In order to generate maximum earnings from their sales forces, companies in the U.S. spend about $80 million on sales incentives every year. Though these costs can consume up to 40 percent of a company’s total revenue, there is still no clear understanding of how to optimize the effectiveness of a sales force. Research by K. Sudhir from Yale’s School of Management, along with Doug J. Chung of Harvard and Thomas Steenburgh of Darden, explores precisely this issue: how do sales agents respond to changes in payment? By using a dynamic structural model, the authors develop insights into how different elements of compensation can improve sales productivity.
Above all else, the study found that both low- and high-level performers are responsive to bonuses. Every quarter, as the agents neared their targets, they accelerated their efforts in order to meet the bonus threshold. No matter how effective commission was in pushing sales, agents without the opportunity to earn a bonus tended to lose momentum over time. Even the most productive agents performed worse on commission only. Though the result might seem obvious, this research provides some of the first empirical evidence that a non-linear compensation plan helps motivate salespeople; the seemingly simple mechanism of a bonus can actually make agents want to do more.
Equally fascinating, the frequency of a bonus—annual versus quarterly—can influence agents’ effectiveness. As the authors put it, quarterly bonuses “serve as a valuable sub goal that helps the sales force stay on track in achieving its overall goal; such incentives are especially valuable to low performers.” These periodic bonuses stimulated continuous work towards an annual target, spurring consistent effort. Without intermediate targets in sight, low performers started off by slacking—an initial trajectory that often prevented them from reaching annual targets.
A parallel insight was sought in the case of high performers: how should managers keep them motivated? Once they reach their bonus targets for the year, high-performing agents may slow down and postpone the hunt for new revenues until the following year. So what incentives can keep them working once they achieve their annual targets? The answer is an “overachievement commission.” This tool provides additional commission rates if agents go beyond annual goals. When run in the model, the overachievement commission helped keep high performers working hard.
The results of this study help clarify the compensation conundrum faced by most sales leaders. For higher revenues and profits, the solution is to know the “art of structuring” compensation—some simple tweaks can ultimately lead to impressive incremental gains.
Contributed by Nirajana Mishra