Sales Challenge: Should We Reward Based on Profit Margin Rather Than Revenue?

Most sales challenges involve offering a reward (often monetary) to salespeople who make the most sales. This ‘pay-for-performance’ approach has proven effective in motivating sales staff to work hard to improve sales results.

But today, companies don’t just expect salespeople to make sales, but profitable sales. This means that sales management can set clear and measurable margin objectives.

For example, when an industrial machinery manufacturer* organized a sales challenge based on gross margin instead of sales, the message to the sales force was clear and the impact immediate. Salespeople granted fewer discounts and focused their efforts on the most profitable product lines, which led to margin growth.

Conversely, in the case of a medical imaging company, the experience was a failure. Frequent changes in production and distribution costs, and variations in granted discounts, turned the calculation of margins by sales territory into a nightmare. The plan was abandoned after only one quarter.

Sales Challenge: What If We Rewarded Based on Margin?

Who Can Implement Margin-Based Rewards?

To help you determine if you should consider rewarding your salespeople based on margin, start by asking yourself two questions.

1. Is profitability a priority?

Sometimes companies sacrifice profitability in favor of objectives such as increasing market share, blocking a competitor, or entering a new market. Only consider rewarding your sales force based on profitability if profitability is a strategic objective.

2. Do your sales force have real control over the margin?

Salespeople who sell only one product at one price have no impact on gross margin; they mechanically increase profit by increasing sales volume. Thus, there is nothing to gain by challenging them based on margin: the result will be the same. Salespeople can increase gross margin when: 1) they can influence the price and/or 2) they sell multiple products with different margins.

Challenging the sales force based on profitability only makes sense if at least one of these two conditions applies.

How to Encourage Salespeople to Prioritize Margin?

If profitability is both a strategic priority and controllable by salespeople, then these four additional questions will help you determine the best approach to achieve more profitable sales.

1. Can you measure gross margin at a territory level?

Sometimes it is too complicated or too expensive to estimate gross margin at each territory level within a reasonable timeframe. If the cost is too high, consider other options to encourage more profitable sales. (See questions 3 and 4).

2. Do you want to share profitability data with your salespeople?

If you want to protect the confidentiality of your profit margins from your customers and competitors, you should avoid sharing margin data with your sales force. Some companies* have successfully organized sales challenges based on relative margins, i.e., artificial margins that reflect the relative profitability of products (among themselves), without revealing true margins. However, relative margins still reveal a lot of information. If confidentiality is a priority, consider other ways to encourage more profitable sales. (See questions 3 and 4)

3. Do salespeople have an influence on pricing?

If the cost of measuring and sharing gross margin by territory is too high, then organizing a sales challenge based on the average selling price is a good alternative to encourage profitable sales, when salespeople have an influence on pricing. For example, during a sales challenge, an office supplies manufacturer had an incentive plan with a multiplier linked to the effective average selling price.

• For sales closed below 3% of the base price, salespeople received the base commission.
• For sales signed between plus and minus 3% of the base price, salespeople received the base commission multiplied by 1.1.
• For sales closed above 3% of the base price, salespeople received the base bonus multiplied by 1.25.

The multipliers discouraged the sales force from making price concessions to inflate their volumes.

4. Do you want to boost sales of products with the highest gross margin?

If measuring gross margin is too complicated, reward based on the product category: priority or non-priority. For example, a technology company created a reward program for its sales challenge with two product categories: ‘strategic products’ (the newest products with high strategic importance and a gross margin above 50%) and ‘essential products’ (older products with an average gross margin of 30%). Salespeople received a 5% commission on sales of strategic products, but only 2.5% on sales of essential products.

The difference in commission rates encouraged salespeople to focus on products with the best gross margin, thereby improving profitability.

Thus, the sales challenge is the ideal time to align salespeople with the company’s financial objectives by rewarding based on margin. But this is only possible if salespeople have control over that margin.

*according to The Complete Guide to Sales Forces Incentive Compensation by Andris A. Zoltners, Prabhakant Sinha, and Sally E. Lorimer.