Houston Fearless 76: The Sales Incentive Plan Modification Proposal
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This report focuses on the sales function and incentive systems of Houston Fearless 76, Inc. (HF76). First, some background information and strategic objectives of the company will be provided. Then, analysis will be made on the current sales incentive plan and the proposed new incentive plan along with some recommendations on implementation of the new plan and other managerial issues.
Houston Fearless 76, Inc. is a medium size manufacturing company that provides designing, manufacturing, marketing, and servicing of high quality micrographic and photographic products. Customers range from companies in banking, healthcare, and movie industries to government entities.
HF76 has different strategic objectives for different products. For products in the emerging and growing markets, sales force should identify new customers and new markets. For products in the mature stage, sales force should utilize the company brand name and maintain sales in the niche market.
Even though HF76 has roughly $15 million in sales annually, its profit margin has declined over the years and the management is very concerned. The management realizes that the main cause of this problem is the mismatch between company objectives and sales force incentives due to inappropriate performance measure and different compensation structures for different products.
The Old Sales Incentive System
The old sales incentive system uses a combination plan – a base salary plus commission – to pay salespeople. The base salaries range from $40,000 to $60,000, while the typical commissions earned are approximately 50% of base salary. A bonus system is also in place for sales assistants for reaching the overall sales goal.
The idea of using a combination plan is good since it provides flexibility by relating incentives to accomplishment of less quantitative objectives, such as customer satisfaction, as well as sales volume. It also provides salespeople with a more stable income.
However, there are some drawbacks with this system. First, the commissions earned are based on sales rather than profitability. Thus, goal congruence cannot be reached as salespeople only focus on pushing out any products regardless of the profit margin earned. Consequently, salespeople will mainly focus on sales volume rather than being aggressive in achieving other objectives such as developing new markets, expanding existing markets, or finding synergies among product markets. The lack of goal congruence also makes it hard for sales assistants to get bonuses since they do not see a clear relationship between their job description and the bonus. Furthermore, the fact that commission rate is different across salespeople based on product characteristics and market situation has led to employee dissatisfaction.
The New Sales Incentive Plan and Unsolved Problems
The management has come up with a new sales incentive plan that might solve the old problems; however, the new sales incentive plan has produced a dilemma while leaving some problems still unsolved.
The new plan focuses on providing commission based on the products’ gross margin with accurate forecast as contingency. Such plan does solve the problem of declining profit margin of the company; however, the salespeople will try to avoid selling low or negative margin products, which may have strategic importance to the company.
One cause of the company’s higher than average cost structure is the forecasting problem because much of the production planning process involves sales forecasts from the sales personnel. However, many salespeople do not put much effort in forecasting as they think sales are unpredictable and there is no accountability for inaccurate sales forecast. Even though the new incentive plan does encourage salespeople to forecast seriously, it does not give any penalties for inaccuracy. Thus, the salespeople will still not be aggressive enough in forecasting accurately.
HF76 also faces other difficulties in aligning company objectives to individual incentives such as exploring new markets, better sales/operations coordination among salespeople and manufacturing department. These difficulties are not addressed by the new incentive plan.
Suggested Modification to the New Sales Incentive Plan
On the corporate level, a successful sales incentive plan should be a tool to support corporate strategy and objectives for product management. On the individual level, the sales goal should be challenging and realistic, and designed for the job rather than for people. Also, it should entail a simple mechanic, provide rewards that adequately impact the behaviors, and encourage people to overachieve. Since the company’s main objective is not only about making the sales volume or gross margin, profit margin is not an effective indicator to calculate salespeople’s monetary reward above basic salary. Instead, a point based system is more appropriate to reward the salespeople for conducting behaviors that are aligned to company objectives.
Since HF76 has different strategic objectives for different products, and the profit margins vary greatly among different products, it is difficult to determine the commissions for products that have low or negative profit margin even though it is the company’s strategic interest to sell them. Therefore, the company should assign points to different products, and products with higher strategic interests to the company should be assigned with more points. Consequently, salespeople will focus on selling the products with higher points. Such method rewards the salespeople for selling products that have higher strategic importance rather than the most expensive ones.
For the sales forecast, a truth inducing incentive system should be adopted because forecasts greatly affect the company’s inventory and production planning process. In other words, successful forecast leads to reward while bad forecast leads to penalty and salespeople should be strict about their estimation. Therefore, if the salespeople’s prediction is within +10% or -10% of the actual sales, positive points will be given for the accuracy. In contrast, negative points will be assigned into the calculation to penalize the salesperson if the forecast is beyond +10% or -10% of the actual sales. As the deviation becomes greater, more points will be deducted; as a result, salespeople will try to provide higher accuracy.
Unlike the sales volume and sales forecast, MBO targets focus more on positive behaviors. Therefore, a balance scorecard, a tool that evaluates both quantitative and qualitative performance, should be in place to let the salespeople aware of company’s objectives and to warn the sales manager of inadequate performance of his subordinates. A balance scorecard is chosen because it provides the framework to unify the workforce around common goals and gives an evaluation on employees’ behaviors. Moreover, it communicates the cause-and-effect relationships for key strategic initiatives and delivers evidence that these initiatives are contributing to the organization’s objectives. Different objectives should be assigned with different number of points to reflect their importance and management’s priority.
For example, getting new customers and coordinating well with production are important company objectives under the customer perspective; thus, a high point would be rewarded for achieving this objective. In contrast, learning and utilizing Microsoft Office is an objective under innovation and learning perspective, but this objective will be assigned with less point because it is less important.
In addition to the MBO targets, there will be a team-based compensation scheme, where both the salesperson and his/her assistant will be given a $1000 bonus for attaining a high score in the balanced scorecard. Team-based compensation scheme helps employees to work cooperatively. Some objectives in the MBO targets such as network with professional associations, improve communication through email, and utilize Microsoft Office can be alleviated by the sales assistants. By rewarding as a team, task redundancy can be greatly reduced and salespeople are able to focus on core competency such as making sales while letting the assistants do the customers follow-ups and utilize the necessary technical abilities. Moreover, the sales assistants will become aware that there is a correlation between their performance and compensation.
The New Formula
Compensation = Basic Salary + Sales Reward + Forecasting Reward/Penalty + MBO reward
Basically, the salespeople’s total compensation is the aggregation of the basic salary, sales of products, forecasting tasks, balance scorecard evaluation, and bonus for working well as a team. Below is a typical compensation report for salespeople.
The compensation scheme:
Base Salary $3500
Points from sales 13
Points from forecasting (5)
Points from MBO $3500 9
Total Points 17
Points until higher Bonus 3
Bonus from Points $3000
Team Bonus from MBO $1000
Assistant: Eva Colton
Total Salary $7500
With this system, salespeople are induced to achieve tasks that are important to the company yet they are encouraged to overachieve. Moreover, the system is easier to understand because the measurement method is consistent across different categories (i.e. the point system). Compensation and penalty at each level are significant as portraits in the illustration above; thus, salespeople will emphasize on gradual performance improvement rather than marginal.
Successful Implementation of the New Incentive Plan
In adopting any incentive program, management would be likely to face obstacles in the implementation process. Some significant impediments include communication problem, management commitment, costs, organizational culture and employees’ perception.
To achieve the desired result of an incentive plan, mangers must be effective and consistent in communicating desired performance, providing feedback to the sales crew, and encouraging desired behaviors. These may not be easy to accomplish, given that the vice presidents, managers, and sales people are geographically spread across the country. Hence, effective communication mechanisms must be in place. For example, the organizational structure may be changed to enhance efficiency, accuracy, and efficaciousness of communication between top management and lower level employees. Also, more emphasis will be placed on team-based compensation since it provides more positive impact by encouraging cooperation between staff.
Since the magnitude of the change in incentive plan is large, salespeople may not be able to accept those changes easily. Thus, management commitment becomes particularly important. They need to show the salespeople that they are actively and consistently committed to the new performance requirement in order to make the change effort succeed.
Under the new incentive plan, management is likely to spend more on total compensation to ensure salespeople’s easy acceptance of the change. Training would also need to be provided to educate sales personnel on how the new program works and how to maximize their pay. In order to achieve company objectives more easily, salespeople would also need to attain more knowledge on products and local customers through training. While this can help HF76 save costs by cutting down the number of dealers and reps, large amount of costs in compensation and training would likely to be incurred. Therefore, management needs to create safeguards. For instance, they can establish a rule that if total award payments exceed one-third of pre-award net income, each award is proportionately reduced by the percentage that one-third of net income is less than the total computed payment.
Finally, it is very important that HF76’s culture displays trust, respect, and willingness to work together toward common goals. Moreover, the sales staff needs to perceive the new incentive system as fair, understand the purpose of it and recognize the links between incentives and individual and corporate performance. After all, the plan will not work without employees’ support.
To ensure that the proposed new incentive plan will be successful, it is necessary for HF76 to change its organizational structure, or more specifically, its departments’ relationship with one another.
As indicated in the above diagram, salespeople should report to the marketing department as well as the operations department in order to reduce the sales/operations frictions. Moreover, sales assistants should report directly to the salespeople since they are providing support to the salespeople. At the same time, sales assistants should also cooperate with the customer service department as they also deal with the customers during the follow-up after a sale has been made.
To summarize this proposal of changes in incentive plan, HF76 should adopt a point-based incentive system. Total award payout should be classified into four categories: sales of products, accuracy of sales forecast, balance scorecard, and team-based bonus. The amount of money that a salesperson receives would depend on the number of points he or she scores in each category.
Although HF76 would likely encounter some impediments when implementing this proposed incentive plan, the benefits of implementation outweigh its costs. This modified incentive system helps to motivate HF76’s employees to sell products that are more strategically important to the company, to make sales forecast accurately, to perform more positive behaviours that benefit the company, and to cooperate with each other to reach goals that are congruent to company objectives. These benefits show that the plan is long-term focused since they are all aligned with company’s goals. Thus, the costs incurred from implementation are likely to be offset by the long-term profits that this incentive plan will bring.