In a recent article on growing margins, I discussed the “Danger Zone” of small orders with low margins as these are money-losing orders for distributors.
For most distributors, sales rep compensation plans reward reps for all sales regardless of company profitability. This disconnect between what’s good for the company and what’s good for the sales rep is something that progressive distributors are addressing as they implement strategies to improve profitability and build value in their business.
Unfortunately, most rep commission structures don’t differentiate between ideal clients and money-losing clients. Every order a rep writes gets the same commission formula, so reps get paid the same percentage of gross margin, regardless of how much profit or loss the company incurs. Progressive distributors utilize commission formulas that encourage reps to be strategic with their decisions and write more orders that are profitable for the rep and the distributor.
Randy Conley
President, Promo Consulting
Sliding scale commission formulas have been used to reward reps with higher commissions based on larger orders or higher margins – reps can earn a larger percentage of the gross profit as order size and margins increase. Often commission is calculated on an order-by-order basis, which provides an incentive for reps that is more in alignment with company goals.
Bergman Commission Model
One of the easiest sliding scale models I’ve seen was developed by Omaha, Nebraska-based distributor Bergman Incentives and is widely known as the Bergman Commission Model.
- In this model, the rep earns a percentage of the gross profit that equals the GPM% on each individual order.
- So, if the order is at 40% GPM, then the rep earns a commission equal to 40% of the gross profit.
The nice thing about this model is the simplicity and easy ability for reps to calculate commission as they quote clients. The incentive for reps is clear – the higher the margin, the larger the gross profit – and a larger piece of the gross profit goes to the rep. Of course, the opposite is also true, so reps are discouraged from lowering margins.
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Most modern commission formulas typically include an automatic floor and ceiling when it comes to margins and commission. Floors are typically set at 30% GPM, which means reps must achieve 30% margin to receive any commission and if you want above average company margins, I suggest setting this closer to 35%. The ceiling is typically set at 50% which means the most distributors are paying is a 50/50 split on high margin orders.
Sliding scale or Bergman models incentivize reps to grow margins, but what about those small orders that cost the distributor money? The answer is to also establish a minimum order size for reps to earn commission.
- Many distributors set this between $200 – $500, but with recent inflation, most larger distributors have fixed overhead costs (after sales compensation) of over $200 per order, thus the minimum order size likely needs to be even higher.
The idea is that if a rep needs to write the occasional small order for a good client, then that’s ok, but neither the rep nor the company is going to earn commission or profit on that order. But both parties make lots of money on the larger orders.
Now we have alignment, and distributors can empower reps to be strategic and make decisions that are more often win-win for themselves and the distributor. Most industry specific ERP systems can program commission formulas like Bergman and allow you to establish minimum order sizes and minimum margins for reps to earn commissions on an order.
What About Exceptions?
Sometimes distributors and reps agree that a lower margin might be needed to secure a large order or new client. That’s okay, and the suggested commission structures encourage discussions about these order exceptions. This gives the distributor and the rep the opportunity to agree on a margin and commission formula for that one order that works for everyone – just change the commission formula for that one order.
Finally, changing commission structures is a scary thought for most distributor owners. Reps understandably don’t want to hear about money being taken out of their pocket. Successful changes must include a plan to help the reps increase sales and/or margins, so they have an opportunity to raise their income at the same time the distributor increases their profit.
To recap, adjusting commission structures to align sales rep goals with distributor goals is a good way to improve profitability by encouraging business growth with very profitable clients. Commission formulas that encourage higher margins and larger orders are the easiest way to provide this win-win alignment.
As an entrepreneur with over 40 years of promo experience, Randy Conley has built his own successful distributorship, been an executive at a leading industry SaaS provider and worked with some of the top distributors in the industry as a consultant. He’s currently president of Promo Consulting, which is focused on helping distributors do better.
