Examining Sales Commission Plans and Pricing

by Scott Thacker

Scott Thacker serves as CEO of Ivory Consulting and on the Board of Directors of the Equipment Leasing and Finance Association as well as its Financial Accounting Committee. He also serves as the co-director of the Research Committee of the Equipment Leasing and Finance Foundation. Prior to joining Ivory Consulting, Thacker was a partner at Accenture responsible for creating and delivering management consulting and software solutions to the North American equipment leasing and asset finance industry. Previously, he held leadership positions with Oracle where he was instrumental in creating the company’s now widely used Oracle Lease and Finance Management application, and with American Airlines, where he was involved in executing aircraft, equipment, real estate leases and other financial transactions.

Ivory Consulting’s CEO Scott Thacker provides advice and counsel to equipment lessors and lenders on ways to improve customer satisfaction, enhance employee engagement and increase shareholder value using modeling and pricing techniques.

In my role as CEO of Ivory Consulting, I visit with many of our customers and attend quite a few industry events every year. During 2017 I noticed several CEO’s talking about revising or improving their commission plans for their sales staff.

The Role of a Commission Plan

As we all know, a well-crafted commission plan is designed to motivate behavior, such as selling certain products to selected customers. Often commission plans motivate multiple behaviors – higher commission rates for certain products, a different commission rate for products and services, commission sharing plans to encourage teamwork or varying commission override rates for exceeding specific thresholds.

Commission Plan Options

Commission plans must be based upon driving at least one metric. Some examples of metrics include:

  • ROE – return of equity
  • EPS – earnings per share
  • EBITDA – earnings before interest, taxes, depreciation and amortization
  • Total revenue
  • Incremental revenue from existing customers
  • Number of new customers
  • Commission plan rates vary as well:
  • Spread above the required MISF yield
  • Spread above the required IRR yield
  • Spread above the required ROE yield
  • Percent sharing in the SVA (Shareholder Value Added) dollars in the transaction
  • Percent of present value of pretax cash flows
  • Percent of present value of after-tax cash flows
  • Percent of book income

Because of the complexity of most sales commission plans, it can be difficult for a salesperson to determine his or her commission from a proposed lease transaction. For example, many lease transactions are complicated, taking into account taxes, fees and other uneven cash flows, the structure of a lease will likely affect the commission. Balancing the commission plan drivers with transaction profitability is a delicate management task.

The CEO’s I’ve spoken to raised two questions. First, what is the correct metric upon which to base the commission plan? Second, how do you ensure that the structure of a lease quote drives the most profitable deal (including the commission burden) and is transparent to the salesperson?

Most CEO’s prefer to base the commission plan on a quota that enhances both revenue and transaction profitability. Using a broader measure, such as corporate EPS, corporate EBITDA or divisional contribution, is much less interesting to them.

One approach upon which to base a commission plan is to determine the Shareholder Value Added (SVA) on a transaction basis. It fits very well into using commissions to incentivize behavior. SVA is the present value of after-tax earnings generated from a transaction that is above the company’s required ROE (Transaction SVA = Transaction Net Operating Profit, after-tax – Cost of Capital, after-tax). SVA blends well with Risk Adjusted Return on Capital modeling. The transaction factors which drive a positive SVA include amount, term, ROE and credit quality. Other conventional metrics tend to be more one dimensional.

SVA is a more appropriate measure upon which to base a commission to a salesperson who has created a transaction where MISF, IRR, or ROE is above the company’s stated threshold. This is because transaction term, amount and credit quality are usually not part of a simple MISF, IRR or ROE yield. SVA blends it all nicely together.
One way to ensure that a lease quote is structured to maximize both the commission to the salesperson and the profitability of the transaction (including the commission burden) is to use a modeling and pricing tool which shows how the commission changes with the structure of the deal. For example, the deal can be structured in SuperTRUMP. Here is an example.

Assume a lessor is offering their salespeople a commission of 2.5% of the present value of the after-tax cash flows of the transaction at a discount rate of 3%, paid up-front for new business booked.

An asset cost of $1,000,000 is being leased for 60 months commencing on January 15, 2018 using 100% bonus depreciation and a 21% tax rate pursuant to the Tax Cuts and Jobs Act of 2017. Payments are to be made monthly in arrears, and a 20% residual value is assumed.

Rent is to be determined such that a 6% nominal after-tax MISF yield is achieved without the commission. The present value of the after-tax cash flows at a discount rate of 3% is $74,216.
The commission is 2.5% of $74,216 or $1,855.41, and is paid up-front and amortized straight-line over the 60-month term.

In the table below, this commission is included in the second set of yields which reflect the lessor’s economics. Note that the after-tax yield (MISF) of the transaction dropped by about 6.5 basis points.

To be a truly successful lessor, it is important to follow a few guidelines when creating a commission plan:

  • Agree on the behavior you want to encourage.
  • Determine the metric upon which to base the commission plan.
  • Establish the commission rate.
  • Use a transparent tool like SuperTRUMP that allows the salesperson to see how their commission will change as the deal structure changes.

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