From MarketingProfs.com’s Marketing Challenge: Gross Sales vs. Gross Profit:
Our star salesman is the best closer I’ve ever seen. He sells products and services. He’s paid a salary plus commission on gross sales. He does have some pricing latitude. I’ve noticed a fairly stable gross profit percentage on products, but it’s much different on service sales.
It looks like he’s “giving away” services to get more product sales. Service costs are somewhat vague and hard to accurately measure, but I need to grow the service side of our business profitably.
Should I switch his commission structure to a gross profit percentage on services?
In a word, yes. Gross profit is the most effective structure for sales commission plans. The hiccup is determining costs and their is a pitfall to avoid. If you have variable costs based on production or service delivery, it is best to establish an estimated cost for each sale.
Here is the issue – I worked for a LAN cabling company where I was paid on the gross margin of my deals. I designed the solutions, quoted the project and closed the deal. The problem was that some of the installers were quite liberal with their material usage. That is putting it nicely – one guy was assigning material costs to my job while moonlighting installations using that material. I didn’t know this at the time, I simply knew that the installation I had designed had plenty of extra material built into it.
My commission was crushed on a handful of big deals and slowly dissolved on smaller deals. The President finally stepped in after I toured a few job sites with the lead engineer and measured the amount of cable installed (well under the amount listed on the job completion sheet). Needless to say, I have never forgotten this issue.
This suggestion sums it up (emphasis mine):
Gross margin is the way to go. The trick is to define the cost of goods to drive the correct behavior that yields profit on the bottom line. The calculation to get this right requires a clear understanding of the end-to-end process that delivers the “product,” whether it is goods or services.