Common Mistakes in Sales Management (Part 2): Misaligning Sales Incentives with Corporate Priorities

(This post originally appeared on LinkedIn here)

“Every company, every boardroom in which I sit, has a plan, and they have objectives, goals, and a process. And to make it work, the pressure and incentive have to come from the top.”

Vernon Jordan

Make no mistake: Incentive plans drive salespeople and if you don’t like their behavior, it is most likely because you screwed up your incentive system. And that’s a leadership problem, not a people problem!

One of the companies I worked for charged their services on a consumption-based model but based the sales incentive on invoiced revenue. What’s wrong with that?

Well, consumption does not equal invoicing if you offer pricing mechanisms where the customer can make upfront payments in exchange for discounts.

So what happened?

At the end of the year when sales managers got into trouble in making their (invoiced revenue) quota they forced the entire sales team to stop working on new consumption and focus all their attention on selling upfront payments on existing consumption.

As a result, future revenues were damaged twice: less new consumption plus fewer net revenues from existing consumption. The gain in invoiced revenue in the actual year resulted in an even bigger loss in invoiced revenues in the next year!

So what does good like?

Almost 30 years ago I came across the most sophisticated incentive system at EDS, the inventor and leader of IT outsourcing. Their formula factored in three parameters to calculate what they called the commission pool: contract term in months (M), Total Contract Value (TCV), and Net Present Value (NPV).

It read Commission Pool = M^2∗√TCV∗NPV translating into: over-weighing contract term (squared) while under-weighing TCV (root) and using cash-flow (NPV) as a limiting factor so an NPV of 0 killed the entire commission.

The formula was set centrally and globally, local management couldn’t change or amend it. As a result, sales were incentivized to sell longer term contracts building a growing Contracted Backlog while minimizing Outgoing Cashflow, exactly the two parameters EDS was reporting to investors.

Sales incentives must be set by the Executive Board and reflect the corporation’s long-term goals.

And don’t worry about making it complex: Successful salespeople are extraordinary smart when it comes down to understanding what behavior will maximize their commission!