How to Stop Discounting Practices of Salespeople from Destroying Your Profits
You set prices. You tell salespeople the price customers should pay. You send them out to sell. And lo and behold, they tell you your prices are too high and you need to lower them.
After a few rounds of negotiating the price to demand with every salesperson on every sale, you set up an approval escalation process. You tell them a minimum acceptable price before an approval has to be granted. Before you know it, the cycle repeats. Every sale is made at the minimum acceptable price or worse; they come back to you asking for a lower price on way too many deals so they can hit their numbers.
Has it happened to you? If so, how do you stop it?
Excessive Price Concessions in Customer Negotiations is the Symptom, Not the Problem
Price concessions during customer negotiations are a normal part of selling any high-ticket item in a competitive market. While some managers may like to live in the Apple world and have consistent prices on every sale, most managers live in J.C. Penny world where discounts are not only common, but also necessary to drive customer choices and company profits.
The problem isn’t discounting per se, the problem is too much and too excessive discounting.
Reigning in excessive discounts via decree, as in setting minimum acceptable prices, only sets up the manager to make pricing decisions on nearly every deal while signaling to salespeople that the target prices are just a fiction. The real focus becomes the minimum acceptable price demanded before the approval process kicks in, and once it kicks in, managing that process to close the sale at the low price.
The alternative to making decrees is changing incentives. Incent salespeople to sell at a higher price and they will.
If You Change What is Measured, You Change What is Achieved
Incenting salespeople to sell at better prices is actually simple. Change their performance metric.
Most salespeople’s performance metrics revolve around revenue. Commissions are paid out as a percentage of revenue. Quotas are set by revenue. Everything is judged by revenue. But the company doesn’t just want revenue — it wants profitable revenue. More specifically, it wants profits.
The alternative is to measure sales performance by profits. But, direct measurement of individual salespeople’s performance by profit contributions is a non-starter. Neither revealing the company’s cost structure to front line salespeople, nor managing sales performance metrics and salespeople’s compensation with constantly varying variable costs isn’t strategically beneficial or managerially realistic. Alternatively, profit sharing plans have been used, but they don’t reward individual performance, just team performance. The goal in designing sales compensation plans is to encourage salespeople, at an individual level, to perform the actions the firm desires without constant managerial oversight.
To fix this challenge, some firms have gone to variable commission rates depending on the amount of discount: commission rates get lowered in a stair-step fashion, as discounts get deeper. While this is a partial solution, it usually ends up with salespeople targeting the edge of the commission stair-steps, and more specifically, accepting the commission that is just above the point where the sales approval process begins. This isn’t a good-enough fix. It ends up leaving the process just like it would if managers set decrees.
A better solution is to use deal points. Deal points mirror the profit contribution of a sale. They are a form of profit-based incentives that (1) don’t reveal costs and (2) strongly encourage salespeople to communicate the value of their offerings and capture that value at an appropriate, more profitable, price.
Profit-Based Incentives with Deal Points
Deal points, like revenue, are calculated at the individual transaction level according to the quantity sold and the price at which they are sold. Importantly, deal points also include factors related to the target price and a parameter, k, commonly known as the sales kicker.
If the sales kicker is one, deal points are simply quantity multiplied by price, or revenue. Adjusting the sales kicker, therefore, affects how sensitive deal points are to changes in price.
Proof of Concept on Deal Points
Take a sale of 1,000 liters of a product with a target price of $500 and a margin of 40%. Assume a revenue commission and that the salesperson and customer negotiate an 8% discount on the price. After discount, this transaction contributes $460,000 toward revenue.
But while the 8% discount only reduced the salesperson’s revenue performance by 8% ($500,000 to $460,000), for the company that same discount reduced the deal profitability by 20% ($200,000 to $160,000). The company is much more impacted by the discount than the salesperson.
Let’s see what would happen in the deal point scenario, using a sales kicker of 2.5 on the above transaction. With the same 8% discount, the salesperson’s deal points would decline by 20% (500,000 to 400,000).
Whereas before the salesperson only felt an 8% loss while the company felt the full 20% loss, now both the salesperson and company and feel the full impact of the price concession.
A higher kicker would of course make the salesperson even more sensitive than the company. Incentives are aligned.
Deal points internalize for salespeople the actual effect of their price concessions. This has wide ranging positive effects for sales, marketing, finance, product, and the company as a whole. Deal points:
- Incentivize salespeople to seek the highest price and margin in each customer interaction
- Reward salespeople according to the profit they contribute
- Reduce the incentive for salespeople to negotiate internally for a price reduction
- Empower salespeople still to make price reductions when necessary
- Hold salespeople accountable for their price concessions
- Enable salespeople to walk away from unprofitable deals
- Encourage proper product mix by using different kickers for different product groups
- Maintain company focus on profit
Revenue or Profits
People, salespeople especially, like to perform. In business, performance metrics determines actions and outputs.
If you measure salespeople by revenue, you get revenue. If you measure salespeople by profits, you get profits.
A deal point is an actionable approach to implementing profit based performance metrics and incentives.