Sales Manager Compensation

Furniture World Magazine

A key to creating owner/ sales manager relationships that can be maintained and grow with your business.

How do you know that your sales manager is doing a good job? If he or she is, how do you know that you're compensating him or her adequately? In previous articles, key areas of sales management have been discussed. Taken together, they describe many of the basic tasks which sales managers should concern themselves. This article, will focus on the results of sales management; specifically, how to determine the impact that your sales managers are having on growth, and then develop compensation plans that pay them for their performance.

MEASURING A SALES MANAGER'S IMPACT
All too often the effectiveness of sales managers are weighed by very broad or inappropriate measures. Owners often credit advertising and merchandising for sales increases. The same owners blame their sales managers for poor sales. Conversely, I have witnessed situations in which sales managers take the credit for sales increases that were entirely due to advertising, merchandising, or a bullish economy. The most obvious source of conflict in both of these cases is simply a lack of information. If you wish to have absolute confidence in your judgments, you need to look beyond sales volume trends. Specifically, you need to understand what to measure and how to use those measurements.

There are three factors that influence sales in any store:

• Traffic: the number of people that walk into a store.
• Closing rate: Of the people who walk into a store, the portion that actually buy.
• Average ticket: Of the people that buy, the amount that they purchase (on average).

The sales department can only control the closing rate and the average ticket; it does not have any control over traffic. Although sales people may have a small influence on traffic with be-backs and personal trade customers, this influence is generally negligible. Sales managers should only be evaluated and compensated based on the things they control.

Therefore, keep a constant eye on average ticket and closing rate. If they rise, this indicates that the sales manager is doing the right things to improve performance (e.g. working one-on-one, observing on the floor, using measurements effectively, etc.). If these measures fall, the sales manager is not doing an effective job and may need coaching or other assistance.

If a store's sales rise by $500,000 over 12 months, but closing rate and average sale remain unchanged, growth is simply not due to an improvement in the performance of the sales staff. It can only be attributed to an increase in traffic which is controlled by store location, facilities, merchandising, and/or advertising. Any sales increase not accompanied by an increase in average ticket and closing rate can be only attributed to one of these four factors - not sales management!

I recently returned from a store that had grown from $2.5 million in sales to $5.7 million over a two year period. A sales manager was hired at the beginning of this explosive growth cycle to take over sales management duties from the owner. Because this individual added a new level of management and sales rocketed from $2.5M to $5.7M, it seemed to the owner that he had done an excellent job. Measure-ments made over the same two year period indicated that there was no appreciable increase in closing rate or average ticket. Although he may have become busier as sales increased, this sales manager was not improving the performance of his staff and was clearly not responsible for store growth. His compensation plan, however, did not reflect this reality.

He was initially hired at a salary of $36,000 a year ($2,500 per month), plus 1% of the stores sales volume, paid monthly. At $2.5M he was earning $25,000 in bonuses, bringing his total compensation to $61,000 (a bit high for this store but acceptable if he met his goals). Two years later he was still earning a $36,000 base, but with the sales increase his bonus had inflated to $57,000, and his total earnings to $93,000. And, he wasn't responsible for the growth!

Although it has become popular in our industry to pay sales managers based on a percentage of overall sales, this arrangement often results in several glaring problems that need to be addressed:

• It fails to provide adequate incentive for a sale manager to improve the performance of his staff.
• It often results in undeserved monetary compensation.
• It ends up being very costly to the store.
• It jeopardizes what could otherwise be a great long-term relationship between the owner and the sales manager.

POOR INCENTIVE
The manager described above earned an automatic $25,000 bonus on the store's $2.5M in sales during his first year. His effective base pay was really $61,000, not $36,000! The owner had to come up with additional incentive to push his sales beyond the status quo. In this case, that amounted to $32,000 (1% of the sales between $2.5M and $5.7M).

If you pay a percentage override bonus on total sales, you're basically double paying your managers. You pay once for the status quo and once for the incentive - and that is on top of the base salary! This clearly provides little incentive to move beyond the status quo.

UNDUE REWARD
When sales manager compensation is based on total sales and stores grow due to factors that are outside their control, they are unduly rewarded. Another client that recently doubled the size of its showroom and added different lines of merchandise experienced dramatic sales increases. Although the sales manager had done little to increase the performance of his selling staff, he experienced a big jump in income because his compensation was based on total sales.

Undue reward places great pressure on the relationship between the owner and the sales manager. When a sales manager's compensation does not reflect his performance, the owner begins to feel as though he is not getting his money's worth. Likewise, the sales manager often knows that he is not being paid specifically for his contribution and begins to feel insecure. This is a recipe for conflict and disaster. It can only be avoided by developing an appropriate compensation plan based on actual performance and achievable goals.

COSTLY TO THE STORE
Yet another problem with a percent of sales bonus arrangement is that, as sales rise, a sales manager effectively prices himself out of a job - no matter how effective he is. The manager from our first example earned a high but acceptable $61,000 during his first year, but by the end of the second year he was up to an unwieldy $93,000. The fact is that earnings could and should go up - perhaps from $61,000 to as high as $70,000 or $75,000 two years later. However, $93,000 is simply too much to pay when a sales manager is responsible only for the sales on the floor, not general management.

IT JEOPARDIZES THE WORKING RELATIONSHIP
If a compensation plan is not carefully structured and well thought out in the beginning, several years down the road it can be the single tragic blow that ruins an otherwise great relationship between a store and a sales manager. Once earnings exceed an individual's contribution (as in the above case), it is extremely difficult to bring the pay back down to be in line with the job. If we attempt to do so, a sales manager's pride will often force him to leave the company, even if it means accepting a lower paying job on general principle. Had a more appropriate compensation plan been implemented at the beginning of the relationship, this end result could likely be avoided. So how can you avoid this problem?

THE SOLUTION
First and foremost, the process should begin with a clean slate every year. This means abandoning bonuses based on a percentage of total sales. Begin by paying a livable salary, possibly more than $36,000 but maybe less depending on the location and size of your store.

On top of the salary, pay an incentive bonus for the achievement of specific results, and establish the value of that bonus in total dollars. I recommend a minimum of 20% to 30% of the sales manager's earnings. Next, allocate this bonus in two parts:

The first half should be paid annually if the volume goal, based on written (not delivered) sales, is achieved. The goal itself should be based on a specific increase in sales, not total sales.

The other half should be paid quarterly when quarterly average ticket goals are achieved. Since a store's average ticket is such an important measure of a sales manager's success, this is a critical incentive. It forces managers to focus on the things that must be done to increase individual sales person performance and, thus, sales.

A typical bonus will work out as follows. If a manager is going to receive $10,000 for performance; $5,000 would be paid when the store's annual volume goal is reached. The other $5,000 would be paid in quarterly installments of $1,250 each time the sales manager achieves his average ticket goal.

While average sale bonuses are paid quarterly, sales managers should be given the opportunity to collect unearned bonuses from previous quarters. The foregone bonuses would be paid if the combined average sale for the current and previous quarter(s) exceeds the goal for each quarter. This gives double the incentive to 'pull the train back on the tracks' following a poor quarter.

For example, if during the first quarter, a sales manager had an average ticket goal of $900 but the actual average ticket was only $850, he would not receive the bonus for that quarter. However, if the combined figures for the first and second quarters equaled $900, then the sales manager would collect his bonus for both quarters.

Closing rate goals have purposely been left out of this discussion. Although closing rate is a key performance indicator that needs to be measured, it can be difficult to document accurately (especially in short staff situations). Bonuses need to be based on precise figures that eliminate any question of whether someone should or shouldn't be paid. Yes, closing rates should be carefully tracked, but it is unfair to base someone's earnings on this often unreliable measure. I will say, however, that I have never seen a situation in which a store's average ticket increased while the closing rate fell. The same things that typically increase average ticket also increase closing rate.

CONCLUSION
When a good person is put into a bad system, the bad system wins every single time. Many great owner-sales manager relationships fall apart because either they based their beliefs on the wrong information or the sales manager's compensation was based on poor measures.

Judgments need to be based on the facts (e.g. average ticket and closing rate) and not merely individual opinions. Compensation of sales managers should be based on their specific performance and not on some general measure that they may or may not influence. Careful crafting of compensation agreements helps create owner/ sales manager relationships that can be maintained and grow along with your business.