What do we mean by compensation cost of sales?

“Yeah, fugazi, fogazi. It’s a wazi, it’s a woozi. It’s fairy dust. It doesn’t exist, it’s never landed, it is no matter, it’s not on the elemental charge”

It may seem like fugazi but Compensation Cost of Sales (CCOS) could be the difference between sales plan success and failure.

In simple terms, CCOS is the cost of compensating the sales team, relative to the sales volume generated. Typically this is the target or actual cash compensation divided by the equivalent revenue.

This can become a little bit more complicated. It can refer to target cash compensation (base + target incentive) or it might refer to actual cash compensation (base + actual incentive). Equally the revenue number may not be as simple as it sounds since we are looking for the revenue directly attributable to the sales team which likely excludes certain revenue streams. There are also varying degrees of CCOS granularity ranging from CCOS for the entire sales team, right down to the CCOS of an individual.

“While CCOS is always a consideration, the degree to which it informs vs validates plan design, varies according to the company philosophy”

The reason this number is so important and unique to sales incentive plan compensation is that it has a direct impact on company profitability. With the sales team, we need to compensate them in a way that has a positive impact on the bottom line.

So what is the right CCOS? 5%? 20%? 50%? The absolute number is of limited importance without the right context around it. Industry, stage of development, product margin, performance, for example, all play a significant role in determining the appropriate number which means that CCOS is often more useful from an internal perspective than for external benchmarking.

While CCOS is invariably a consideration, the degree to which it informs versus validates plan design, varies according to the company philosophy.

Certain industries and stages of development will orient their sales plans around commission rates, calibrating the commission such that an appropriate CCOS is achieved (the “cost of sale” approach). In this case, the actual total cash paid, is of interest, but secondary to the compensation cost of sale.

In other scenarios, target total cash drives compensation and market levels of pay determine the package (the “cost of labor” approach). CCOS needs to be reviewed on aggregate and territory alignment will help ensure consistency but it is not the driving force behind pay decisions.

Where I find that CCOS becomes exceptionally useful is financial modeling of proposed sales incentive plans.

It is easy to get sucked into the minutiae of sales plan components while forgetting the overarching objectives which is usually incentivizing profitable sales growth. If we can demonstrate that under varying performance scenarios, that CCOS remains fair and reasonable, we can be reasonably sure that the plan will do its job. That means we can move away from discussions about caps or whether a threshold should be 50% or 75% and highlight that in aggregate, the plan will be profitable in all scenarios. As I mentioned in a previous blog, CCOS as a result of financial modeling is often the tool to convince stakeholders that a cap is not required.

So if you are trying to get that plan over the line or convince your CFO that they should sign off on a proposal, consider bringing CCOS to the table as your weapon of choice.

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