Pay for Play: A Case Study in Sales Compensation
Back in 2014, the logistics company I own had a serious problem: our gross margin on sales was too low. In our industry, the average gross profit margin sits between 14-15%, but that year, we only managed to squeak out 12.45%. We were obviously under-pricing ourselves, AND we still had to bear the same administrative costs on those loads—paying our support staff to do all the work needed to set up carriers, process bills, create invoices, etc. After payroll, overheads, debt service and capital investments, there was nothing left over. Our net profit margins were incredibly slim, and that put us in a precarious position as we looked toward the future.
The question of how to fix this problem loomed large at the end of the year. We knew we had to waste less time on low-margin freight and get our sales folks focused on closing customers who were less price-sensitive. We offered high levels of service on difficult freight, and we needed to find customers who appreciated our expertise and partnership, and were willing to pay for it.
At the time, our sales compensation was simple—all our salespeople earned the same commission rate no matter what their gross profit margin was on a load. It didn't matter if they made 1% or 50% margin. Of course, the dollar amounts changed significantly, but there was no additional incentive to negotiate for a higher margin, so they often just took the first offer from a carrier and moved on. They were leaving money on the table, and they were spending time on customers who were too price-sensitive and thus ignoring the potential business available from customers who were willing to pay a premium for excellent service.
Any good sales compensation plan takes into consideration your financial goals—whether you want to compete on price, margin, service, volume, etc.—and incentivizes appropriately. Our commission arrangement was incentivizing volume over margin, and it was honestly not surprising that our margins were suffering. We had to shift the focus, and do it in a way that allowed us to keep making money while still allowing our salespeople to earn roughly the same amount.
In designing this plan, we broke out each individual salesperson's profitability and compensation, while also looking at the market trends from the previous three years. We settled on a plan that gave significant upside potential to the majority of the sales team while still preserving our ability to pay for overheads and invest in capital improvements. We ended up breaking our commission structure into three tiers:
Tier One - Last Resort
The first tier, which paid 13 percentage points less than their current commission rate, was for all freight moved below 12% gross margin. We wanted everyone to understand that this was undesirable freight, and that if they were going to move it, they weren't going to make as much money as they used to. They either needed to negotiate better rates from customers, lower pricing from carriers, or pass on the opportunity to move this freight and focus on higher-margin freight from other customers.
Tier Two - Goldilocks
The second tier paid 10 percentage points more than Tier One, and just 3 percentage points below their current commission rate, and applied to all freight moved between 12-19.99% gross margin. This was the spot where most of our salespeople would settle, and it allowed them to earn good money on a wide swath of freight while still covering the company's expenses.
Tier Three - Jackpot
The third tier paid 5 percentage points more than their current commission rate and applied to all freight moved for greater than 20% gross margin. This was jackpot freight, where customers were willing to pay premium pricing for excellent service, and our salespeople were able to negotiate lower rates from trucks, either for dedicated service, or because the market would bear it.
We rolled this plan out in December of 2014, to begin on January 1, 2015. Rolling out compensation changes is always tricky business, but we over-communicated through the process, and showed all our salespeople how we wanted them to work smarter, not harder, and to make more money for doing the same work they'd been doing already. We showed them where negotiating an extra $50 or $100 on many of the loads they'd moved in 2014 would push them into higher commission brackets, and make the company more money. We had no problem if a salesperson made more commissions in 2015 on the same freight because that meant they were finally demanding the price they were worth in the market.
It only took us a few months to see the fruits of our labor—by the end of Q2 2015, our margins had climbed to 13.58%, and by December, we'd increased gross margin to 14.95%, an astonishing improvement that put us right in line with industry averages. At the end of 2016, after two years on this plan, we were beating the industry with 16.16% GPM and we've hovered right around that number ever since.
Leveraging our sales compensation plan allowed us to be more profitable with the same number of employees, the holy grail of business growth. And any new salespeople we brought in were automatically incented to negotiate a little harder and seek out customers who were willing to pay us what we're worth. These changes were a resounding success, and I would encourage anyone facing the same type of issues to look critically at how your people are being compensated, and see if you can't move the needle with a revised plan.