A Preface to Payment: Designing a Sales Compensation Plan

FOR SOME decades now, marketing textbooks and professors have assiduously distinguished between sales and marketing. Theodore Levitt’s 1960 definition is still the classic: “Selling is preoccupied with the seller’s need to convert his product into cash; marketing with the idea of satisfying the needs of the customer by means of the product and the whole cluster of things associated with creating, delivering, and finally consuming it.”1 Nonetheless, whatever else marketing encompasses, it certainly includes selling—the getting and keeping of customers and revenues. As the old saying goes, “In most companies, sales is the only revenue-generating function; everything else is a cost center.” Sales’ importance as a source of revenue tends to define the form and substance of companies’ marketing programs—for both good (e.g., close attention to buying processes at specific accounts) and ill (e.g., confusion between sales and marketing).

Of all sales issues, compensation is probably the most discussed. It is now the focus of a vast and varied literature with enough folk wisdom and quantitative studies to satisfy most managerial temperaments.2 But the great bulk of this literature focuses on what might be called “compensation hydraulics”: push this pay lever, is the typical claim, and get this kind of field sales behavior. Lost in this approach is a recognition that sales compensation is an area in which data analysis, values, and the motivation of complex human beings are inextricably linked. The frequent result is that managers, focused on the hydraulics, forget that addressing the fundamental question, “How should we pay the people responsible for dealing with customers?” inevitably implicates a range of issues involved in sales management, as well as other aspects of the business. The emphasis of the sales compensation plan will affect the quantity and kinds of orders received by manufacturing, the cash-flow profile managed by finance, the recruitment and training needs faced by marketing and personnel, and the daily organizational interactions between sales and all of these other functional areas.

To make these decisions, managers need a preface to sales compensation which outlines the issues that must be addressed before worrying about the specific numbers or debating between incentive-based and fixed-salary plans.

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References

1. T. Levitt, “Marketing Myopia,” Harvard Business Review, July–August I960, pp. 45–56.

2. A seminal and still pertinent discussion of sales compensation is the two-volume study by H.R. Tosdal and W. Carson, Jr., Salesmen’s Compensation (Boston: Harvard Business School Division of Research, 1953). For more general discussions for managers, see:

J.K. Moynahan, Designing an Effective Sales Compensation Program (New York: AMACOM, 1980);

C.A. Peck, Compensating Field Sales Representatives (New york: The Conference Board, Research Report No. 828, 1982); and G.A. Churchill, N.M. Ford, and O.C. Walker, Sales Force Management (Homewood, Illinois: R.D. Irwin, 1985), ch. 14.

The more theoretically oriented, marketing-models literature has also devoted considerable attention to the design of “optimal” sales force compensation systems. Under assumptions about the salesperson’s objective function (usually, to maximize income), constraints under which the salesperson operates, and the firm’s knowledge of the individual salesperson’s sales-response function, these studies have generated models for considering how the firm can set compensation to maximize the firm’s profits across a line of products or accounts. The key managerial decision at issue in these models is the amount and composition of commission pay versus “fixed” salary. Important studies here include:

J.U. Farley, “An Optimal Plan for Salesmen’s Compensation,” Journal of Marketing Research 1 (1964): 39–43;

C.B. Weinberg, “Joindy Optimal Sales Commissions for Non-Income Maximizing Sales Force,” Management Science 24 (1978): 1252–1258;

R. Lal and R. Staelin, “Salesforce Compensation Plans in Environments with Asymmetric Information,” Marketing Science 5 (1986): 179–198;

and, for an excellent review and extension of these previous studies,

A.T. Coughlan and S.K. Sen, “Salesforce Compensation: Theory and Managerial Implications,” Marketing Science 8 (1989): 324–342.

Broadening the focus from sales compensation per se, a relevant review of the connections (and contradictions) between many common features of organizational incentive systems and traditional economic theory is available in J.E. Stiglitz, “The Design of Labor Contracts: The Economics of Incentives and Risk Sharing,” in Incentives, Cooperation, and Risk Sharing, ed. H.R. Nalbantian (Totowa, New Jersey: Rowman & Littlefield, 1987), pp. 47–68, and

G.P. Baker, M.C. Jensen, and K.J. Murphy, “Compensation and Incentives: Practice versus Theory,” The Journal of Finance 43 (1988): 593–616.

An interesting discussion of recent developments in pay practices is provided by:

R.M. Kanter, “From Status to Contribution: Some Organizational Implications of the Changing Basis of Pay,” Personnel, January 1987, pp. 12–37.

3. More formally, motivation in the personal selling context has been defined as “the amount of effort the salesperson desires to expend on each activity or task associated with the job. This may include calling on potential new accounts, developing sales presentations, and filling out reports.” Churchill et al. (1985), ch. 13, provide this definition as well as a general review of the marketing literature on sales motivation.

In recent years, “attributional” theories of motivation have become common in personal selling research. This approach views people as motivated to maximize rewards but also “to attain a cognitive mastery of their environment”—that is, they want to know why an event occurred, why they succeeded or failed at a task, and what to attribute for success or failure. Their answers to these questions affect their future behavior. A comprehensive review of this theory and empirical evidence for it are available in B. Weiner, Human Motivation (New York: Holt, Rinehart and Winston, 1980). For its use in the sales context see:

H. Sujan, “Smarter Versus Harder: An Exploratory Attributional Analysis of Salespeople’s Motivation,” Journal of Marketing Research 23 (1986): 41–49; and

A. Dubinsky, S. Skinner, and T. Whittler, “Evaluating Sales Personnel: An Attribution Theory Perspective” Journal of Personal Selling and Sales Management 9 (1989): 9–21. This view of motivation is implicit in my discussion of compensation, evaluation, and motivational links in this article.

4. The relationship between territory characteristics and sales performance lends itself well to quantitative modeling which, in turn, can be a useful input to quota-setting and compensation design. A number of territory-design models have been developed, and declining costs of information technology have made such models increasingly available and practical for companies. For review of the underlying theories, see:

L. Lodish, “ “Vaguely Right’ Approach to Sales Force Allocation,” Harvard Business Review, January–February 1974, pp. 119–174;

A. Ryans and C.B. Weinberg, “Sales Territory Response,” Journal of Marketing Research 16 (1979): 453–465;

A. Zoltners and P. Sinha, “Integer Programming Models for Sales Resource Allocation,” Management Science 26 (1980): 242–260; and

R.W. LaForge, DW Cravens, and C.E. Young, “Using Contingency Analysis to Select Selling Effort Allocation Methods,” Journal of Personal Selling and Sales Management 6 (1986): 16–31.

5. Although not concerned with sales situations, per se, a classic analysis of reward systems that “pay off” for one behavior while the rewarder hopes for another is S. Kerr, “On the Folly of Rewarding A, While Hoping for B,” Academy of Management Journal 18 (1975): 769–783.

6. Sales and Marketing Management magazine publishes an annual survey of competitive pay levels. It provides data, by industry, on average annual compensation levels for different categories of sales personnel (e.g., sales trainee, mid-level salesperson, top-level salesperson, sales supervisor), by region, educational level, and other variables. Other standard sources include the biennial survey, “Salesforce Compensation,” published by Dartnell; and TPF&C’s annual “Sales Compensation Survey,” a data bank that covers different types and levels of sales positions and also looks at various companies’ policies in the areas of benefits, expenses, perquisites, and design of incentives. Interestingly, these sources usually provide different numbers in a given category, because each defines and aggregates its categories differently. This in itself can be useful, spurring thinking about the activities that do and don’t seem relevant for a given sales position in the company.

7. The notion of “transaction-specific assets” is developed most fully by the economist O.E. Williamson in “The Economics of Organization: The Transaction Cost Approach,” American Journal of Sociology 87 (1981): 548–577; and

O.E. Williamson, The Economic Institutions of Capitalism (New York: The Free Press, 1987). Applications of Williamson’s theory to sales compensation include

G. John and B. Weitz, “Salesforce Compensation: An Empirical Investigation of Factors Related to Use of Salary versus Incentive Compensation,” Journal of Marketing Research 26 (1989): 1–14.

An interesting application of transaction-costs theory to more general issues in sales management is

E. Anderson and R.L. Oliver, “Perspectives on Behavior-Based Versus Outcome-Based Salesforce Control Systems,” Journal of Marketing, October 1987, pp. 76–88.

8. See B.D. Dunn and S.E. Morrison, “Incentive Compensation Programs for Private Banking,” The Bankers Magazine, July–August 1989, pp. 16–19.

9. For discussions of how these factors affect the salary-incentive mix, see John and Weitz (1989);

Coughlan and Sen (1989); or

G. Tubridy, “How To Pay National Account Managers,” Sales & Marketing Management, 13 January 1986, pp. 50–54.

10. See FV. Cespedes, “Toward a Conceptual Understanding of Sales Coordination” (Boston: Harvard Business School, Working Paper No. 89–046, January 1989).

11. I am indebted to Robert J. Freedman, a vice president and specialist in sales and executive compensation at TPF&C, for the example provided as Figure 2 of this article. A similar point concerning the interrelationship of goal-setting and reward systems is made by Moynahan (1980), pp. 26–28.

12. F. Herzberg, “One More Time: How Do You Motivate Employees?” Harvard Business Review, September–October 1987, pp. 109–120.