While previous articles is this series have addressed the two most prevalent types of sales personnel compensation — salary and cash difference — this column focuses on a system that is not used as frequently, yet should yield significantly greater results. It is a sales compensation system based on the equipment gross margin.

Based on earlier survey results, 58% of dealers paid sales personnel on the basis of either salary or cash difference, while only 21% of responding dealers paid their sales staff on the basis of the gross margin that they earned. Traditional dealers have resisted paying on the basis of the gross margin out of the misguided belief that the salesperson would be making too much money, while order takers who dominate the equipment industry landscape have an innate aversion to being rewarded on the basis of performance. No wonder that salary and cash difference remains the preferred method of sales compensation.

Compensating sales personnel on the basis of gross margin could take many forms, but the two most common types of gross margin compensation are as follows:

• 25% of the gross margin, or
• 25% of the gross margin plus a very small salary.

The following numbers illustrate the level of compensation for various transactions when sales personnel are compensated on the basis of 25% of the gross margin.

Based on the above transactions, a $20,000 reduction in the sales price will result in a $5,000 reduction in compensation. While gross margin-based compensation does not guarantee, or even suggest, the viability of achieving list price, it should encourage sales personnel to “hang in there” and sell the benefits of the product, the dealership and themselves.

For example, if the salesperson was able to generate an additional 3% on Transaction #3, the salesperson would collect an additional $2,400 in cash and their commission would increase by $600, or 80%. Now that is an incentive to sell value.

When compensating sales personnel on the basis of gross margin, actual remuneration may take the form of either a monthly commission check or a monthly draw. The monthly commission check is based on what the salesperson earned, either for that month or, more likely, for the previous month. There are, however, two basic problems with the monthly commission check. During slow selling periods, the lack of income may discourage the salesperson. On the other hand, during frenetic selling periods, a large commission check may adversely affect the dealership’s cash flow.

One way to compensate the sales force while “smoothing out” the dealership cash flow is to pay them on the basis of a monthly draw. Using separate accounts for each salesperson, commissions are credited and periodic withdrawals are made. This monthly draw should be high enough for the salesperson to meet basic monthly expenses but low enough to motivate the salesperson to generate additional revenue. Then, the dealership “squares” up with the salesperson either on a quarterly, semi-annual or annual basis.

While gross margin-based compensation will almost certainly increase the equipment gross margin, it may or may not increase the used equipment turnover. To simultaneously increase the equipment gross margin and the used equipment turnover, a simple modification to the compensation plan could be made.

A portion of the compensation could be held back until the used piece of equipment is sold within a specified period of time stipulated by the salesperson. This could be accomplished by paying 10% of the gross margin up front at the time of the sale and the other 15% when the used unit is sold within the specified period of time. If the used unit is not sold — whether by the individual salesperson or any other salesperson — then the dealership keeps the unpaid commission to cover the carrying costs of the used equipment. This then shifts some of the costs of ownership to the sales force.

A simpler modification that could also focus the salesperson on both the margin and turnover would be to pay a lower commission on the new sale and a significantly higher commission on the used sale; for example, 15% on new and 35% on used; or 20% on new and 40% on used.

Gross margin-based sales compensation is especially successful when the sales personnel are overachievers and the sales tasks are clearly defined by the sales manager/dealer. On the other hand, if sales personnel are traditional order takers, this system may only force them to seek employment elsewhere, which is also not necessarily a bad thing. Remember, when paying sales personnel, it is not about how much you pay out, but rather, what you get in return.