The Cost of Doing Nothing:
Financial Impact of Sales Compensation Problems
The ineffective management of sales compensation plans causes significant and often hidden costs, which fall into six categories.
Good sales compensation plans embody the strategy of the organization and drive sales force behaviors. If each sales rep understands the plan and receives frequent, timely, and accurate feedback, the plan motivates and challenges them to strike better deals. However, problems often arise, rendering sales compensation plans ineffective.
Optymyze analyzed over 100 companies with large sales forces and identified six major sales compensation problems that have direct ties to financial performance. These issues also disrupt productivity and break the link between strategy and execution.
1. Cost of Administrative Resources
Highly skilled administrative resources – sales operations managers and analysts, HR managers, compensation analysts, finance managers, finance analysts, and auditing managers – are also highly paid. When companies do not closely manage and correct sales compensation problems at the source, they simply hire more administrative staff to fix them, increasing costs by hundreds of thousands of dollars per year.
As organizations expand and hire more sales reps, they also need dedicated compensation analysts and sales managers. The ideal ratio of sales managers or compensation managers to sales reps is subject to many variables. However, experts suggest a ratio of 1 : 15-20. That is, one sales manager for every 15 to 20 salespeople.2
Many organizations direct Human Resources or Finance to fix sales compensation problems. This requires highly-paid HR professionals with skills in performance management and organizational development, or expensive finance analysts and auditing managers.
Sales management, HR, finance, and sales operations all ultimately play a role in managing sales compensation – maintaining the system, processing payments, reprocessing and correcting inaccurate payments, making system changes, and handling inquiries and disputes.
Focusing so many highly skilled resources on sales compensation management is not only extremely expensive, it also overburdens staff who already have a full plate of responsibilities, and causes the organization to miss opportunities when highly trained staff are taken away from strategic projects in order to settle compensation disputes.
The average pay for a Compensation Analyst in the US lies in the neighborhood of $58K per year, while the salary of a Human Resources Manager is $60,499 per year.1
2. Cost of Information Technology Resources
Information technology (IT) staff includes IT managers and analysts, data analysts, software developers, and software testers. As with administrative resources, IT resources maintain and support the existing system, process compensation payments, manage system errors, oversee data processing, and correct server or connectivity issues. Ignoring sales compensation problems can increase time spent on system errors, maintenance, and ensuring the compensation system communicates with other systems.
In addition to staff costs, IT pays annual fees for licensing third-party software, incurs periodic expenses for infrastructure maintenance and upgrades, and suffers opportunity costs when IT staff are not taking on more important, innovative projects.
3. Cost of Overpayments and Errors
Sales compensation problems can cause overpayments and other costly errors, which occur at a higher rate in companies with global operations. Diagnosing and correcting these failures falls squarely on sales operations and finance managers.
Some overpayments are caused by known, but unfixable problems, while others are caused by human or technical errors. Both can lead to regulatory non-compliance and related auditing fees, fines, and decreased stock valuation. A chronic cycle of mistakes and corrections often causes high turnover, lost selling time, and lack of motivation, which indirectly decreases revenue and margins. In the end, the cost of overpayments and errors can jump to over $300,000 a year, depending on the payroll variable and non-compliance consequences.
Gartner revealed that up to 8% of all sales compensation expenditures are overpayments, while Aon Hewitt estimated that variable pay is over 11% of total payroll.
4. Cost and Lost Revenue Due to Sales Force Turnover
When salespeople do not understand their sales compensation plans or develop a lack of trust in the plan, turnover increases, especially among top performers. This translates to increased recruiting, hiring, and training costs. In addition, revenue and margins suffer as new hires with less experience ramp up to full productivity.
The average turnover rate for sales organizations is 35% – an expensive problem for any company, in terms of hiring and training a replacement. With the average sales rep receiving $3,400 in training per year, adding 10 new reps can dramatically impact the budget.
In highly regulated industries such as insurance, turnover makes it even more difficult to sustain sales momentum. Studies reveal that 60% of employees leave the insurance sector in less than one year after getting hired.3 Research attributes this to compensation problems, reinforcing the need to deal with issues right away to avoid disputes and frustrations.
If you multiply the average training cost per year by the high number of agents in a large insurance company, turnover costs can easily run into hundreds of thousands of dollars every year.
The cost of hiring and replacing a lost worker is 150% of the previous worker’s annual salary, and even more for people who are highly trained or who have specialized skills.
5. Lower Revenue Resulting from Less Selling Time
Revenue suffers when salespeople spend time on activities other than selling, yet sales compensation management problems lead directly to salespeople engaging in more non-sales tasks. From shadow accounting and plan inquiries, to disputing plan results and complaining to others about them – sales compensation problems decrease selling time, decrease motivation, and increase turnover.
In addition, sales managers spend more time handling inquires and disputes, further degrading sales’ ability to generate revenue. Depending on the business, lost selling time can have a financial impact ranging from hundreds of thousands to millions of dollars.
60% of sales reps’ time is spent on activities unrelated to selling, such as shadow accounting.
Source: CSO Insights
6. Lower Revenue and Margins Because of Undesirable Behaviors and Poor Motivation
For most companies, the greatest cost of poorly managed sales compensation plans is related to behavior and motivation of salespeople. These costs are largely in the form of lower revenue or margins resulting from sub-optimal customer targeting, selling the wrong products or services, and excessive discounting.
Furthermore, the inability to adapt sales compensation plans in response to changes – including new sales strategies and tactics, new products, discontinued products, changes in pricing, and competitive movements – results in lost opportunities that lower revenue and margins.
Mix of Costs
Figure 1 – Average mix of costs associated with mismanaging sales compensation plans
Every organization has a different mix of costs stemming from mismanagement of sales compensation plans. Figure 1 depicts the average relative mix of those costs in each of the six categories, as revealed by the Optymyze study on over 100 large sales organizations. Each of the costs discussed above is related to one or more of the six sales compensation problems plaguing organizations. Figure 1 maps problems to their related costs.
Figure 2 – Six sales compensation management problems and cost correlation
Root causes of problems
Most organizations, at least initially, wrongly attribute the root cause of the six sales compensation problems to an inflexible system for managing sales compensation plans. However, the Optymyze analysis reveals this is rarely the case, as all of the problems associated with ineffective sales compensation management can be traced to three root causes (as shown in Figure 3).
In most sales compensation management systems, the plan logic is hard-coded into data extraction and integration routines, crediting methodology, earnings and payment calculations, and report creation and distribution processes. Even a minor change to any one of these becomes a major programming project.
Problems occur when rigid, hard-coded systems collide with a need to frequently tweak sales compensation plans to keep them up-to-date with the company’s strategy and objectives. When plans cannot be rapidly and frequently modified, they quickly fall out of alignment with strategy.
While many problems are often a result of an inflexible system, the more common root cause is labor-intensive, manual, inefficient processes. These processes produce errors, delay payments and reporting, trigger excessive disputes and inquiries from the field, and result in unproductive rework by time-constrained staff.
Most inefficiency stems from poorly documented or manual processes for data extraction, integration, and validation. These upstream processes cause many of downstream problems. If problems can be discovered and corrected after each step in the process—rather than at the end of the process—delays and errors are eliminated.
To avoid these problems, organizations must thoroughly evaluate and redesign processes with automation and centralization in mind, and then document processes clearly. Then, the company can automate the right processes and improve efficiency, productivity, and consistency across the organization.
Lack of Expertise, Experience, and Time
Sales compensation management is a complex, administrative process with significant strategic implications. Salespeople must be paid accurately and on time. Sales management must have a good understanding of the performance of their people. And sales executives must know how well plans are working so that changes can be designed and modeled if needed. All of these processes take specialized expertise—and sufficient time—to do them well. Yet, most organizations are unaware of sales compensation management best practices and lack a consistent, reliable source of expertise.
In addition, sales compensation management is often too dependent on a few key resources that cause a bottleneck, or staff cannot devote sufficient time to value-added process improvement because they are continually bogged down correcting errors.
Figure 3 – Root Causes of Sales Compensation Management Problems
Almost every sales organization swears by the accuracy and effectiveness of its sales compensation plans. Yet most organizations find themselves saddled with the impact of poorly managed plans, uncertainty over what can be improved, and how to go about it.
Of the root enablers, a flexible system and efficient processes are essential to success. However, true success comes only from dedicating people with the expertise in implementing and managing processes – the foundation for solving sales compensation management problems.
1 http://www.davekahle.com/qa/manage.htm, last accessed 18-05-15
2 http://www.payscale.com/research/US/, last accessed 18-05-15
3 International Research Journal of Management Science & Technology, http://www.academia.edu/, last accessed 18-05-15