able to meet those commitments.
If our compensation offer is a percentage of sales even though fixed salary is more desirable to our applicant, there are just two ways this salesperson will accept our offer. The first possibility is that the salesperson will accept our $ 40,000 to $ 60,000 variable plan but will remain unsatisfied and continue to look for more desirable terms of employment elsewhere. The second is that we will have to increase the upside potential of the commission plan to the point where the salesperson views it as equal in value to a $ 50,000 salary. For some candidates, this might be $ 40,000 to $ 70,000 and for others $ 45,000 to $ 65,000.
In either case, Bigglie must expect that the privilege of maintaining a variable pay system will come at a cost. In the first case, we pay more recruiting costs as we hire employees who accept our offer but leave as soon as they find the job they really wanted. In the second, the variable wages we pay are actuarially higher than the salary the candidate demanded. For example, if we offer a range of $ 45,000 to $ 65,000 and all numbers are equally probable, we are paying the actuarial equivalent of $ 55,000. Because we were not willing to guarantee a $ 50,000 salary, Bigglie has put itself into a situation where actuarially it can expect to pay $ 5,000 more in wages than it would have otherwise.
Let’ s look at a group of 10 such salespeople who are performing within a system. We vary their wages from $ 45,000 to $ 65,000 based on their sales. When we tie compensation to sales even though all the salespeople fall in a range where none of their results show a statistically significant difference in their quality of work, the only benefit Bigglie receives from a variable compensation system is the right to match our employees’ pay to our sales. When sales are low, we have the privilege of paying less salary to offset lower profits. What we are paying for, effectively, is low sales insurance— the right to offset a sales slump with lower wages. In this example, the actuarial cost per salesperson per year is $ 5,000. So here we are, a half billion-dollar company, buying low sales insurance from each of our salespeople, with the insurance premiums taking the form of salary ranges actuarially higher than the salary that otherwise would have been demanded.
Finally, from an ethical standpoint, tying compensation to sales implies that salespeople control sales outcomes. For salespeople within a system, statistics prove that to be wrong, so suggesting to our salespeople that their commissions are proportional to their efforts and effectiveness is at best misleading. How can we be successful if our relationship with each salesperson is based on a lie?
To be continued next month.
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1
Jeffrey Pfeffer, The Human Equation, Building Profits by Putting People First( Boston, MA: Harvard Business School Press, 1998).
2
A. Conan Doyle,“ The Sign of the Four,” Lippincott’ s Magazine, Feb. 1890. Available online at Project Gutenberg, www. gutenberg. org.