume, as higher commission rates normally drive higher levels of sales volume. The different sales forecasts attributed to each compensation plan being considered reflect this fact and must be taken into account when selecting a compensation plan. Some students will argue that Option C is the best compensation alternative as selling expenses are minimized under this scenario. However, such an argument ignores revenue considerations. When choosing the optimal compensation plan, students should calculate net revenue. As defined here, net revenue for each alternative is computed using the following formula:
(Price per Case x Cases Sold)
-{Base Salary + [(Commission Rate x Price per Case) x Cases Sold]}
NET REVENUE
Or
Option A: ($35.00 x 25,000) – {$10,000 + [(.06 x $ 35.00) x 25,000]} =
$ 875,000 - $62,500 = $ 812,500
Option B: ($35.00 x 25,000) – {$10,000 + [(.06 x $ 35.00) x 25,000]} =
$ 700,000 - $53,000 = $ 647,000
Option C: ($35.00 x 25,000) – {$10,000 + [(.06 x $ 35.00) x 25,000]} =
$ 525,000 - $50,500 = $ 474,500
NOTE:
* The professor may wish to explain to students that while the sales response function presented in the simplistic example shown here is linear, such is not always the case in the real world.
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