Sales Compensation Strategy: Cost of Sales vs Cost of Labor

Stages of Company Maturity

"When looking at costs and doing comparisons and understanding ROIs, you have to understand that organizations are typically going through an evolution in any given time (whether it be a company itself, or whether it be divisions of companies)." Joseph DiMisa told us in a recent BLR webinar. There are typically three stages of maturity of an organization (or division within an organization):

• The early stage—more of a start-up division or company
• Market momentum—the company is becoming entrenched and more significant in the marketplace
• Maturity—the company has a long-term growth strategy and may be a market leader or dominant in the space

"The type of goals and objectives and the things that you’re measuring (and the costs and the ROI) are different for each stage of maturity that an organization goes through." DiMisa explained. In the early stage, the company uses more of an acquisition model. Both costs and ROI are typically higher. The company is looking for almost any form of revenue ("any dollar is a good dollar"). Cost of sales may be high, but growth is key.

At the momentum stage, companies are looking for more profitable revenue growth. They’re looking for specific product sales to drive long-term growth.

At maturity, companies are more likely to use sophisticated coverage models and have varying sales roles. The cost of sales varies, depending on how entrenched the company is. There are probably recurring revenue streams to focus on retaining and growing.

Comparisons on ROI need to take the maturity stage into account and how the costs incurred will vary. Over time, the growth strategy and sales compensation strategy should change. Typically companies will move from a cost of sales (product and sales driven compensation) approach to cost of labor (market driven compensation) approach.

Sales Compensation Strategy: Cost of Sales Versus Cost of Labor

In a cost of sales approach, the company bases the dollars paid to salespeople on the volume they’re bringing in. The focus is on the cost and the revenue associated with that cost. Payouts are typically based on a percentage of volume or dollars per unit sold. Market pay survey data is usually not used.

In a cost of labor approach, the company is more focused on the individual and how much they need to pay that individual based on what the market is paying. More market research is needed to find typical pay. Compensation can still be tied to a quota/goal, but that is also tied to a standard industry performance benchmark.

Costs will vary in these two scenarios. Which is right?

"Compensation is part art, part science. Any tools or methodologies or concepts that you can apply to the thinking will really help you answer some of the questions. At the end of the day, there’s really not a ’best practice closet’ that you can look to to go get an answer. The best practice is really making sure that your philosophy is aligned, or your business strategy is aligned to your comp plan." DiMisa told us.

That said, there are some guidelines for when each approach is typically used.

Which Sales Compensation Strategy Is Right for your Organization?

Here are some situations where cost of sales is typically used:

• In start-up businesses
• When there are lots of transactions
• When the sale transaction or sales process is relatively simple
• When the salesperson is the main point of contact and has control over the sale (and the customer buys directly from him or her)
• When pay is the primary performance measure (sell more = pay more)
• When the sales people are "lone rangers"

Here are some situations where cost of labor is typically used:

• In mature businesses and complex sales organizations
• When the sales transaction requires a consultative selling approach or relationship building
• When the transactions are complex
• When the company controls the sale after the salesperson brings in the customer (i.e. the customer is buying from the company, not the individual)
• When the sales require significant support from the company

For more information on creating an effective sales compensation strategy, order the webinar recording of "Sales Compensation Plans: How To Measure ROI to Find Out If Your Strategy Is Truly Working." To register for a future webinar, visit http://catalog.blr.com/audio.

Joseph DiMisa is a senior vice president and the head of the sales effectiveness practice for Sibson Consulting. His areas of expertise include working with companies to develop and implement direct and indirect compensation plans, sales strategies, and sales effectiveness programs.