About Sales Commissions

by Krishna on January 9, 2012

Dan Ostlund at Fog Creek Software talks about how they have got rid of commissions for sales people:

We did it because we were having a lot of the problems with commissions described above even though all of our salespeople are ethical and decent. Commissions just encourage certain kinds of behavior; dysfunction is built into the logic of the system. […] So we did it, and no catastrophes struck us. No earthquakes. No plagues, and no one quit. In the year since we dropped the commission system our sales have gone up. In fact, four of the last five months have been record months.

There are many problems with sales commissions, but by introducing a fixed salary, you are introducing newer ones:

First, why did no one quit in the last one year? Usually, if people don’t find themselves earning as much as they used to, they try to find a new job. What this sounds like is that every sales person was paid a salary that was equal or close to what they were getting before. Since it is not a commission model, I am assuming that salaries are tied to an annual review: a monthly or even quarterly salary review is really a commission model without the name. In a commission scenario, the sales risk is split between the company (salesperson’s base salary) and the salesperson (their commission). Now it has almost entirely shifted to the company.

Second, was any new salesperson hired in this year? What was their salary? If their salary is similar to that of an established salesperson, that means the company is taking a huge risk (paying too much money) on an unknown resource. A good salesperson in one company may not have the same performance in another (even if they have the potential), hence the risk. But if they are starting at a lower salary, are you able to attract a salesperson who has a proven sales record and is worth investing in? The way most companies structure this is that salespeople have a base salary and, if they switch jobs, they can regain their previous income by quickly selling more so that the commissions kick in sooner. With fixed salaries, the only way you can achieve it is to keep increasing the salary as the salesperson performs, which is once again like the commission model, but locking in the risk for the company.

Third, was anyone fired this year? What is the basis of measuring the performance of a salesperson? Is it the overall company revenue or the sales closed by the salesperson? If it is the company revenue, then poor performers could coast at the expense of better sales persons. If it is individual sales, you have introduced a new commission system. In that system, very poor performance means loss of job (zero revenue), average performance means retention (with no or little hike) and good performance means a good salary hike. This is once again shifting most of the risk to the company. Unless it is a really poor market, the salesperson is usually retained or can easily find a new job.

So, there are at least 3 possible ways that you are introducing greater risk to the company. The important thing to understand with risk is that it can be independent of the salesperson. A lot of sales has to do with external factors. For example, when the economy (or an industry) slows down, companies will reduce or eliminate purchases. Usually this happens gradually and a salesperson who had been running great sales numbers suddenly hits a plateau and starts going down, despite putting the same effort as before. With a commission system, the compensation system automatically adjusts. But in a salary model, it takes time to identify the situation with the market. By then, your losses could run in the tens of thousands of dollars (and more with a large sales team). And then, you have to decide whether to lay off people or reduce everyone’s salaries.

Finally, while Theory X is counter-productive, how you approach the topic of money for people’s efforts is very important. Specifically, giving people more money does not motivate them as much as you would like. In some circumstances, giving people more money can be insulting and counter-productive. But the contrary situation where you give people less than they think they deserve: that is an absolute no-no. When people think they are being denied the fruits of their labor, they get hopping mad and will either demand more or quit producing so much.

This needs to be understood carefully. Suppose you volunteer your time at the local hospital to help some elderly patients. You are doing it out of the goodness of your heart and don’t expect to be paid. In fact, if someone offered you some money, you would feel insulted. But suppose you were hired to do the job and were told you would be paid a salary, and when the time came to get your money, they tell you, “This work is its own reward and you are gaining pleasure from the work, so we are keeping back 10% of your paycheck.” You would be outraged and quite rightly so. Essentially, employees have expectations (financial and otherwise) and you need to meet them.

So suppose you have a salesperson who is paid a salary. You asked him to bring in 15 clients and instead he brought in twenty. Well, you have to give him a good hike. Next quarter, he outdoes himself and brings in ten for the quarter. What do you do? Do you wait till the end of the year to give a hike? Suppose he brings in fifty for the year. What kind of hike does he get? What happens?

As you can probably guess from human nature, this will not go that far. As soon as a sales person starts doing way more than you had asked them to do on the basis of their fixed salary, the first thing they will look for is greater compensation. They know that the money coming in is proportional to the company’s profits. If such compensation is not provided (either in the form of higher salaries or company shares), they will most likely quit or, if that is not possible for whatever reason, calibrate their efforts accordingly.

In sum, a fixed salary serves primarily to transfer greater risk to the company and create a trend for salespersons in the company to maintain a constant sales-to-salary ratio over time. That may be acceptable to you, especially when marketing can support sales efforts in a rising economy. It may not work at other times.

{ 3 comments }

rpa January 10, 2012 at 9:18 am

Very valid points. However, Dan Ostlund didn’t mention the real reasons. The whole article felt like a long rant.

May be there is more to it. FogCreek was/is a developer centric company. It is likely that Joel started seeing Sales guys butting into the devs. Like many mature companys, a commission based sales guy will over promise features to customers and rig dev leads to implement the feature. We have numerous evidences in industry that such an intervention will eventually produce a bloatware. I am guessing fog creek has started seeing the trend. They just nibbed it at the bud. Thats all !!

As a fogbugz customer I am happy with this meausre. Thats all what it matters at the end. Happy customers!!

Krishna January 10, 2012 at 9:55 am

Me too! Though more Kiln than FogBugz (I like BaseCamp better).

You are probably right about the actual reasons. If you want the sales person to back off a deal, then they have to be on a salary.

amit ganguly January 11, 2012 at 3:31 am

Commission is certainly an incentive.If direct marketing has to be done then also the people involved need to contributed.The contribution has to be quantifiable and hence necessarily a remuneration needed.

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