In the last article, we looked taking a basic commission and creating some method to allow for “covering the costs” of the employee (primarily done via draw or seat cost). Now we can look at the commission itself.
The flat rate version is simple and the most common method used when combined with a draw approach. In a flat rate, one rate is applied to all gross margin dollars produced regardless of volume within a period. In fact, the only time that any kind of “period” needs to be considered at all is when you are considering if the draw has been covered. At some point, you have to cut off the calculation (and decide when a load counts in one month vs. another) to know what number you are using to subtract the draw from (is it weekly, bi-weekly or monthly for example?).
The problem with flat commission rates is that doing well on them is a bit like winning a pie eating context when the award is a pie. It’s just more of the same, over and over. Eventually it becomes “not worth it” and most reps will stop working beyond their income needs[1]. Under a straight commission (once they clear the draw or cover their base or clear the threshold) they get to decide what good looks like, and they will do something like this. “I need to make $5,000 a month to sustain my desired lifestyle without killing myself. My flat, first dollar commission rate is 20%, so I need to generate $25,000 a month in gross margin to ensure I make $5,000. That, for me, is good enough.” Well, what if it’s not really “good enough” for the company? What if management has added resources or improved the TMS system, or added automation so more work can be done faster? Is $25k a month really good enough? Will it still be good enough when the rep has been with you for five years? Should the employees be dictating what “good enough” is when they don’t understand the business economics and all the costs that go into running a brokerage? Of course not.
So, one solution to this is to create tiers in your commission plan that help them see what YOU define as good enough. We already understand the concept of a threshold (the point below which no incentive pay is earned) but now we need to introduce the concept of goal or quota and the concept of excellence. At a minimum you need to define these three points and change the pay rate between them. For example, you could say that the rate is 0% to threshold, 10% between threshold and quota, 15% between quota and excellence, and 20% above excellence.
Ahh..but now comes the question: is the 10% that is paid when threshold is reached paid on all dollars generated to that point, or only on the dollars above threshold? This is the difference between a retroactive commission rate and a progressive (or marginal) commission rate.[2] A simple graph should help illustrate:
As you can see, the retroactive rate creates a stair step effect on pay. This creates a disproportionate incentive to generate one additional dollar in gross margin. In this example, the reward is relatively small ($200 for 1 dollar generated above $9,999) because I used a low commission rate, but now consider the impact if the commission rate is higher. Retroactive rates BEG the reps to cheat the plan to succeed. In fact, I consider these plans to be an intelligence test of your staff. If they are not all landing at the start of the next higher step at the end of the period, either they don’t understand the plan or they aren’t very bright. It also misaligns their economics with yours. As the owner, you would rather they didn’t generate that last dollar, but of course they will do whatever they can (often, unfortunately, unethically) to get that last dollar.
A better approach, though I admit it’s harder to explain, is the progressive rate. This pays the higher commission rate only on the dollars within the tier…NOT back to previous tiers or the first dollar. This allows you to get a much smoother payout curve so there is now very little reason to cheat the plan. It’s only the next one dollar that is paid at that rate, not all the preceding dollars as well. You also can create a much finer degree of control over the payouts under a progressive plan, allowing you to define the plan economics for poor performers vs. top performers more precisely. In the graph, you can see that I set the rates (deliberately) to pay underperformers less and overperformers more. It doesn’t have to be this dramatic, however. I have converted companies from retroactive to progressive rates and the new progressive line cuts right through the middle of each step. It’s entirely up to you how you want your payout curve to look.
Both examples shown for retroactive and progressive rates use “fixed tiers” in terms of how the goals are defined. This means that a dollar value for production is shown in the tiers used to band the rates.[1] You can use relative tiers as well. This would come into play primarily for smaller sales forces (maybe your enterprise sellers) who have vastly different books of business so that you cannot use one standard production number. The monthly quota for one of them might be $150k and another might be $300k. Both numbers are “good” based on where the rep is starting. In this case you would set a goal ($150k and $300k) and set the commission tiers relative to the goal. The first tier might be 0% to 49.99% of quota, the second 50% to 74.99% of quota, the third 75% to 99% of quota, etc. You get the idea. If you are using a commission, the person with the higher quota will still make more in absolute terms as they are using a larger number to multiply against the commission, but it gives the person with a smaller quota the chance to get into higher commission tiers faster as their production buckets are smaller in absolute numbers. Relative tiers could be paid using either a retroactive or progressive approach to the commission rate, as well.
While the goal-based commission is certainly the most complicated of these options, in many ways it solves a variety of problems caused by fixed tier commission models. Using a relative goal that you can adjust by person (or group of people) allows some degree of control over the outcomes that you simply cannot get with a straight or tiered commission model that pays the same to everyone based on raw production. There is no “lever” to pull to account for different books of business, different automation levels, or different customer types. Using a relative goal gives you that lever. Fundamentally, when you are managing a business you have the responsibility to be fiscally prudent about how the company’s money is spent, and compensation is likely the single biggest expense item a brokerage has. Every straight commission brokerage will tell you how they’ve grappled with adjusting economics by adding taxes, or overhead charges, or changing the way the draw is calculated, or some other (convoluted) way they are trying to adjust the payouts to align with new economic realities. Using a goal is a very transparent and direct way to do this. Goals go up. On occasion they might go down, but usually they go up. People know this and there can be solid rationale given to why this is so. Using a goal-based commission allows you to make these adjustments.
[1] Yes, there are those for whom there is never enough money, but they are few and far between and tend to get fewer and farther between as the workforce ages and families are started that create time demands that didn’t exist before.
[2] For years, I’ve called this a “marginal” commission rate but since brokerage firms pay on gross margin (almost universally) this creates confusion because the term “margin” is being used in two different ways. If it helps ease understanding it could also be called a “progressive” rate.
[3] You don’t have to use as many tiers as I have done, by the way, but more tiers allow finer control over the shape of the payout curve. At minimum you need four tiers: below threshold, threshold, target, and excellence.
Beth Carroll is the founding partner of Prosperio Group, a compensation development firm that focuses on the strategic management of compensation for global transportation & logistics companies. Beth is based in Chicago, IL and has over 25 years’ experience developing and administering incentive compensation plans for companies across the globe in a variety of industries. Prosperio consultants have completed projects with more than 300 Transportation & Logistics companies. Beth can be reached at 815-302-1030 or via email at beth.carroll@prosperiogroup.com.