Everything you need to know about compensation plans. Compensation is defined as the money received by employees from the organization on account of the performance they render.
When the employee receives the money in terms of salary or wage, it is known as direct compensation.
When the employee receives benefits such as – health insurance, medical benefits, travel allowances, etc., these are known as indirect compensations.
Compensation is an integral part of an employee’s sustenance and survival which has a motivational element also.
An organization always wants to draw an effective compensation plan to make their employees content and motivated.
An effective compensation plan fulfills the expectations of the employees and satisfies them. At the same time, it works towards the overall fulfillment of an organization’s objectives.
1. Introduction to Compensation Plan 2. Definitions of Compensation Plan 3. Features of Compensation Plan 4. Factors Influencing 5. Steps in Designing 6. Trends in Compensation Management.
Compensation Plans: Definitions, Characteristics, Factors Influencing, Steps in Designing and Trends
- Introduction to Compensation Plan
- Definitions of Compensation Plan
- Features of an Effective Compensation Plan
- Factors Influencing Compensation Plan
- Steps in Designing a Compensation Plan
- Trends in Compensation Management
Compensation Plan – Introduction
The success of any sales organization depends on the achievement of the sales goal set for short- term as well as long-term periods of time. While other programmes such as sales force recruitment, training, and motivation are a cost to the company, sales force compensation deals with the management of the performance of the salespeople for generating revenue for the firm.
The sales performance of an organization depends largely on the efficiency of the salespeople. Salespeople tend to increase and manage their performance by linking it to the compensation they receive from the sales organization. A sound compensation plan will motivate salespeople to enhance their performance and achieve higher targets for the organization.
The compensation plan should encourage realizing larger sales, bringing stability to sales, and controlling the performance of the salesperson- If the compensation plan is motivational enough, the salespeople tend to overcome the fluctuations, competitor’s onslaught, and other market-related problems.
A good compensation plan is also vital for the organization, society, and nation. It contributes to the growth and success of the organization and brings cash to the organization, which is the lifeblood of the organization. The society is benefited in the process of creating more job opportunities and delivering higher standards of living.
The nation changes from an agrarian based economy to a developed economy as more and more jobs are created and products and services are consumed more and more.
Though sales force motivation-related research has identified the compensation as a hygiene factor, in countries such as India, compensation plays a great role in motivating people, and managers are often advised to pay according to the nature of duties of the salespeople. Since compensation has a direct bearing on the moral and productivity of the organization, the salespeople should be paid purely based on managerial objectives, value system of the organization, and long-term goal of the organization.
Researches have evaluated the importance of various rewards in motivating the salespeople. It has been observed that the most important motivating factor is the pay structure for the salesperson. Salespeople are highly committed to a better pay structure than elements such as compliments and security. The importance of the set of motivators also varies with the demographic variables such as age, position in the organization, and stages in the life cycle.
Compensation Plan – Definitions: Provided by Flippo, Foulkes, Livernash and Agarwala
Compensation is defined as the money received by employees from the organization on account of the performance they render. When the employee receives the money in terms of salary or wage, it is known as direct compensation. When the employee receives benefits such as – health insurance, medical benefits, travel allowances, etc., these are known as indirect compensations.
Compensation is an integral part of an employee’s sustenance and survival which has a motivational element also. An organization always wants to draw an effective compensation plan to make their employees content and motivated. An effective compensation plan fulfils the expectations of the employees and satisfies them. At the same time, it works towards the overall fulfilment of an organization’s objectives.
Flippo (1984) defined compensation as the adequate and equitable remuneration of personnel for their contributions to the organizational objectives.
Foulkes and Livernash (1989) defined compensation as the payment of wages and salaries including incentive, bonus payments, and benefits to employees in exchange of work.
Agarwala (2007) defined compensation as the sum total of all forms of payments and rewards provided to the employees for performing tasks to achieve organizational objectives.
In a broad sense, compensation is a kind of employee reward. An organization lays an effective reward system management that works for the selection of rewards and its distribution to the employees.
Ingram et al. (2007) categorized organizational rewards into two types as follows:
1. Compensation rewards.
2. Non-compensation rewards.
1. Compensation Rewards:
Compensation rewards are offered to employees in return for their acceptable performance. Again, compensation rewards can be of two types – financial and non-financial. Financial rewards are given in terms of money such as – salaries, commissions, etc., and non-financial rewards are non-monetary but no less attractive than financial rewards such as – opportunity for growth, recognition, etc.
2. Non-Compensation Rewards:
Non-compensation rewards relate to the favourable work situations and employee welfare, for example, a healthy job environment, consulting salespeople on sales plans, assigning a salesperson to an attractive territory, etc.
Agarwala (2007) mentioned two types of financial compensations, direct and indirect. Direct financial compensations include salaries, commissions, etc. Indirect financial compensations are pensions, insurance, paid time-off work, etc. Direct and indirect compensations are collectively called extrinsic rewards. Intrinsic rewards for employees are recognition, praise for job performance, etc.
Sales organizations design compensation plans with multiple objectives. One of the key objectives is to attract quality salespeople. If the company’s compensation and reward system is attractive, the best salespeople will come to work in the organization. It will also help to improve the productivity level of the existing salespeople in the organization.
It also helps in optimizing the sales effort by the salespeople and maximizes the sales, reducing the sales expenses and also the production cost. Such companies are able to cover their marketing costs due to higher sales efficiency in the short run than an average company with a poor sales compensation plan.
A good compensation plan helps in retaining quality manpower and reducing the attrition rate in the organization. This moderates the performance of the salespeople and serves as a control mechanism in the organization. A good compensation plan also establishes a good rapport between the sales force and the sales supervisors and managers in the company, and the salespeople try to present a better image for the company as well as the product in the marketplace due to the high level of motivation generating from a good reward system in the company.
Compensation Plan – 18 Important Features of an Effective Compensation Plan
The reward system should address the short-term as well as the long-term issues of the salesperson. While survival is a short-term issue for the salesperson, recognition and growth in the company and career are the long-term issues for a salesperson.
The sales compensation plan should address the fair wage to the salesperson. The compensation system should guarantee a fair wage, which is essential for the survival of the salesperson’s family, failing which he will feel dissatisfied and become unstable on the job. The pattern of the remuneration should be such that it should reflect a stream of stable income flows for the salesperson. Any deviations and fluctuations in this flow will put the salesperson under tension and he will be looking for opportunities to move out of the job.
The salary should have a fixed component and a regular flow of income so that the salesperson can maintain an average standard of living. The compensation plan should be linked directly to the efforts and performance of the salesperson. If there is no link between them, then salespeople either tend to take benefit of the system or feel demotivated to contribute (in the case of a fixed salary pattern) as they compare the contributions and remunerations of others in the organization with their own.
The reward system should have future orientation. The remuneration should take care of the salesperson’s housing need, dearness allowance, conveyance, pension, provident fund, and medical needs.
A sound remuneration plan should be based on the principles of equity and equality. As the rule of the land has to be universally applied across all citizens, the principles of remuneration and reward should be based on equality and equity among all types of employees. People with similar job functions and performance expectations should get comparatively similar rewards.
The reward system should be designed in such a way that it helps the people to go higher than the current performance. It should be a sum of multiple incentive components. Many sales compensation programmes are so complex that the level of comprehension of the salespeople about the salary structure is affected. So it should be simple and easy to describe and understand.
The sales manager should be able to describe the programme easily and implement the compensation plan without much difficulty. A good sales compensation plan should help the sales manager to control the sales force by controlling their work hour commitments and call realization in the organization.
A comprehensive sales compensation programme should be economical to the company, failing which the cost of sales and customer service will go higher and the salespeople will enjoy at the cost of the company. The reward system should have a link to the paying capacity and budgetary provisions of the sales organization.
The sales manager should take into account the comparable salaries of the competitors and that of the industry so that they can keep the compensation plan competitive in comparison with other firms. A competitive remuneration plan will keep the good salespeople in the company and the competitors will not be able to take them away with a higher offer.
A rigid compensation plan runs the risk of being outdated when the environmental is undergoing changes and the competitors are changing in response to these changes. This calls for increasing the flexibility of the compensation programme so that it can fit into the changing environmental needs, emerging technology, and competitive landscape prevailing in the industry.
A sales manager should take into account the salesperson’s opinion while designing the sales compensation plan. A participatory method of the compensation plan which is prepared in consultation with the employees, has a higher power of motivation than a programme that is thrust upon them.
The compensation plan should have the ability to hedge against the inflation and should carry a relationship with growing market rates and prices. The rate of compensation should be based on factors such as the current industry rate for the same job, the nature of the sales job, the difficulty involved in realizing the sales, and the abilities and experience required for doing the job. However, there should also be provisions to control the costs.
Following are the features of a good compensation plan:
1. It is consistent with the position held by a salesperson and the job description laid down for such a position.
2. It decides the right salary and other benefits befitting the position and is at least in conformity with the prevalent salary structure for such a position in the industry.
3. It acts as a catalyst to improve the productivity of the organization.
4. Money is a great motivator. It acts in this direction. It provides satisfaction and security to the sales force.
5. It helps to improve the financial health of the employees, organization, and the society at large.
6. It does not distract the team spirit and the group cohesion within the sales force.
7. It helps to generate a hearty and a cordial relation between the salespeople and the sales managers.
8. It is simple and very easy for the salespeople to understand. The sales managers find no difficulty to apprise them on the plan.
9. It is flexible so that future changes in the compensation structure can easily be accommodated.
10. One of its components (particularly variable part such as – commissions, bonuses, etc.,) has a direct relationship with the sales force performance.
11. It helps to retain the existing sales force particularly those who perform satisfactorily for the firm. Alternatively, it keeps the competing firms away to pull out the efficient salespeople.
12. It is in sync with the sales and profit objectives of the firm.
13. It is acceptable to both the salespeople and the employers.
14. It generates a positive correlation between compensation and motivation, and motivation and performance.
15. It provides salespeople with a direction for individual goal-fulfilment.
16. It enhances the job involvement and the commitment to the job.
17. It increases the sense of belongingness of the salespeople to the company.
18. It acts within the contours of the strategic marketing plans of the company.
Compensation Plan – Factors Influencing: Internal and External Factors
Compensation level is influenced by a host of factors. Some factors are internal in nature and others are external. Internal factors are company-specific that relate to the company’s resources, abilities, policies, etc. External factors are those that operate outside the organization, i.e., the external environment that have an effect on the compensation plans.
1. Internal Factors:
The internal factors are discussed in brief as follows:
i. Financial Ability:
A firm’s liquidity position, returns on investment, financial outlay, etc., indicate the long-term financial capacity of a firm. A company’s financial strength should be such that even in uncertain situations, it can adhere to the compensation policies and pay uniformly to all its employees.
ii. Compensation Policies:
A company’s compensation policies are determined by the number of employees working, number of permanent employees, number of casual staff, etc. Moreover, whatever policies the company follow (say, only salary schemes or performance-based incentive schemes) should have a relationship with the total remuneration volumes of the company.
iii. Recruitment and Selection Policy:
This influences the number of people that are on the payroll. The compensation policies should take into account the number of new employees inducted and the number of employees that are retired or have left.
iv. Promotional Policy:
Compensation plans should be consistent with various managerial or non-managerial ranks and promotion from one rank to the next should be coupled with reasonable rise in salaries and other benefits.
v. Job Descriptions:
The volume of job (sales volume), its importance, and characteristics are related to the compensation level assigned to a job position.
vi. Job Evaluation:
The worth of the job in terms of contributions in financial terms to an organization is related to the compensation level. For example, the contribution of a salesperson in selling a high unit value item such as – a turbine or furnace to the firm is immense and therefore, the concerned employee needs to be suitably compensated.
vii. An Employer’s Designation and Position:
An executive or managerial position definitely deserves higher pay level. Secondly, a senior in position demands a higher remuneration package than that of the junior employee.
viii. An Employee’s Relative Contribution:
Here, merit of the employee is a decisive factor in finalizing his pay package. A high performing salesperson in a rank can deserve special attention in terms of incentives or rewards.
2. External Factors:
The external factors including a compensation plan are discussed as follows:
i. Prevailing Compensation Policies in the Industry:
Every industry has a trend to offer compensation to its salespeople and it is safe for a firm to follow the industry trend. This is especially true for medium and small companies with limited financial strength. But efficient salespeople, once they prove their worthiness, can bargain for better salaries or commissions. There is no difficulty in putting them on premium compensation packages in large companies.
ii. Legal Conditions:
As companies operate within the legal frame of governments, they need to strictly observe the legal policies and regulations of the governments. The government has legal stipulations on the minimum wages act or provisions for fringe benefits. But, many companies often violate these norms and engage salespeople on a meagre pay package and exploit them.
iii. Economic Conditions:
These are important pay level determinants. It is a customary practice in the industry circuit that with the rise in inflationary conditions, the companies escalate the level of the dearness allowance so that the employees can cope up with the rising price level. Similarly, under recessionary condition, the company itself remains in a depressed condition and percolate down the same to the employees. Therefore, employees are forced to remain with their existing pay package for a long time unless the gloom is over. Sometimes, one can see a reduction in the compensation as well and this is not an uncommon practice.
iv. Market Competition:
It is a great trigger to manage employees tactically on the compensation packages. Under highly competitive situations, the companies deploy strategies to sustain or survive in the chaotic situation and here, skilled employees become valued resources of the organization. The company wants to retain them desperately by giving them attractive pay levels to prevent sudden attritions. The efficient employees also can play their cards to compel reluctant companies to augment their pay levels.
v. Trade Unions:
It often plays a mediating role in the company’s decision to fix up different pay levels for employees along various positions. This is true in public sectors and large private sector firms. In small- or medium-sized firms, trade unions are generally non-existent and employees are forced to swallow the salary or wage levels as determined by the company.
vi. Global Considerations:
These are important when the company establishes any subsidiary units in foreign nations or send their employees abroad to work on international projects or businesses. It is essential, therefore, for the company to understand the cost of living, tax structure, social or cultural norms, etc., of a nation that has strong relationships with compensation levels.
Ingram et al. (2007) noted that individualism is a prized practice than collectivism in work operations in the industry of some nations. Some other nations believe working in a team. So, the compensation for salespeople working as a team (e.g., salespeople engaged in team selling) is expected to be different than individual employees who are solely entrusted to perform a piece of job. Unites States is a follower of individualism whereas; Japan is a strong votary of collectivism.
vii. Criteria for Sound Compensation Scheme:
A compensation scheme needs to follow some basic criteria or requirements. These are important for both the organization and salespeople for peaceful coexistence under one roof. It should serve the interests of both the parties equitably.
Compensation of sales force is a vital aspect of sales force management. It not only meets the basic needs of salespeople but also fulfils social and esteem needs, according to Maslow’s need hierarchy.
Compensation Plan – 6 Major Steps in Designing a Compensation Plan
A sales manager needs to design a compensation plan for the organization. There is a scientific method of designing the sales force compensation plan, which every sales manager should follow in organizations. The sales manager should take into account the various factors influencing employee motivation and the purpose of compensation. We will now discuss the various steps followed in designing an equitable, justified, and strategic sales force compensation plan.
The sales manager should identify the corporate objectives and also the objectives of the salespeople while developing a compensation plan.
The sales objectives can be attainment of the annual sales volume target and gross margins, attainment of monthly and specific period-wise sales targets, market penetration and exploitation of the territory potential at a specific rate, management of sales calls and development of potential in key accounts, development of new customers, and gaining support of the salespeople for the new product introduction.
By evaluating the relative importance of these broad objectives, the sales manager will be able to finalize the level and type of compensation plan to offer to the sales force.
Once the sales manager is able to finalize the compensation objectives, he needs to compare his available payment structure with that of the industry and major competitors. In the case of a new compensation plan, the industry average and the competitors’ compensation plans serve as the benchmark for designing the compensation plan.
The major components of salary are decided by taking into account the wage level, the wage structure, the salesperson’s wage, and the salary administration procedure.
The wage level of compensation talks about the salary in relation to the competitors’ sales force compensation. If the organization’s salary level is lower than that of the competitors, the salespeople will always wish to join the competitor, and the competitor will in turn allure them to work with them, which may lead to loss of manpower for the firm. Salaries for various salespeople should be established by doing a comparative analysis of the salary level in the industry.
The wage structure is the explanation of the pay differential inside the organization at different levels. The evaluation of the job and description indicates the extent to which the job contributes to the success of the enterprise. Depending on this evaluation, salary structures are planned at various levels in the organization.
The individual wage is the salary paid to the individual salesperson depending on his work experience, nature of the job, and personal background. His abilities related to job descriptions are evaluated while deciding on the compensation structure.
The administrative issues related to compensation management include the sales force evaluation and control mechanism, mechanism for modified compensation, and pay revisions and raises which should be meaningful enough for the salespeople to stay longer with the sales organization. The sales manager prepares the budget for compensation of the salespeople, considering the ability and intention of the organization to compensate the sales force in the form of wages, commissions, perks, bonus, and incentives.
The sales manager should take both long-term and short-term views of the sales compensation plan. While in the short term, it should address the issues of adequate compensation and low cost drive for the firm, in the long-term, it should reduce the attrition rate and develop employees to take up higher challenges including managerial responsibilities.
Long-term planning includes promotions, retirement plans, disability benefits, and life insurance for the salespeople. The compensation plans should have a long-term vision and lasting value for the organization. Short-term issues related to the compensation plan include bonus, expenses management, and sales contests. This should be coordinated with the total marketing efforts of the organization and in sync with the long-term compensation plan.
The sales manager should communicate the compensation plan to the sales staff inside the organization through inter-office memos, email, newsletters, and all other means, and explain the advantages and mutual benefits of the sales compensation plan. Many salespeople ask the company at the time of joining about the nature and type of compensation they are likely to receive for the job.
The sales compensation plan should be designed and communicated in such a way that it increases the clarity and comprehensiveness of the salespeople in the organization. The sales supervisor is the key link in the chain of communication to the salesperson. Since salespeople normally work in the field, it is important to brief the sales supervisors about the compensation plan so that they can handle the salespeople’s queries.
The compensation message should include the part of the salespeople’s job that will help the organization in attaining its goals. The sales supervisor should also brief them about the role of the salespeople in achieving the sales objectives.
The sales supervisor should make the salespeople realize that their compensation will largely depend on their ability and intention to contribute to the organization’s goals. If the salespeople commit themselves to the organization and their performance improves, so also will be the sales of the organization and hence the level of compensation for the salespeople.
In a scientifically designed compensation plan and the plan-related communication strategy, the rewards are always related to the sales performance. This is an important stage in the compensation process, where each stage of performance and reward system should be linked with the contribution of individual salespersons towards the organization.
Step # 5. Measurement of Performance:
Like the compensation plan, the method of evaluations should also be objective and transparent. Sales organizations need to measure the performance of the salespeople periodically. The criteria for evaluation should include the new sales volume achieved in the last period, the level of customer satisfaction, and the level of information dissemination about the performance of the company and its product in the market.
It is necessary to look at the redundancy effect of the compensation plan. This should be done on a periodic basis so that the sales manager can find out the relevance of the company’s compensation plan in the face of competition and evolutions in the sales management function.
The success of the plan can be evaluated by looking into the achievement of compensation objectives, ability of the firm in attracting new salespeople with- the current compensation plan, and finding out the relationship of the compensation plan with the attrition rate in the organization. The compensation plan should be updated continuously to respond to new sales force objectives. There should be a continuous attempt to link the available compensation methods with the desired performance of the salespeople.
Compensation Plan – Trends in Compensation Management
Various trends are emerging in compensation management. As new organizations are emerging, so also are new methods of compensation. Here is an attempt to find out the emerging trends in the sales force compensation methods and its implications for modern-day sales management. We can classify the emerging trends in compensation into four broad categories. The most important trend has been the compensation plan based on the idea of customer satisfaction.
Today, the sales force is not compensated only on the basis of sales volume. The level of customer satisfaction is an important tool of evaluating and rewarding the salespeople. A company like Xerox is the pioneer in designing a compensation plan based on customer satisfaction. It follows a compensation plan based on customer satisfaction defined by the customer itself. This serves as a challenge for the salespeople to achieve the customer-defined satisfaction level.
Another emerging trend is team-based compensation. Though the idea has a Japanese origin, it has found acceptance all over the world. Majority of the B2B selling is done through the team selling strategy and cross-functional teams are designed for handling customer objections in a better way. Clients are also going international in their business operations, and hence customer management is done by more than a single contact point or salesperson.
More and more key account and national account managers are coordinating with the local salespeople to close a sale at multiple points. Many customers are now operating across the territories and geographical boundaries. The organizations need to address their demands and problems at multiple points and in multi-location situations. Hence, it is important to have sales teams.
The performance of the individual salesperson is now linked to the performance of the salespeople in other territories catering to the same set of customers. So companies are replacing the standard straight salary- based or commission-based compensation with team-based compensation, which links the pay of the salespeople with the performance of the customer service personnel, delivery people, and managers heading and supervising the teams.
The technological advances have changed the horizon of customer handling by the salespeople. In the past, the salespeople had to visit every customer to fulfil the information requirement of the customer. Today, email management systems, broadband technology, videoconferencing, and other Web-based technologies enable the salespeople to respond to the customer’s increasing and evolving information need easily and faster.
The customers are also happy with the non- personal form of communication with the salespeople as it leads to lower cost of service and lesser interference by the salespeople at the customer’s place. The e-commerce application has made the communication between the buyer and the seller more interactive and less interfering in nature.
This has made the sales job more target-oriented, as salespeople now can concentrate more on real sales activities than on feeding existing customers with relevant market information, and thus, it has led to an increase in their compensation level due to higher sales realization.
Customers are now spread across the globe and the salespeople serve them by innovative technology and operating across different boundaries and time limits. This has brought the issue of global compensation management systems. Previously the general impression was that third world countries are poor in customer care and quality product deliveries, but more and more companies from the West are changing their perception.
Today, majority of customer care and sales service jobs are outsourced to third world countries due to availability of cheap labour and quality of service output. It is a challenge for management to compensate the global sales force working in different countries in different cost zones through an equitable and flexible compensation plan.
Similarly, the challenge is to compensate the sales force with people from various countries but working in the same workplace. While an Indian salary may not be suitable for the European executives in India, the salary paid to an Indian working in the US at the Indian rate may not be adequate for him/her. Therefore, it is also necessary to equate the salary levels of people working in different countries or economy zones.
Compensation plans should be perceived as equitable across the organization. It is observed that the salary structure is low at the base level where the real sales happens and goes higher as one moves farther from the customers to the upper hierarchy levels of the organization. This is a growing trend, which may hamper the growth of many organizations.
It is important to project the sales compensation as equitable for all levels in the sales organization. In many sales, organizations the standard Indian compensation is not equitable from various points of view, including gender inequality.
Male and female employees are paid differently in many companies although they are doing a similar kind of job. The management should beware of such discrepancies and try to eliminate them for an effective and equitable compensation plan.