The Mastery of Compensation
While there are many factors that contribute to the success or failure of direct selling companies, the compensation plan is one of the biggest. The companies who achieve long-term success always have a sound one. Plans that are not well designed and consequently fail to motivate distributors for whatever reason can become a brick wall to company growth. The fact of the matter is few companies seem to really grasp the art of compensation. A word to the wise—carpe diem! Seize the day and learn this art, because those companies that do, tend to reach heights of success that many others e n v y.
To create the best, custom compensation plan for your company, it’s important to do your homework—study in depth: 1) the principles of creating a compensation plan, plus, 2) each of the three proven plans and the differences between them. To assist you in this endeavor, this white paper presents the proven principles of success common to most successful network marketing compensation plans as well as a comprehensive review of today’s three proven plans in the network marketing industry.
Following, are some proven principles of success common to virtually all successful compensation plans. Seriously consider them when drafting or revising your network marketing compensation plan.
1. Company Mission
The questions you need to ask yourself as you begin designing a compensation plan should revolve around the theme, “What do I want my company to do?” Like any entrepreneur hoping to build a successful business, you need to be very clear on what you want your company to achieve and how it should operate to attain that goal.
The compensation plan you develop and implement needs to reflect your values and beliefs, and then they must guide and control your company. You must develop a compensation plan that encourages distributors to behave in such a way that fosters and support those values and beliefs. Success is more likely when your compensation plan drives behaviors that support your company’s values and beliefs.
2. Basic Compensation Plan Components
The basic components that should make up every compensation plan include:
• Commissions. A commission is an amount paid to a distributor on his/her direct and downline commissionable volume. It usually comprises commissionable volume within his/her own group. Some plans call all forms of payment to distributors commissions. A compensation plan is the combination of rules, commission types, and structure that defines how distributor compensation is calculated and paid. By the way, commissions alone do not define the compensation plan.
• Rules. Rules define the qualifications a distributor must meet in order to be paid commissions on downline activity. They also specify the criteria for earning other awards or benefits from the company. For example, do you expect new distributors to purchase a sales kit when they sign-up? How many months can distributors be unqualified before losing their distributorship? How much must a distributor sell each month to remain qualified at the current rank? What are the most common qualifications?
• Structure. Structure is comprised of the specific set of rules in compensation plans that determine where people are placed in the organization. The compensation plan defines what the organization will look like. Today, almost all successful compensation plans include sales force classifications or divisions. Plans are built on finding ways to divide the downline and compensate the different levels. How do distributors build downlines? What will the downline look like as the company grows? How effective will the organization be in terms of motivation, payout, distribution, and so on?
Some compensation plans are very structure-oriented. For example, a distributor may be allowed to build his business by personally sponsoring only three distributors. Other compensation plans simply require that a distributor do certain things without requiring a specific structure.
3. How to Compensate
How does a company pay its sales force for the behavior it desires? How much should payout be? How much can you afford to pay out? For $1,000 of product sales, should the payout be $60? $100? $200?
The pricing methodology of a company’s product line has a lot to do with its payout. There are a lot of pricing-related issues that have to be considered and decisions made, then all the characteristics of the compensation plan flow from these decisions.
In today’s network marketing companies, two prices are discussed:
1. Wholesale Price: The highest price distributors pay for product.
2. Retail Price: The price retail customers pay for product.
Retail is typically 25% higher than the wholesale price. In order to avoid confusion, companies choose either the retail or wholesale price as their “base” price.
Party Plan companies generally employ a retail-based pricing method. Distributors sell to customers at retail and take the difference between retail and wholesale as profit. MLM companies typically use a wholesale- based pricing method.
Note: In an attempt to reduce confusion, all of our pricing examples in this white paper are based on a retail price model.
How much can you pay out based on your product price mark up to retail? If your mark up from your product cost to your retail price is 500% (5x) and a distributor makes 25% for selling the product ($25 retail profit), it shows that you should be able to pay out about 28% of wholesale. Wholesale is revenue to the company on the sale of each product to a distributor exclusive of tax and freight.
The commission payout standard in the industry today is 40-45%. That is percentage payout of the wholesale dollar—the money that actually comes in from the distributor. This represents an eight-time mark up from wholesale to retail. In other words, the retail price of the product is eight times its cost. Most companies want to pay the 40-45% in commissions, and the rest in incentives like car programs, trips, and global bonus pools.
Variance from the payout standard brings predictable consequences, which should be carefully considered. If a company promotes a plan paying only around 20% commission, it may have a hard time recruiting and keeping distributors. It may also find great difficulty competing in the marketplace against other direct selling companies. If you’re going to pay more than 45% in commissions, you have to know where that money is going to come from. Some companies go up to 50%, but when you start going much higher than that, it’s very hard to sustain long-term profitability. The higher percentages are possible with high product margins. Theoretical payout—the percentage the plan would pay if all commissions were paid out in every case—should not be more than 8% above actual payout to avoid disappointing distributors expecting more.
How do you distribute the standard 45% commission? If you give each individual 5%, then you can pay about 9 people. If you pay everybody 10%, you can pay 41⁄2 people. If you pay 20%, then you can pay about 21⁄4 people. Companies can’t pay the standard 5% commission to all distributors. Sometimes when a distributor makes a sale, he/she might have a 50-60-person upline. So, if there were 50 people in that upline and the company paid everyone 5%—5 x $50 = 250% payout! Obviously, the company has to limit and decide which individuals to give the 5% to. Companies have to put some deep thought and study into making fundamental decisions about how they’re going to divide this money. What do most companies do? Today’s commissions are typically based on the 5% Plus Theory.