Variable Compensation Cost of Sales

Variable compensation cost of sales (VCCOS) illustrates an organization’s variable compensation costs as a percentage of sales. Many organizations search for the market benchmark. The challenge is every company is different. Here are some of the factors that prevent you from using a market benchmark:

Pay Mix Variation

– Not all companies have the same mix of pay between base salary and incentive compensation. It’s not appropriate to compare the VCCOS for a company whose pay mix is 50/50 to a company whose pay mix is 75/25.

Sales vs. Profit Margin

– It can be misleading to look at your organization’s cost of sales when you can increase sales, but decrease profitability.

– You may want to calculate your cost of sales as a percentage of profitability in addition to as a percentage of sales.

Lack of consistency in calculation

  • Are you calculating VCCOS by role, for all roles involved in the sales process, or both?
  • Are you including partial year employees (new hires, terminated employees, etc.)?
  • Are you including sales managers?
  • Are you including additional incentive payouts like sales contests?

Tracking Your Variable Compensation Cost of Sales (VCCOS)

We encourage all organizations to track their VCCOS on an annual basis so that they can track how this trend changes over time. The expectation is that sales and/or profitability levels should increase at a larger rate than your variable compensation, translating to a decrease in your organization’s VCCOS over time. Many companies ask what we should do if our VCCOS is flat or increasing. Here are a few places to start:

Have there been any significant changes within your sales organization?

  • Did you recently change your sales incentive plan?
  • Have you added new roles to your sales process?
  • Did sales decrease from prior year?

Do you pay multiple employees for the same sale?

  • Paying multiple sellers on the same sale can increase your VCCOS.

Do you have enough differentiation in incentive payouts for varying levels of performance?

  • Paying too much to lower performers can increase your VCCOS.

Has there been a significant shift in the distribution of performance?

  • Although 2020 has been a challenging year for many companies, there are a subset of top performers who have persevered.

> The challenge is when the performance of the top performers is not enough to offset a larger group of lower performers, this can alter the relationship to variable compensation costs and sales in aggregate.

Another interesting statistic many organizations track is the relationship of total variable compensation costs as a percentage of budget compared to the total sales or total profitability as a percentage of budget. Most companies conduct extensive modeling to determine the ideal relationship of pay and performance. This includes a review of varying individual payout levels at varying performance levels based on varying distributions of performance.

This statistic is probably atypical in 2020 given unpredictable impact of COVID-19 on business results, but that shouldn’t stop you from taking the time to review the effectiveness of your 2020 sales incentive plan to identify opportunities to enhance your sales incentive design for 2021.

2020 has been a year of uncertainty and unfortunately this period of uncertainty will likely continue for most, if not all, of 2021. Even more reason to review your cost of sales and make sure it’s in line with what you can afford at varying levels of performance.

Written by: Erik Berman, BCR Consultant