Why do/would a company limit commissions paid to salespeople?

Factual Questions
1

A plot device in the TV series ‘The Office’ involves a company that at one point has limits on commissions paid to salespeople. The company subsequently removes those limits.

I had never heard of limits on sales commissions. I have never worked in any kind of sales job, so I may be missing some very basic things here. I understand that sales commissions provide incentive for the salespeople to sell more, which the company wants. I also understand that many sales positions provide a wage/salary, and minimum sales quotas as a condition of that wage/salary.

Assuming (to quote Homer Simpson) that TV hasn’t lied to me, what would be the reason for maximum limits on commissions?

If a company wants to maximize sales revenue, a dollar of revenue would be worth the same whatever the salesman had already earned.

TIA.

2

I have a real life example of this. I was making a pretty decent salary as the Director of Business Development at a small defense company reporting directly to the CEO and President, who was the owner of the company and as it turns out, a jerk. At one point when the economy started going downhill, our HR manager suggested to him that he could lower my salary simply because they knew I would get less money going to another company given the economic conditions. Unfortunately (for them) they lowered it far too much, and I left at the end of 2009. The guy they hired as my replacement (presumably at the lower salary) has not won any work for them in all of 2010. I presume they gave him the same commission deal I had, but from what I’ve heard, he is about to get fired for poor performance.

The deal was, I was to have my salary lowered $30,000. Since one of my specialties was winning the company grants, I was told I would get $3,000 for every one I won during the year, up to a maximum of 10, which would restore me to my previous salary. Since the most I had ever won was four in a given year, that seemed like a good gamble for them never having to pay more. That said, they certainly didn’t want to have to pay me MORE as a result of their new commission program.

So why limit it? Well, there are two main reasons in government contracting. The first is simply that there is a quality of work issue. If I win lots of grants, they have to hire lots of people on a short term basis to do the work, which is a pain, and with that much potentially coming in, the work quality was sure to suffer. Ergo, they theorized the maximum they could ever handle would be ten before the company’s reputation would suffer. The other is a matter of size. In government contracting, there is a magic figure of $23.5 million in revenues that makes you jump from a ‘small business’ to a ‘large business’. The government makes lots of set aside contracts for small businesses that allows them to win work more easily, particularly if they are service disabled veteran owned, in economically disadvantaged areas, etc. A company that is, say $23 million is a big fish in a small pond and can easily win business in the small business category. If they bust through the $23.5 million mark, now they have to compete with IBM, Lockheed, Northrop, Raytheon, etc., which have endless resources, and now they are a small fish in a huge pond. Most mid size defense company flounder at this stage and have to sell out to a larger company, or risk disappearing. If I won too many grants, I could have breached that threshold combined with their other existing business, and that would have actually hurt the company - hence the limit.

And let’s not forget the all important ‘jerk factor’. No senior level executive ever wants to have his salespeople earning more than him, even if they deserve it for the sales they bring in. As such, they will tend to set an upper limit so they always earn more. I have always been of the philosophy that I would want my top salespeople to earn more than me as too many sales is a nice problem to have, but I think my way of thinking is not common in this industry.

3

Some people have a sense of social justice when it comes to compensation, in that they don’t think it is “fair” that you should earn above a certain amount of money. From a purely economic perspective, this should not be done, obviously. In order to maximize productivity and efficiency in a free market system, a wage should be a boundless and dynamic variable that is determined by supply and demand. In such as system, a commissioned sales associate who is making $5M/year is worth $5M/year, and a commissioned sales associate who is making $30K/year is worth $30K/year. The social justice crowd does not see it this way, however.

4

When I worked in jewelry sales a very long time ago, we made minimum wage plus commission. I have never heard of a ceiling being placed on commissions, but I have heard of other ways to limit commission pay.

The jewelry company would start a “new” commission structure periodically, but it seemed to me to be random as opposed to annually or biannually or whatever. I don’t remember the exact details of the commission structure, but it would look something like this:

1% commission on total retail sales up to $10,000. When that goal was met, it would increase to
2% commission on sales up to $50,000, then 3% on total sales up to $100,000, etc.

As sales would accumulate during the year, one could actually start to earn a little money, so the company would then announce a “new” commission structure and start everyone over again at zero.

The company always tried to present this as a “new and improved plan” that would somehow benefit the employees, but it pretty effectively limited the amount of commissions one could earn, and generally pissed everyone off.

I moved on to a medical supply company that was trying commission sales for the first time. Because the current employees had never worked on a commission structure and I had, I pretty much sold the pants of everyone there the whole time I worked there. It took the existing employees a while to make the connection between sales and an increased paycheck, so I took advantage of their slowness to hit the learning curve.

That company went out of business a short while after I left, but I don’t know why. I think the change to commission-structured pay was some attempt to save the business and that it didn’t really work out.

5

When I handled incentives for a large hotel chain, it had unlimted bonuses, but the problem was no one ever had really agressive sales people. Then suddenly we hired two sales people that were very agressive. They were basically working 24/7.

In short in six months they wound up at over 200% of their salary. This blew everyone out of the water, and also killed the budget. The regional controller was coming at me every day to make sure I calculated it correctly. Which I did.

To make matters worse, the booking were generally a year out and at the time, in the hotel business, a year was a long time for a salesmen. It paid to “jump jobs.” So they could be booking and the group would not materialize or cancel and then they would be paid in full while the booking fell apart a year later, when they were gone.

6

Just a WAG (maybe not that wild), but in addition to the concerns already raised, is it possible that companies are concerned about encouraging too much competition among salespeople? In the Office, the salesman presumably have some limited geographic region they typically sell to. With no limitation at all on comissions, a particularly agressive salesperson may start poaching potential sales from other salespeople in the company. This nets no additional sales for the company, but may result in lower employee morale.

Having said that, I think that Markxxx makes the best argument for limitations. Depending on the industry, too many sales in a particular timeframe may hurt the company if it cannot fullfill orders.

7

My sister was the top salesman in a large jewelry chain and they limited her commissions with the result that stopped trying for part of the year and they lost whatever business she might have brought. It is the same mentality that leads many supermarket managers to limit the number of checkout clerks. Yes, an idle checker costs money, but so does a customer who takes one look and walks out. There is a simple observation that should show them their error: every cent that goes into the register goes through a checkout clerk.

8

So I went to work for a guy that did mail order performance auto parts once. He had been selling about $7,500-$8,000 in parts every month.
He proposed a pay deal for me, part salary and part commission of sales over $10K/month.
Great, I took the business to 15K/month.
He was happy.
I took sales to 22K/month
He was pissed, I was making more than him.
He “restructured” my pay so my commission was from dollar one, but at a much lower % than before.
I took sales to 35K/month
He fired me.
:rolleyes:

9

Also Dunder Mifflin was bought out by SABER. It’s entirely possible that SABER had a different commission setup from DM (or even have their sales staff on straight salary), but they kept the DM staff on the old system. To keep the disparity between the two sales forces at a minimum, they’d put a cap on the DM sales commissions.

10

Most businesses have a commission structure set up to be simple and easy to understand, which helps it’s purpose, an incentive to salespeople. But most businesses aren’t that simple, and attributing the value of a sale to a salesperson is complicated. If you were just selling widgets through salesmen, and every deal was closed on a COD basis, and the volume and size of sales had no effect on production or other business operations, and the salesmen worked totally independently, and had no on-going service requirements involved in the sales, then a limitless commission would make sense. But that doesn’t happen too often.

11

In real estate every agent has to sign a legal contract with the broker as to their commission breakdown. Our office had a sliding scale–the more income they brought in, the higher the percentage.

This was a legal document. While it could be renogotiated, arbitrarily messing with it would bring the Real Estate Commission into the office.

12

The solution to that is to pay the commission only after the customer actually turns up and uses the booking. (It wouldn’t matter if the salesperson had moved to another job by that time: you could still pay them the commission.)

13

I owned a business for 20+ years. The last thing I would ever do is put any type of limit (percentage, territory, etc) on a sales person. This assumes, of course, that the commision percentage/deal was equitable to both the company and the sales person. It also assumes, if territory based, the sales person is “covering” the area thoroughly.

Mine was a service business and the commissions we paid were based not upon gross billing, but profitability. I told our staff it was my fervent wish they made more money than they ever thought they could. I meant it, too.

14

I have to agree on this. I worked in a computer store, as holiday help this past Christmas at the checkout.

Usually it was simple, the salesman sold a laptop and stuck his sticker on it. I would scan the price, scan the ticket, he got 10% of the sale. Easy right?

Not so…

Suppose Mr Coyote, sold the computer, then the customer goes from the computer section to general sales, and buys a computer laptop case, DVDs, power cords, USB drives, etc etc. And Mr Road Runner helped the customer find those. So Mr Road Runner puts his stickers on those items.

Now I as a check out clerk, scan the item and the laptop gets credited to Mr Coyote and the other items get credited to Mr Road Runners. Sounds correct right?

Not so, since Mr Coyote, sold the laptop and none of those other items would’ve been bought had he never sold the laptop, Mr Coyote got credit for it.

And they’d leave it to the check out clerks to figure out. I was glad I was holiday help 'cause I said, “I’m scanning the tickets and the sales clerks can fight it out later on.”

15

I do a lot of employment cases and I see this much of the time. For many people in business it is not about making money so much as it is about power and prestige and then making money. Successful commissioned sales reps are frequently messed with by owners, HR, managers, etc. to try to reduce their commissions and transfer that income to others for a variety of reasons that hurt overall revenues.

16

My experience is pretty well covered in post 2. I have seen them used in service based sales. The issue being that if you went past a certain point there was nothing left to sell.

It also works on a category basis. If you have maximized your service resource placements (jobs) you now focus on maximizing your return on resource (rate).

The reason being that a widget does not care if it is sold cheap, but you really don’t want employees that you value scraping along unable to get a raise because somebody who gets an up front commission could give two shits about margin.

A third reason to cut back on commission is to not exhaust the local supply of hookers and blow.

Based on purely observational data when a company says they are revisiting the sales compensation model to mutually benefit all parties involved someone is going to get burned.

17

Sorry Giles, but I don’t know of any business that would pay a commission after a salesperson resigned barring a specific contract requiring that. One of the grants I won for my company is resulting in them getting their first patent. When I left, the VP of Operations was very sorry to see me go, but completely understood why I was leaving with the ridiculous terms of the commission deal and it’s limits. He assured me I would still get the $3,000 bonus after I left, but ultimately that was up to the President/CEO/owner - the same jerk who implemented the dumb commission structure to begin with. Guess what? That never happened and they won’t return my phone calls now. What a shocker!

That’s o.k. though, because this owner has now burned numerous other employees with similar shenanigans and his reputation is now becoming well known in the industry, hence his lack of new business…

18

If the company was run that way, then they deserve whatever they lost. They should have payed the bonus when the bill was paid.

19

I work with salespeople who do have a maximum on commission. Their compensation plan periodically gets juggled, but as I understand it it works something like this;

They have a compensation plan based on a nominal salary. Their actual compensation is a fixed 60% of the “nominal” plus a variable amount that is a proportion of their sales. They have a sales target or “budget” and the numbers are supposed to work out that if they hit their sales target for the year then the “variable” part of their compensation will work out to 40% of “nominal”, thus getting them to 100% of nominal for the year.

If they don’t hit target budget, then their compensation is less than nominal, and if they do better than their budget then they make more than nominal.

Referring to the OP, there is a maximum or “cap” that they can make on the variable part such that their total compensation does not exceed 120% (or maybe its 150%) of nominal.

One reason put forth for this is that in our industry some customers may suddenly and unexpectedly purchase wildly more of our products than would be expected, truly out of proportion to the effort the salesperson expended, and the salesperson should not benefit from such a fluke. Budgets are updated each year to reflect such variability in customers purchasing trends. Having a cap helps discourage salespeople from under-forecasting what their expected sales will be for the upcoming year, when budgets are being set.

So, yes there are sales people who have a ‘capped’ commission, and there can be a reason for it.

20

While that’s great for the company, I doubt it will produce the desired result. Instead, you’ll have salespeople very eager to book trips for next month, but who can’t be bothered to return phone calls about next year. Nobody wants to be paid a year from now for work they did today if they have other options.

This really goes back to the observations others have made: commission systems are usually a gross oversimplification of the real complexity in the sales and revenue collection process. Management tries to come up with something that motivates the behaviors they want. Sometimes that results in oddities like a cap on commissions or employees who game the system in a way that screws the company.