PUMP IT UP: Put some muscle behind your compensation system to boost profitable sales performance.
Leader's Edge Magazine, June 2005
- To motivate salespeople for profitable growth, you have to look beyond top line performance.
- A well-rounded compensation program considers case size, retention and loss ratio in addition to growth.
You’ve got two goals when motivating salespeople. One is, obviously, to get them flashing those pearly whites to their clients and potential customers. But the other is more self-serving: you need them to feel rewarded and content so they will continue to add value to your organization. There is a delicate balance between achieving sales goals and keeping your sales pros motivated. Compensation is the sore-muscle rub for your top performers.
It’s not as easy as simply throwing money at the situation, however. Whether you are anticipating impending needs of your top-performing salespeople or they are making noise about being dissatisfied, only a well-structured plan is certain to keep your sales athletes functioning at their peak.
Start with the basics. What’s your current system? Whatever you create must blend in without creating a monster or backfiring with other staff.
Conventional producer formulas allow for a division of compensation between the company and the individual. But this is not your father’s firm, and the era when such a simple plan would work is quickly fading. Nor does such a scheme address the underlying “qualitative” aspects of the producer’s book of business.
Looking upstream, your carriers provide compensation based on loss ratio and production. But you also stand to gain from larger clients and retention. Might any or all of these four factors also be appropriate yardsticks for measuring producer compensation?
Working smarter is key in our current atmosphere of soft markets and weak relationships. Many firms are just struggling to maintain the status quo. To work smarter, you should reward producers who drive the greatest level of profitability, rather than just evaluate performance by the top line. The benefits to this strategy will improve the overall financial fitness of your business, from direct revenue to indirect expense costs, such as the two- to three-year investment of replacing a high-producing salesperson with a new team member.
In a period of intense competition and inadequate rates, the knee-jerk reaction of many firms is to work harder, to focus on volume as a way to maintain their profitability. But more time in the gym, while it builds muscle mass, by itself doesn’t win any races. Bigger is not always better.
Why? A prime reason is that you’re creating significant exposure to adverse selection of business. By intensely focusing on new accounts, you’re more likely to take on bad risks. Athletes and their coaches know that pushing oneself too hard can backfire.
This path also ignores a prime maintenance issue: client retention. Because the true cost of securing a new account is significantly higher than maintaining an existing customer, by intensely focusing only on new clients, you are knocking the supports out from under yourself.
Consider all the expenses in finding new clients: sourcing new markets, spending time doing client support, buying advertising and collateral, or spending administrative time working with carriers and getting new accounts on the books. Consider the cost of your time coaching sales staff and directing their efforts. No, it is far better to maintain and retain existing clients, as renewal revenues are typically more efficient to the overall firm resources.
Do your sales professionals believe their success is gauged simply on the amount of new business they bring in? If so, their efforts may be misdirected. To follow through on your goal of retention, you must motivate salespeople to provide consistently stellar service to existing clients.
There’s opportunity beyond retention, too. Average case size is a factor that is too often overlooked as a metric to motivate a sales professional. The greater the overall average client revenue per case, the greater the “contribution” of profit to the firm. The larger the case, the less direct or incremental cost per revenue dollar is being spent. Thus, the firm will ultimately derive a greater profit margin. It’s in your best interest to calculate this number for each producer and explain why it’s important.
Toward a New Plan
Talking about which metrics you should evaluate is like reading about the best exercises to get those six-pack abs. To see any benefits, you have to put down this magazine and start working out. So, how do you apply your understanding of these metrics to a revised form of compensation, one that drives new, healthy growth to the firm and balances the producer’s and the firm’s objectives?
You must derive a formula that is unique to your business. The best formula blends the base pay for production (traditional fixed commission rates) with a matrix-based incentive that combines qualitative and quantitative measures.
Let’s use an example of a key producer who holds a 50% provisional commission on his own book of business. Figure 1 shows that, based on $895,000 in revenues, the producer receives provisional compensation of $447,500.
How do we create a significant increase in his compensation by adding incentives? Figure 2 illustrates how to calculate a “Variable Compensation Matrix.” It shows four key areas that can be used to gauge the producer’s qualitative as well as quantitative results:
1. Production Growth Base Incentive. This shows that, if he quantitatively increases his base by certain percentages, he will get a bonus scaled to the volume of increase.
2. Loss Ratio Variable. In this metric, a lower loss ratio results in a higher bonus factor, tying his book of business to risk performance, just as a carrier calculates its success. This is a qualitative measure.
3. Average Case Variable. This quantitative measure is based on the size of each client’s purchase. If the producer can, through cross-selling or marketing to more lucrative clients, gain a greater average case size, he should be compensated for it. A larger client can drive better profits to a firm because the greater commissions will not be offset by greater administrative costs. The bonus factor goes up as the average case size rises.
4. Persistency/Retention Variable. Similarly, if a client stays with the firm, better profits are realized than received from new clients, due to the acquisition cost. The higher the retention percentage, the better the bonus factor allocated to the producer.
One caveat to these metrics is that they will, by necessity, vary from firm to firm. The lines of business sold will have a factor on retention, case size and loss ratio. The marketplace and economic situation will affect the ability to increase production, as well as have an effect on the other factors. The incentives must be aligned with your business goals. Finally, all factors must take into account the historical profitability of the firm because only you can calculate how much value you will derive from, for example, additional business or higher rates of retention.
Let’s get back to our star athlete and his compensation package. Figure 1B shows the bonus calculations. Based on gross revenues, he earned a 10% production growth factor. He falls into the high-middle of the chart, which will show him that an incentive for improvement exists. Similarly, his loss ratio is good at 44%, but by lowering it he could add to his bonus. He’s maxed-out on the last two metrics, average case size and persistency/retention, but his excellence on these variables add to his bonus. This provides incentive for him to keep those great results.
With this scheme, you have effectively rewarded the producer for good performance and shown him how he’s contributing in all these ways to the success of the firm. The firm sustains gains in efficiency, lower incremental support costs and higher profit margins. If this model could be replicated among a team of producers, this firm would be a very high-performing entity within the upper quadrant among its peers. In fact, to effectively contribute to overall firm performance, this plan must be deployed to an entire sales unit, and not just one producer. All ships rise with the tide, so this type of plan can have the effect of unifying the firm.
An athlete will get a bigger boost from Gatorade than from water, and high-performing producers need significant incentives in order to perform. This style of plan provides it. He’s added nearly 20% to his compensation.
A good incentive plan adds to firm reputation, carrier relationships, a staff that works smarter instead of harder and, ultimately, shareholder value. Conversely, if a firm squeezes margins and profit distributions, it would be forsaking long-term profitability for short-term gains. You could expect higher producer turnover and inappropriately aligned incentives that create greater back-office costs, organizational distraction, constant reinvestment in the sales infrastructure and lost contingents due to a lack of quality. These are the factors by which you can separate the Olympian firms from the weekend warriors when doing peer analysis.
You’re coaching a team of athletes to do their best. By taking a long view of their health and well-being as well as your team record of wins versus losses, your players will be better equipped to help the team meet its goals.
Just like building a championship season, though, you can’t expect results overnight. If you want to introduce a matrix-based incentive compensation plan, it is far better to take an evolutionary vs. a revolutionary path. Build the program slowly, with input from financial advisors and the salespeople themselves. Gain buy-in as it’s developed.
Keep in mind that implementing such a plan will carry additional administrative and systematic burdens and costs. Look at these as investments in the growth and quality of your firm’s book of business.
After all, as competition increases and recruitment of those star athletes intensifies, you want your program to present the best package, one that differentiates itself from all the other teams a top producer could join. If you can accomplish that, you’ve won before you ever hit the field.