Commissions (in all possible forms, including percentage-base bonuses and even royalties) are curiously contradictory – they are revenue-driven expenses. Unlike other costs in the value chain, they don’t precede, but follow commercial transactions of converting products and services into business returns. These incentives are basically wages calculated as a percentage of one or another base. And it is the selection of the base that, unfortunately, hurts most of the companies using this type of remuneration.
In many industries commissions are traditionally based on volume – sales, purchases, collections, etc. Employing a system like that stimulates the race for big numbers – the more you sell (procure, collect), the higher are your commissions. The sales force, or procurement team, runs down every single order without any concern for its contribution into the company’s bottom line. Of course, returns, allowances, price discounts are all accounted for in the calculations, but otherwise volume-based payees don’t care whether the company looses or makes money on their deals.
This eats away profits of many organizations. Even if a company consistently doing well, even if you have a system of pre-approving deals by projecting their profitability, there are always some transactions that will end up loosing money for one or another reason: the freight rates, for example, have a tendency of suddenly going up all the time due to the spikes in oil prices. Yet, the commissions on those sales will be paid anyway, further deteriorating the bottom line.
Of course, some good CFOs and controllers try to absorb the possibilities of losses into their calculations and fight for reduction of rates. But the truth is that most of the time, especially in smaller businesses, the companies stick to industry standards and you need a revolution to change them.
The only way to avoid this multiplication of losses is switching your company to commissions paid based on the transactional gross profit. The reason I use the term "transactional" here is because, unless you have one person receiving commissions for the entire volume, you will have to enter the world of segmenting your business into portions that correspond to all recipient's sectors: countries, regions, products, and even transactions.
I will not deny the fact that it is a pain: there is a lot of work involved into all that, including the process of allocating shared expenses and overheads. Moreover, I can guarantee you that your calculations will be severely scrutinized by all interested parties.
Over the years of my career I was able to implement such systems in two companies. The matters were further complicated by the fact that procurers and sales people cooperated on different transactions, in different combinations. Can you imagine dividing all those shared credits?! Both times I had a dedicated analyst assigned to the task and personally dealt with complaints from the traders. But the benefits to the businesses were undeniable – no commissions were ever paid on loosing deals. Think about it.
The Frustrated CFO 