Chapter 2
Team Exercise:
Web Sales
Scenario:
Creative Communications Inc. (CCI) is an Atlanta-based manufacturer of consumer electronic devices, most notably digital audio players. In recent years, these devices have exploded in popularity with their increase in memory capacity and as prices declined to affordable levels. A key element in the CCI success story is the growth of major retailers such as Wal-Mart, Target, and Best Buy. CCI uses major account teams to serve these and other major retailers, which account for 60 percent of CCI’s sales. The remaining sales come from smaller retailer accounts who have traditionally purchased from independent reps with whom CCI has a contract for a commission of 4 percent of sales.
In an effort to reduce costs last year CCI established a WEB site as an alternative channel for small retailers. Cost of sales on the Web site was a modest 2 percent of sales. Sales volume on the Web site amounted to 3 percent of CCI’s sales last year, but it is forecasted to increase to 7 percent of sales this year, and perhaps as much as 15 percent the following year.
Many of the salespeople selling to smaller accounts are upset by the move to Web sales since they received no commission on these sales. Although not all of CCI’s product line is offered over the Web, this did not appease the salespeople. Some of the stronger salespeople are threatening to go to a competitor who is offering salespeople compensation on Web sales.
As national sales manager for CCI, you have been asked to keep sales costs at 5 percent of sales. Sales force costs are running at 7 percent for the major account sales teams, and ninety-percent of the cost is compensation-related – salary plus incentive pay. How would you assess CCI’s alternative sales channel over the Web? What changes would you recommend to minimize conflict with the independent reps and still stay within your budget?
KEY DISCUSSION QUESTIONS
1.How difficult will it be for CCI to lower sales costs to 5 percent of sales?
It turns out to be a very difficult task to accomplish, indeed an almost impossible task if only the commissions of the independent reps selling to small accounts is adjusted. Exhibit 1 at the end of this note shows why this is the case.
Exhibit 1 analyzes the impact on sales costs as a percent of revenue for different compensation plans over a three-year period of time. A critical assumption in this analysis is that the mix of sales will change over the three years so that Web sales will increase from 3% to 7% and finally 15% of total sales with the change resulting in a decreasing percent of sales going through independent reps. Under the current compensation plan, major accounts sales costs are 7% of sales, independent reps cost 4%, and web sales are 2% of sales. With this compensation plan and mix of sales, the cost of the current plan would be 5.74% the first year, 5.66% the second year, and 5.5% in year 3. The reason for the decrease in cost over time is the migration of sales from the independent reps to the Web. There are at least two problems with the current plan, however, costs are too high (i.e., above 5% of sales) and independent reps are unhappy with the loss of sales to the Web. The negative attitudes of the independent reps may actually reduce sales through this channel. Interestingly, this would actually further increase the average cost of sales since a greater proportion of sales could end up going through the more expensive major account channel.
Plan A involves reducing independent rep commissions to 3% of sales, but compensating them for Web sales to small accounts at 3% as a quid pro quo for the reduced commissions. While this plan may be easier to sell to the independent reps, it results in an even higher cost of sales as shown in Exhibit 1, Plan A. Even reducing independent rep commissions to 2% of sales and compensating them on Web sales (Plan B in Exhibit 1) results in unacceptable sales costs, though the figures are closer to the 5% target until the third year.
Plan C takes a different approach. Instead of reducing commissions to independent reps, the cost of major accounts is reduced from 7% to 6% of sales. The exercise notes that 90 percent of the sales costs of major accounts is sales compensation, so this reduction may be possible. This might be a good discussion point as well, that is, how this could be achieved, e.g., greater effectiveness, greater efficiency, reduced compensation, reduced support, better account selection, or some combination. Notice that the cost of Plan C is still above the 5% target, but it is moving in the right direction and would achieve its target in year 3 due primarily to Web sales. The problem of what to do with the independent reps and their reaction to the loss of compensation due to Web sales remains.
Plan D involves reducing major account sales to 6% and changing the commission of independent reps to 3% of sales, while compensating them at the rate of 2% on all Web sales. Under the present assumed sales mix and assuming that the program can be successfully sold to the independent reps, this plan would achieve the 5% target for all three years. Notice, however, that the target costs would be exceeded in year 4, so this is not really a long-term solution to the 5% problem.
- A major growth area in recent years has been the major account sales, what happens to sales costs if major accounts continue to grow faster than sales to small accounts resulting in an increasing proportion of total sales accounted for major accounts?
Exhibit 2 following this note examines this issue under an assumed scenario that major account sales will grow faster than smaller sales and account for 63% of total sales in year 2, and 66% of sales in year 3. This strictly an assumption since no information is provided in the scenario as to how fast major account sales have increase, but this assumption seems fairly reasonable. You may wish to give students this scenario for purpose of comparing their results to those provided in Exhibit 2.
Notice that the net effect of increased major account sales is to make it even more difficult to achieve the 5% target cost objective. This is because of the high cost of major account sales. The five plans examined in Exhibit 2 show that there is no way to achieve the 5% target without reducing the cost of major account sales. Even with a reduction in major account sales costs and a reduction in independent rep commissions (Plan E), the target is still missed in the third year. Once again, this points to the need to really manage the major account sales effort closely by ensuring that the additional costs are off-set by increased sales.
It is worth noting that even though this exercise takes into account sales costs, it does not fully address profitability. The major accounts have greater channel power and may negotiate lower prices, special discounts, or higher service costs. In this case, they will generate a lower gross margin on each sale which will drop to the bottom-line and reduce profits.
As many companies are finding out, selling and working with a limited number of major accounts can be exciting and rewarding, but can also put extreme pressure on costs and profits.
ROLE PLAY OPTION
There are several role play opportunities here. First, you could have students take the role of the national sales manager presenting to the CEO or CFO, played by another student, his or her solution for reducing sales costs to 5 percent of sales. A second role play would involve one student playing the role of the national sales manager, while a group of students assume the role of independent reps. In this role play the national sales manager is presenting his or her new compensation plan to the independent reps. Both scenarios should result in an interesting exchange and discussion of what is the best way to go and how to present the alternatives.
Exhibit 1
Sales Cost Analysis
Stable Portion of Major Account Sales
This Year / Year 2 / Year 3Major Accounts / 60% / 60% / 60%
Other: Reps / 37% / 33% / 25%
Other: Web / 3% / 7% / 15%
100% / 100% / 100%
Current Plant: Sales Costs
Major Accounts / 4.2 / 4.2 / 4.2
Other: Reps / 1.48 / 1.32 / 1
Other: Web / 0.06 / 0.14 / 0.3
As a Percent of Sales / 5.74 / 5.66 / 5.5
Plan A: Reduce Rep Commission to 3% and pay on Web Sales
Sales Costs:
Major Accounts / 4.2 / 4.2 / 4.2
Other: Reps / 1.11 / 0.99 / 0.75
Other: Web / 0.15 / 0.35 / 0.75
As a Percent of Sales / 5.46 / 5.54 / 5.7
Plan B: Reduce Rep Commission to 2% and pay on Web Sales
Sales Costs:
Major Accounts / 4.2 / 4.2 / 4.2
Other: Reps / 0.74 / 0.66 / 0.5
Other: Web / 0.12 / 0.28 / 0.6
As a Percent of Sales / 5.06 / 5.14 / 5.3
Plan C: Reduce Major Account Sales Costs to 6 percent
Sales Costs:
Major Accounts / 3.6 / 3.6 / 3.6
Other: Reps / 1.48 / 1.32 / 1
Other: Web / 0.06 / 0.14 / 0.3
As a Percent of Sales / 5.14 / 5.06 / 4.9
Plan D: Reduce cost of major accounts to 6% and pay 3% on small account sales, 2% on web sales
Sales Costs:
Major Accounts / 3.6 / 3.6 / 3.6
Other: Reps / 1.11 / 0.99 / 0.75
Other: Web / 0.12 / 0.28 / 0.6
As a Percent of Sales / 4.83 / 4.87 / 4.95
Exhibit 2
Sales Cost Analysis
Major Account Sales a Growing Proportion of Total Sales
This Year / Year 2 / Year 3Major Accounts / 60% / 63% / 66%
Other: Reps / 37% / 30% / 19%
Other: Web / 3% / 7% / 15%
100% / 100% / 100%
Current Plan: Sales Costs:
Major Accounts / 4.2 / 4.41 / 4.62
Other: Reps / 1.48 / 1.2 / 0.76
Other: Web / 0.06 / 0.14 / 0.3
As a Percent of Sales / 5.74 / 5.75 / 5.68
Plan A: Reduce Rep Commission to 3% and pay on Web Sales
Sales Costs:
Major Accounts / 4.2 / 4.41 / 4.62
Other: Reps / 1.11 / 0.9 / 0.57
Other: Web / 0.15 / 0.35 / 0.75
As a Percent of Sales / 5.46 / 5.66 / 5.94
Plan B: Reduce Rep Comm. To 3% and pay only 1% on Web Sales
Sales Costs:
Major Accounts / 4.2 / 4.41 / 4.62
Other: Reps / 1.11 / 0.9 / 0.57
Other: Web / 0.09 / 0.21 / 0.45
As a Percent of Sales / 5.4 / 5.52 / 5.64
Plan C: Reduce Rep Commission to 2% and pay on Web Sales
Sales Costs:
Major Accounts / 4.2 / 4.41 / 4.62
Other: Reps / 0.74 / 0.6 / 0.38
Other: Web / 0.12 / 0.28 / 0.6
As a Percent of Sales / 5.06 / 5.29 / 5.6
Plan D: Reduce Major Account Sales Costs to 6 percent
Sales Costs:
Major Accounts / 3.6 / 3.78 / 3.96
Other: Reps / 1.48 / 1.2 / 0.76
Other: Web / 0.06 / 0.14 / 0.3
As a Percent of Sales / 5.14 / 5.12 / 5.02
Plan E: Reduce cost of major accounts to 6% , pay 3% on small accounts, 1% on Web Sales
Sales Costs:
Major Accounts / 3.6 / 3.78 / 3.96
Other: Reps / 1.11 / 0.9 / 0.57
Other: Web / 0.12 / 0.28 / 0.6
As a Percent of Sales / 4.83 / 4.96 / 5.13