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October, 2007

Peak Performers

An Exclusive LBM Journal Report: The Results of our latest research into outside sales compensation.

By Greg Brooks

The 2007 Outside Sales Compensation Survey was conducted in July 2007 for LBM Journal by Richard Carter Consulting Inc. (www.rcciservices.com). The study focused on the compensation paid to outside sales personnel, as well as compensation to related occupations. For this study, the statistical information within the report may be deemed as accurate within a margin of error of +/- 3.2%, at a 95% confidence level.

Who We Contacted for the 2007 Survey

It’s always tempting to use survey results to construct a profile of the "typical” respondent, but in a business as diverse as building supply, it’s not only impossible, it would be misleading.

Out of the two dozen or more SIC codes that sell building products, we focused on the two largest: lumberyards and specialty distributors. Even then, there are a lot of variables that dictate the way suppliers operate, but many of them are driven by the choice of target customers, so we asked respondents to tell us who their customers are by choosing among nine groups:

  • top 150 production builders (500+ homes per year)
  • independent production builders (100-499 homes)
  • mid-sized spec builders (25-99 homes)
  • small spec builders (1-24 homes)
  • custom home builders
  • remodelers
  • residential architects
  • consumers
  • commercial/industrial accounts

Small spec builders, custom builders, and remodelers represented the most frequent target customers at 58.1%, 55.2%, and 46.3% respectively. But nearly a third of respondents say they also pursue consumers and commercial/industrial clients, while production builders were least likely to be core customers—only 12.5% say large production builders are important to them, while 22.8% go after independent production builders.

In our previous 2005 sales compensation survey, more than two-thirds of the respondents came from companies with less than $20 million in annual sales. This time around, more than 55% of respondents were above the $20 million mark, and 21.3% grossed more than $100 million last year. That’s not necessarily more representative of the dealer population as a whole, but it does reflect a greater concentration of respondents in metropolitan markets where sales compensation is more frequently performance-based. As in our 2005 survey, independents operating one location made up the largest single group of respondents, but declined dramatically as a percentage of total respondents—33.0% this year versus 51.2% in 2005. The number of respondents operating at least 10 locations grew correspondingly, from 8.6% to 20.2% of the total.

Not surprisingly, the vast majority of respondents—86%—say they employ both outside and inside salespeople. Given the greater participation by large companies, it’s also no surprise that the average number of salespeople per company rose since our 2005 survey: from 6.9 to 35.7 outside salespeople, and from 8.6 to 19.9 inside salespeople. But the median (midpoint) may be more useful; the typical respondent employs six outside salespeople and 6.5 inside salespeople.

It’s common knowledge that quite a few dealers employ salespeople who specialize in only one or two product categories. Our respondents tended to be generalists, though. When asked which products their salespeople specialized in, the average respondent chose 3.2 categories.

As you’d expect, more dealers employ salespeople who sell windows and doors (54.4%), framing lumber (52.2%), and interior trim (47.1%) than any other product lines. But nearly 30% said cabinets and countertops were a specialty, and nearly 22% sell installed packages.

All in all, our respondents reflected the tremendous diversity of the industry; every market is different, requiring suppliers to tailor their operations to capitalize on those opportunities.

Quite a few things have changed since we published the results of our first outside sales compensation survey in October 2005, but none more dramatically than the housing market. Housing starts in 2005 set an all-time record; as of mid-2007, the market was slipping into what could ultimately turn out to be the most severe downturn since the crash of 1979-82, when home building was brought to its knees by double-digit inflation and 30-year fixed mortgage rates that topped 16%.

That makes close attention to employee compensation particularly timely—not to mention important—for a simple reason: Now more than ever, performance matters.

It’s a big enough challenge preserving your bottom line when the home building well runs dry. But when employee-related expenses account for nearly two-thirds of the typical dealer’s total operating expenses, there’s very little room to cut anything but personnel costs in an extended drought. At the same time, cutting people can weaken your operation to the point where viable service levels can no longer be maintained.

That’s why a downturn is a golden opportunity to capture market share. "We’re taking customers away from the competition because we’re out-servicing them,” says one dealer whose 2007 sales are off 10% in a market that is down 30%.

Dealers who are beating their markets right now aren’t cutting people. Some do have the natural advantage of a presence in multiple segments—remodeling or multifamily, for example—so they can shift their resources when single-family starts fall off. Many are cutting hours, and most are letting their employee count decline through natural attrition. But some are actually hiring, taking opportunities to replace problem employees with good people who have been laid off by others.

It takes guts to stay the course when everything around you is going south. But it is possible to grow in a shrinking market. The catch is that it’s only possible if everyone in the company is as motivated as you are. That’s no guarantee of success, but it is a prerequisite: Employees have to understand the urgency of the situation, go the extra mile (or two) to squeeze every possible nickel out of the market, and then service those sales flawlessly.

If you can create that environment, a down market presents a unique opportunity to re-engineer your organizational DNA. The productivity gains you make when jobs depend on it can leave you with a lean machine when the market turns around. But to maintain those higher levels, employees have to believe they’re getting fair return on their investment. Compensation obviously isn’t the only factor in motivation, but it’s the footing beneath the foundation.

Money talks. Here’s what it told us.

Commission Plan Structure

One key difference between this year’s survey and its 2005 counterpart is the size of the companies that participated. In 2005, the greatest number of responses came from dealers with less than $5 million in annual sales; this time the largest group ranges from $20 million to $50 million in annual sales.

So it’s no surprise that the method by which respondents pay outside salespeople changed significantly in this year’s survey. In 2005, 28.8% said they pay salary or wages only while 18.8% paid commissions only. This year, 24.4% of respondents said their outside sales force works on commission only while just 10.5% earn salaries or wages only.

It should also be no surprise that most dealers’ compensation plans fall between those two extremes. Among this year’s respondents, 24.4% also say that over half of what their outside salespeople earn comes in the form of a salary, hourly wages, or draws, with the remainder in a commission. The largest group flips that formula on its head; 36.1% pay a base salary, wage, or draw that is less than 50% of total compensation, with the remainder coming from commissions.

The actual dollars paid by respondents in this year’s survey are fairly consistent with 2005, with most of the variation accounted for by greater participation of large companies this year. In 2005, the average outside salesperson at a company with over $20 million in annual sales earned $72,374. This year, the average was $78,994.

Larger companies are more likely to be located in urban markets where the sales potential is greater, and that was also reflected in this year’s survey. In 2005, only 9.8% of respondents said their outside sales reps averaged over $100,000 per year; this time around, 11.5% topped six figures.

But as always, averages don’t tell the whole story. This year, 11.5% also reported that their highest-paid outside salesperson earned at least $250,000, and two companies said their top performers made over $500,000.

Compensation philosophies vary widely, and one of the most important driving factors is the size of the market in which a dealer operates. Larger markets create more opportunities to earn commissions. Balancing a compensation plan so it is weighted toward commissions rather than base pay rewards both salespeople and the company when business is strong, and protects both parties in a downturn—flexible compensation reduces the need to use layoffs to control costs.

The purpose of any good compensation plan is to motivate specific behavior by rewarding salespeople for pursuing the company’s objectives. Dealers design their plans in a variety of ways that are frequently a reflection of their product and service mix.

Virtually all respondents who pay their outside salespeople a commission base the rate on either gross sales or gross profit dollars generated—only one reported paying commissions for achieving specific goals. A slight majority, 55.4%, prefers to keep their plans simple by maintaining a fixed commission rate; 21.6% pay a straight percentage of gross sales dollars, while 33.8% pay a straight percentage of gross profit dollars generated.

As installed sales has become more widespread, dealers have also had to deal with the question of how—or whether—to pay salespeople on the labor portion of the job. Slightly over 50% of respondents provide installed sales services; 54.2% pay commission on the gross profit generated, while 29.2% pay on gross revenue.

The question of whether to pay on sales or profit is a critical one; it’s the most important factor controlling what kinds of sales your salespeople pursue. When commissions are based on gross sales, salespeople are encouraged to focus on product categories that generate volume, such as framing packages, but they have no natural incentive to maximize their gross margins. In fact, sales-based plans tend to encourage salespeople to push for lower margins that make it easier to close sales.

That’s why only 9.5% of respondents who pay commissions on gross sales dollars say they give their salespeople full authority over pricing. The majority, 58.1%, gives salespeople pricing authority within a defined range, but requires management approval to discount beyond those parameters. Another 24.3% takes pricing authority completely out of the hands of its sales force (the remaining 8.1% responded to the question but said they don’t pay based on sales dollars).

A commission plan based on gross profit dollars generated gives salespeople a natural incentive to maximize their margins, of course. It can also discourage them from putting effort into low-margin product categories such as framing, though. There are a number of different approaches to balance the incentive to generate volume with an incentive to maximize profit.

In the survey, 44.6% of respondents say they pay a variable percentage of either sales or profit dollars. In this scenario, they may pay a percentage of either gross sales dollars or gross profit dollars, but the rate depends on the gross margin achieved—the higher the salesperson’s gross margins, the higher his or her commission rate will be.

The choice of a straight versus a variable commission plan depends on a lot of factors, some of which are unique to each company. A variable commission plan allows greater control to align the salesperson’s incentives with the company’s objectives. It’s also more complex, which means it can be more difficult to manage and communicate. A straight percentage is simpler, but may require more proactive sales management to ensure that salespeople are working toward the company’s goals as well as their own.

It’s a balancing act and there is no single right answer. The proof of a successful plan is in each dealer’s income statement.

Adjustments to Commissions

Salespeople like to quote the old adage, "Nothing happens until a sale is made.” Credit managers prefer a variation: "Nothing happens until the check clears the bank.”

A critical component of any compensation plan is how commissions are adjusted for sales that go bad due to returns, backcharges, or bad debts. The balancing act here is more complex—not simply a matter of fairness, but also a consensus about what is or isn’t fair.

Only 7.7% of respondents say they don’t adjust commissions under any circumstances; that’s a generous policy that suggests an exceptionally high degree of confidence in their salespeople. That’s not to say others aren’t confident, but when an order goes bad, it usually means that the company incurs additional expenses to correct the situation. If so, it’s only fair to take back the commission on those sales to help cover the cost.

Among our respondents, 55% adjust commissions when materials are returned, but the circumstances do matter.

For example, 23.1% say they make adjustments when in-stock material is returned. It’s not uncommon—and sometimes not unreasonable—for salespeople to send a little more material than their customers need to make sure they aren’t caught short if someone makes a bad cut, for example. That can save money if it eliminates an emergency delivery.

But unless the builder is willing to keep those pieces and use them on another job, the more likely outcome is another run to the job site to pick up unused material. That negates the savings from eliminating an emergency fill-in, and the material frequently comes back in less-than-stellar condition.

Another 20.7% report that they adjust commissions when special orders are returned, no matter whose mistake caused the return. Sometimes salespeople are given incorrect specs and that’s not their fault. But the company incurs additional cost regardless—not just the time and effort to handle the return, but also the cost of the returned materials, which sometimes can’t be returned to the vendor. Nevertheless, 11.2% say they only adjust commissions on special-order returns when the return was due to the saleperson’s mistake.

It’s become more common for builders to backcharge dealers when a mistake causes additional labor charges. But frequently the cause of the problem is less than 100% clear, and only 14.8% of respondents say they reduce commissions for labor reimbursements.

The question of bad debts is a little more complicated. It’s not an issue for 1.8% of our respondents—they pay commissions on dollars received rather than dollars generated. Among the rest, collections are a team effort; 85.7% say the outside salesperson is actively involved in collecting past-due accounts. Slightly more than 20% say they adjust commissions if the debt has to be written off, but only 45.7% pay commissions back to their salespeople if the debt is ultimately collected.

Support Resources

Any performance-based compensation plan aligns the company’s objectives with those of the salesperson in at least one critical area: Both want the salesperson to spend as much time as possible in the field selling.

But it takes more than compensation to accomplish that, and most dealers provide a variety of support services to their outside salespeople to help them maximize their time in the field.

Takeoffs and quotes are one of the most time-consuming chores in sales, but they also pose something of a dilemma. Many dealers—and salespeople—believe that salespeople need to do their own takeoffs in order to fully understand the project and provide the best possible service. But that isn’t always practical or even possible, especially if engineering services are provided.

This year’s respondents were split equally: 25.3% say their salespeople do all their own takeoffs, while the same percentage relies on dedicated estimators. The other 49.4% say their salespeople do as many takeoffs as they can, but send plans to estimators (either in-house or outsourced) when the workload gets too heavy.

The question of how takeoffs are done was split, too; 27.8% do them exclusively by hand, while 25.6% rely exclusively on estimating software. The remainder either use a combination of the two or outsource takeoffs.

It’s pretty well established that software is quicker and can help eliminate mistakes, but the estimator’s comfort level also plays a big role in that decision. Those who learned to do takeoffs by hand often prefer it even though it takes longer. Even dealers who do use software don’t always get the full benefit, though. Only 47.1% of respondents who use estimating software say it interfaces with their POS system.

There was yet another split over the question of paying an outside salesperson’s costs. Dealers may contribute, but when asked about the resources for which they cover 100% of the cost, respondents were divided: 48.5% pay all vehicle expenses, 52.2% fully cover entertainment costs, 54.4% pay all cell phone charges, and just 32.4% pay for computers or PDAs.

But one area where there was little disagreement was the value of support personnel. Over 95% say they provide inside sales or administrative support to help keep outside reps in the field selling.

As you’d expect, those teams are organized differently, typically depending on the outside sales rep’s volume; 66.3% of respondents say their outside salespeople share support staff with other outside reps, while 19.3% assign one or more support people to each outside salesperson. Just 12.1% organize their inside and outside salespeople into teams in which the team as a whole is responsible for its accounts.

Philosophies on how to pay support people also vary; 57.8% of respondents pay salary or wages only, while 41% pay wages plus a commission. One respondent said its company’s support staff receives commissions paid directly by outside salespeople.

Motivating the Troops

Motivation is the main purpose of any commission plan, but this year’s respondents also encourage peak performance with these methods—bonus for reaching goals (34.8%), monetary or non-monetary prize contests (24.4%), perks such as time off or travel (20%), and even quotas with penalties for non-fulfillment (6.1%).

The consensus is that money talks; 44.8% say bonuses or other monetary compensation is a very important motivational method, while contests (13.8%), non-monetary perks (19.5%) and quotas (9.2%) ranked far behind. But over a quarter of respondents cited methods beyond our four, ranging from training to recognition, additional money for customer entertainment, friendly internal competition, and in one case, "weekly paycheck.”

Compensation plans may be as diverse as the companies that design them, but there is one common thread among this year’s survey respondents: Peak performance is a team sport.

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