How to properly pay the seller

If you’re asking for serious topics, be prepared for serious answers that can’t be covered in just one post 🙂

When evaluating the compensation of a salesperson, it is important to understand the following:

• Does the seller do any other work besides direct sales?
• How long does the sales cycle last?
• How many sales are expected from the seller per month?
• Is there a significant gap between the maximum and minimum possible deal?
• Is there a time gap between closing the deal and payment, or is there an installment plan?
• How much does a person with that level of qualification earn in the job market?

If the seller not only makes direct sales but also opens and closes the shop, arranges the goods on the shelves, and bears material responsibility for the entrusted goods, then the reward system should include a fixed component.
If the sales cycle—the time from the first call to the client until payment is received—takes a long time, or if active efforts to attract new clients do not guarantee closing deals in the near future, then the salesperson must have confidence that their efforts will be rewarded, regardless of whether a sale is made or not. In this case, compensation could simply consist of a fixed amount that the salesperson receives in exchange for adhering to activity standards while working under accountability. It is also possible to organize piece-rate pay, but in addition to the sales commission, to also compensate for activity by paying for each meeting, each phone call, each client visit, or any time spent consulting with clients in your salon. Another option is to offer the salesperson a so-called “guaranteed minimum,” where, regardless of the final outcome, the salesperson will receive some guaranteed payment.
The idea of a guaranteed minimum is appealing because when evaluating their earnings, a seller looks at how much they will receive in the worst-case scenario, seeking a reliable source in your company. In trying to offer an attractive rate, it is necessary to lower the commissions in order to keep the overall costs for the seller acceptable. However, by reducing the commissions, we decrease the seller’s income dependence on their efforts.

Additionally, low commissions do not look good in the job market. A guaranteed minimum provides both a good “rate” and good commissions. By choosing a guaranteed minimum at the right level, you can potentially disregard it in your expenses, as the commission earned by the salesperson will always or almost always be higher than the guaranteed minimum. To understand what a “guaranteed minimum” is, take a look at the diagram that shows the difference between the “base plus %” scheme and the “guaranteed minimum.” With the “guaranteed minimum” scheme, you can present both high commissions and a high fixed component in the job market without incurring labor costs for the salesperson that exceed market expectations.

If the difference between the minimum and maximum deal value is significant, it makes sense to pay a fixed fee per transaction instead of a commission, as the seller’s work essentially does not depend on the amount of the deal. However, if the minimum deal becomes too expensive for the businessman, a rule can be established: for deals below a certain threshold, a percentage of the deal; for deals at the next level, a fixed payment per deal; and for the most expensive deals, a fixed amount plus a small commission. Having a “buffer” layer in the payment structure may be necessary to avoid a clear step in commission payments that could demotivate the seller from closing larger deals.
Based on the approaches and data described above, we simply need to create a compensation scheme that includes both a fixed and a variable component, ensuring that the average expected income for the salesperson is competitive in the job market.

Example 1.
A balloon seller walking through the park with a bag of balloons, where children are playing:

• The sales cycle lasts about 15 seconds.
• Expected sales volume: 100 per day or 2000 per month.
• No significant variation in income expectations is anticipated.
• The salesperson does no work other than sales.
• No special qualifications are required to conduct such sales, which means he should earn around 3000 hryvnias a month in Kyiv.

We get:

• Fixed part — 0
• Piece rate: 1.5 hryvnias per ball.

If a balloon costs you 0.3 hryvnias, and you want to make a profit of 1.5 hryvnias, you would have to sell the balloons for 3.30 hryvnias each. At that price, no one would buy them, which is why we don’t see balloon sellers walking around the park. What we need to do is simply increase the perceived value of the purchase for the end customer, for example, by selling balloons in packs of 20. Then, a three hryvnia markup on a six hryvnia cost price would seem acceptable, and a price of 9 hryvnias for a pack of balloons sounds reasonable. (As an example, while I was preparing this post, I noticed near the metro that balloons were indeed being sold on the street for 9 hryvnias. The sellers took the same approach, but instead of increasing the number of balloons in a pack, they increased the size of a single balloon to a gigantic one.)

Example 2
A retail outlet selling goods “Everything for 50 Hryvnias.”

• The sales cycle lasts 2 minutes.
• The expected number of sales is 100 per day or 2000 per month.
• No significant variation in income expectations is anticipated.
• In addition to sales, the seller is responsible for material accountability, opening and closing the shop, managing inventory, and handling the cash register, which altogether takes up 20% of their time.
• No special qualifications are required to conduct such sales, which means he should earn around 3000 hryvnias a month.

We get:

• Fixed part = 3000 * 20% = 600 hryvnias.
• Piece rate: 2,400 / 2,000 = 1.2 UAH per unit of product or 2.4% commission.

At the same time, your seller’s expenses for selling a unit of product can no longer be predicted accurately; they are expected to be around the same 1.5 hryvnias and increase when there are no sales, while decreasing when sales occur.

Example 3
A software vendor for businesses, with prices ranging from 100,000 to 5,000,000 hryvnias, depending on the client.

• The sales cycle lasts for 5 months.
• The expected number of sales after the first sale is 2 per month.
• The range of expectations for income is quite wide.
• The seller does nothing but sell.
• We need a highly qualified individual with a higher education and a serious level of expertise, capable of communicating with the management of large companies. In the job market, such professionals command a salary of 25,000 hryvnias per month.

We get:

• Fixed part = 0.
• The commission consists of two components: 20,000 / 2 = 10,000 UAH per transaction plus 0.1% of the transaction amount. Therefore, the reward will vary from approximately 10% per transaction to 30,000 UAH per transaction, with an expected reward of 25,000 UAH.

Explanation of the calculation: We are clearly dealing with a situation where we need to pay for the deal rather than a commission. However, we also want to pay a commission to incentivize the seller for good sales. At the same time, if we simply give him a commission, he will earn too much on large deals. Let’s say that 10% is a fair commission, which amounts to 10,000 hryvnias from the minimum deal. Since we expect two deals per month, we can say that the seller will earn 20,000 hryvnias (out of the expected 25,000) through fixed bonuses for each deal. Now we just need to “fill in” the remaining 5,000 of his salary with a variable commission.
We assume that the average deal, since we don’t know the distribution picture, is equal to the arithmetic mean and amounts to 2,550,000, while two average deals equal 5,100,000. What percentage is this from the deal if 5,000 is the amount? That’s 0.1%. Therefore, the total employee compensation ranges from 2 x 100,000 x 0.1% + 20,000 = 20,100 to 2 x 5,000,000 x 0.1% + 20,000 = 30,000, or an average of 25,000 hryvnias.

To help the seller survive the first six months, we will provide support in the form of 2/3 of the expected income, which amounts to 17,000 hryvnias. However, this will not be a fixed amount but rather a guaranteed minimum commission that is paid regardless of the actual commission earned. This means that if the seller earns a commission of 10,000 hryvnias, he will receive 17,000, but if the commission is 18,000 hryvnias, he will receive 18,000.

The examples provided show that developing a reward system for salespeople is not a creative task and requires no original ideas. We have performance criteria and a payment solution. If you are a business owner with salespeople whose work you pay for, think about the criteria you used to establish their payment scheme. It’s possible that you “just decided” without considering how your salesperson spends their time, how long a deal takes, how quickly they can find a client, and what the potential range of contract values is.

Now, let’s talk about specific cases.

Advance payment of the commission.
It often happens that a deal is closed and the payment for it is likely to go through, but there may be an installment plan or the payment will only be made after specialists set up the supplied equipment. There are also deals where the services or work will take a very long time (years), and the main role of the seller was to attract a new client. In theory, the seller has done their job, and it would be unfair to deny them their reward. However, it may not be practical to pay them a commission for life or for an extended period. This leads us to the idea of paying a commission in advance—more than the commission from the first payment, but less than the total commission for the deal. However, when paying an advanced commission, caution is needed if the advanced commission equals or exceeds the amount of the first payment for the deal. Additionally, caution is warranted if the total advanced reward from the seller’s deal and their direct manager exceeds the amount of the first payment. In these cases, there is a risk of entering into fictitious deals in collusion with the client or fictitious deals made by the manager and a fake seller, where the client simply refuses the deal after the advanced reward has been paid.

Example: You are involved in the supply of imported parquet flooring. Your main clients are flooring showrooms, construction superstores, and similar businesses. The primary job of a salesperson is to attract clients for collaboration. You understand that by closing a deal with such a client, you gain a long-term partner, and the contract stipulates the delivery of certain volumes on a monthly basis for a year, with penalties and fines for refusal to supply. Let’s assume that you or your salespeople have found arguments for why the client should purchase parquet under these conditions. Therefore, you change your initial idea of a 10% commission for the salesperson on each pack of parquet to the following scheme: 70% commission from the supply in the first month of collaboration (which is clearly a loss) plus 1% commission in each subsequent month.
Of course, all of this needs to be calculated. From the seller’s perspective, you are so generous that you are paying him 8.1 times more than he expected; however, over the course of a year, you end up spending 19% less on commissions. At the same time, the total savings on commissions should be comparable to your risk of losing a client in the first few months of working together before reaching the contract anniversary. In other words, if you expect that out of 100 clients, fewer than 19 will terminate their contracts early, then it’s worth the gamble. (We’re simplifying the picture and not discussing NPV.)
One can afford to be generous with what may seem like unprofitable commissions on equipment or software supplies, especially when a significant portion of the earnings comes from after-sales service, which can be quite costly and does not involve any commission.
The same approach can be used when designing the amount that can be paid to obtain preferences, where the “hidden fee” paid for gaining advantages or privileges may not be beneficial now, but pays off in the future.
Advancing commissions is a great tool for motivating salespeople, especially in the early stages of their work, when their existing client portfolio has not yet generated the income they deserve.

Commission split
A good practice in your company could be the rule of splitting commissions among co-sellers. This approach works very well when a newcomer joins the team, bringing fresh ideas, a new list of contacts, and a fresh perspective, including a mind that hasn’t yet developed specific skills. In this case, when the new seller meets with a client, they will go together with an experienced seller. The newcomer will learn, while the experienced seller will close the deal. Naturally, the reward system should include a commission calculation rule that divides the earned reward into shares that the sellers have agreed upon among themselves. Additionally, such cooperation among sellers is beneficial in situations where they divide their responsibilities. For example, one seller might focus on building a contact base and scheduling meetings, while the other meets with clients and closes deals.

General conclusions
It should be noted that nowhere in the calculations of the seller’s reward system is there an assessment of where to obtain such a commission. However, if a businessman cannot provide a commission level sufficient to attract qualified personnel, he should not even consider hiring salespeople. The example with the balloons demonstrated that one should work on the product structure to increase its value, rather than on the seller’s reward by reducing it.
It is also important to understand that it makes sense to hire salespeople only when the overall gain from increased sales volume addresses several tasks at once:

• improving competitive conditions in the market, so as not to expand the market with their growth, which is difficult, but to displace competitors;
• increase in a businessman’s profit;
• finding funds to pay the commission, as we need to support the sellers.

It should also be understood that when there are any fixed or guaranteed payments, the seller must meet a certain sales plan or activity plan, the fulfillment or exceeding of which should be rewarded, while underperformance should be penalized.

If there is only a commission-based reward, setting plans becomes unnecessary, and motivation for work achievements is ensured through the introduction of incentive systems such as bonuses, prizes, gifts, etc.

When paying a fixed portion of the reward to a seller who has not yet made any sales, it should be viewed as part of the company’s expenses, similar to the costs associated with opening a new retail location in a clothing market.

How can we estimate how many deals a salesperson can close in a month? It’s quite straightforward if we already have active salespeople and know the statistics on how many contacts lead to meetings and how many meetings result in deals. Similarly, if we have an established sales point, we can determine the “average ticket” and the number of purchases per day. But what if we don’t have any salespeople and are building sales from scratch? In that case, we need to make an initial assumption about the number and volume of sales, as well as the average deal size for each salesperson. We should also assess how many salespeople our competitors have and examine their sales volume. Then, we multiply the number of salespeople by the estimated volume to arrive at a figure that we simply need to verify for plausibility. If we lack data on a salesperson’s sales volume, we likely have market volume estimates. If our calculations logically fit within the existing market size without, say, doubling it, then we can trust those calculations. However, if the numbers seem unbelievable, we need to revise our initial hypothesis, which will lead to changes in the salesperson’s compensation system.

What should you do when the compensation required by the labor market for salespeople means that with each new sales point, you earn only about 10% of what you made at your single sales point? Of course, you should open new sales points. You need to increase the number to 10 and stop selling yourself altogether, allowing for even greater income from the resulting economies of scale. However, it’s very difficult to focus on something that brings in only 10% additional income but takes up 50% of your attention. Ideally, you would want to have 10 sales points right away and manage them without having to sell yourself. In this situation, a manager (that is, me) would be helpful to set up these sales points, find and train salespeople, establish a reporting and training system, and also teach you to handle tasks you haven’t dealt with before, before eventually handing over the reins to you. You will face a similar problem when the growth of the company requires the introduction of a new layer—a sales manager—who also needs to be managed and given attention until their total number allows you to increase your profits. What should you do during such transitional periods?