Sales commission in a growing startup

This is a based-on-reality short-story of a sales team, and the effects of introducing commission based salaries on culture and process.

A little company called GoldTub

Once upon a time, in a galaxy very close to ours, there was a startup named “GoldTub”. They sold custom-made bathtubs, usually made out of gold to the higher classed species. “GoldTub” had 3 teams: the IT-, sales- and project-team.

The IT team managed their landingpage, and internal systems for sales and project management.

Visitors landing on their web page could convert to a Lead (if they clicked the right buttons), containing a zip-code and some info on what tub they’d like. A Lead was then phoned by the sales team of GoldTub, which (if they said the right things) could convert the Lead into a Contract.

The project team took that contract and worked with the client to ensure the tub was produced according to specs, and planned the delivery.

The sales team

The sales team consisted of two friendly chaps, Chewbacca and Han Solo. They grabbed the Lead who had waited the longest from a list, and called the potential customer to talk about how the tub may be produced, what materials they had and what was popular. Sometimes the customer immediately said yes in the 1st call, other times they said “I’ll have to think about it”. Chewbacca remembers this one time, where a customer never said no, so he kept calling back. Until the 113th call, when the client finally said yes.

If they landed a Contract, they cheered together and handed it off to the Project team. They were both paid the same fair wage, regardless of their sales numbers.

Marketing

While GoldTub didn’t yet have a dedicated marketing team, R2-D2 (one of the developers) knew how to tune ads to get rich Hutts to visit their landing page. He would routinely crunch the numbers and ensure a steady flow of visitors (and hence sales) for them to manage.

Image: Hutts, a species in Star Wars, are often wealthy.

Month 1: Metrics

GoldTub hadn’t had any metrics yet. IT team had been busy making the website and internal systems for GoldTub to be able to deliver anything at all. But now, they finally managed to scramble together some simple metrics on lead to contract conversion rates:

• Number of sales (total and for each sale team member)
• Conversion rate from lead to contract (1%)
• Conversion rate based on zip-code (0.01% - 10%)
• Proportion of sales happening in which phone call (50% happened in the 1st call, 25% in 2nd call… etc).

This revealed something interesting: Han Solo sold more, but Chewbacca had a higher conversion rate. Investigating a bit further revealed that Han Solo had fewer average number of calls per sale too. What did this mean? Maybe Chewbacca was more persistent in calling back Leads?

Chewbacca and Han Solo didn’t think much of this. Han Solo was happy to be selling well. Chewbacca took pride in high conversion. They were still best buds, helping each other out when needed and talking passionately about sales and customers.

Month 2: Introducing commission

The following month, Luke (the CEO of GoldTub) decided they should use those metrics to improve. And in order to motivate the sales team, he decided to introduce commission based wages for sales.

• Base wages were cut by 50%
• For each sale, that person got 500$ commission.

To ensure that the sales team weren’t disappointed, the numbers were set so (given last months sales) wages would increase in total.

By the end of the month, conversion from Lead to Contract increased from 1% to 1.3%. Success!

Month 3: High abandon rate during Project

After signing a contract, a customer would have 14 days to Abandon (cancel) their sales. Project team started to become frustrated with the increasing amount of customers who cancelled, or just didn’t pick up their phones.

To investigate this problem, R2-D2 took another round of metrics gathering. It seemed like the Abandon rate had skyrocketed the last month, from 3% to 24%. Sales had used the ability to Abandon as a sales argument to increase conversion: “If you regret it, you can always abandon”, was a phrase now commonly heard in the sales office.

To reduce this problem, while still keeping the incentive to sell, Luke said:

In order to align the company goals with the sales commissions, we need to only count sales that aren’t abandoned.

Han Solo and Chewbacca grumbled a bit, but they understood and had to agree that Yes, the change did made sense.

From then on out, GoldTub counted sales with a 14 day delay, and only those who weren’t abandoned within that time.

With this way of counting sales, conversion dropped from 1.3% to 0.99%. While this was a substantial drop, it was still marginally better than the original 1% (0.97% including abandon). Luke tried to see the positive in this.

Month 4: Sales running out of Leads

Sales complained on the intercom that they were often low on Leads lately, and asked R2-D2 to up the marketing spending to increase incoming flow of new ones.

R2-D2 scratched her shiny head. The ads had generated as many click as before. Was something wrong with the landing page? No, she couldn’t find anything. After a while she managed to gather new metrics, indicating conversion from Visit to Lead. But also this was stable.

She concluded the only thing causing Sales to be low on Leads, must be that they’re more efficient than before? R2-D2 gave her findings to Luke, and asked if he should increase marketing spend. Luke had found something else: the proportion of sales happening in the first calls had increased too. Could it be that sales had become better at selling early in the conversation? Nonetheless, Luke told him to increase the marketing spend.

R2-D2 couldn’t shake this thought out of her head. What had happened? She dug up the numbers for the last two weeks, who was not yet shown in the metrics, and then it hit her: The conversion had dropped slightly, but the absolute sales numbers were an all-time high!

R2-D2 rolled over to Luke and said:

I think maybe Sales are reducing the amount of time they spend per Lead, by calling them fewer times. Hear me out:

We have a .99% conversion of 500$, giving Sales about 5$ commission per Lead they grab. The first time they pick up the phone to call a lead, they’ll earn an average of 2.5$. The next time they’ll only earn 1.25$, and from there on out it’s just less and less.

Since we pay them commission per sale, they’re more likely to call a new Lead rather than following up an old one. This way, we burn through Leads faster than before.

Luke was disappointed. Did Han Solo and Chewbacca not think of the well-being of GoldTub? Did they just care about their pay check?

Month 5: New rules for sales

After calming down, Luke realized that there could be value in calling both fewer or more times.

While sales would ideally only call fresh leads for maximum commission per month, it is not that simple for our company.

We don’t want to keep calling Leads forever. There’s a point where calling an old lead has less value than acquiring and calling a new lead.

He thought that if the acquisition cost of a new Lead was less than the expected value differential between a new and old Lead, it made perfect sense to increase marketing spend rather than calling old Leads. So he poked R2-D2, who removed her headset and stared blankly at Luke.

Could you find the ideal number of calls to make before it gives more value to acquire and call a new lead?

R2-D2 responded “…sure?”, and came back with the number 4 after a while.

Luke sat down with the sales team, and explained:

[…] so you see, we still have value in the Leads who has been called 2 or 3 times. We can’t just let them sit there, we need to call those too.

Can we all agree to call each lead 4 times?

Han Solo and Chewbacca looked at each other with raised eyebrows:

Suuuuure, and if they say “No” in the 1st call?

Han Solo asked. Luke had to think for a second:

…Let’s just try to call them. Maybe they have changed their mind? And if they really say a hard no, then OK. But that should be an exception. I’ll be looking at the numbers on this.

They felt like Luke didn’t trust them to do a good job. Han Solo and Chewbacca had been a part of this company since its inception, and now they were told to call exactly four times? Luke left, and they sighed in unison.

Month 6: A new hire

With its new focus on metrics and making data-driven decisions, GoldTub is growing. Project team is making tubs faster than ever, so Luke decides to increase marketing spend and the sales team. As a result, Boba Fett joins the sales team. He’s a smart and experienced bounty hunter, having delivered great numbers in previous job.

After only a few days at GoldTub, Boba recognizes how Leads from certain zip-codes have a far higher likelihood to convert. Over the private intercom, Boba asks R2-D2 if he could get sales stats aggregated by zip-code.

Hutts are easy to identify on the list, since they all live in a zip-code starting with H. And it seems like tubs sold to the Hutts are generally 6-8x the average order due to their enormous body size. So they’re vitally important for GoldTubs revenue. But since they’re hard to come to agreement with, the conversion rate is only 0.5% and often drags out in time.

Since Boba Fetts commission is fixed per sale, he finds that every time he grabs a Lead with a zip code starting with H, he looses on average ~2.5$

So Boba silently skips those Leads, leaving it up to Chewbacca or Han Solo to pick those up.

Boba is the best-selling and highest-earning sales person during his 1st month. Luke is ecstatic!

Summary

In this story above, the company learns many insights, increases sales and grows. Overall, it may have been a positive development for GoldTub. They’ve become more mature, by taking a step in the direction of data-driven decisions. That’s probably good for them financially over time.

I want to tell this story so one is aware of the side effects it may have:

• They go through hurdles, and looses a part of the great sales culture they had.
• The IT-team is basically reduced 1/2 employee, because R2-D2 is constantly working on features, metrics and reports.
• Sales team may no longer be expected to look out for the companies best interests, and could require a sales manager to take on that responsibility.

Employees under a commission based wage are naturally inclined (and not to blame) for taking shortcuts to boost the metric they are measured on, even if it has undesirable effects for coworkers or the company as a whole. I don’t think that’s suitable for most tiny companies.

In the true story this is based on, Bobas mischiefs on picking “the best” leads would be discovered, and resulted in an implementation where sales could only select the next available Lead. And there would be several more similar issues.

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So what could I do differently to improve this situation?

• For bonuses, you could consider company bonus based on how the company as a whole does. Giving the sales team a shared bonus based on total sales (or conversion rate!) can be a compromise between the two.
• Metrics are great as a starting point on a learning journey. Be aware that they require time to extract, understand, communicate and act upon. When finding negative side effects of fixating on a metric, maybe reconsider if it was a good idea in the first place, rather than “hotfixing” the mismatched incentives it produced.
• Rewarding based on simple metric achievements quickly leads to perverse incentives if the reward is substantial and the metric selected is permanent. Make a metric focus temporary, to see if one can “fix it”. You could also make the reward symbolic.