Follow the Money (Part 4)

Can’t we all just work together?

Photo: Roy Lister. Source: Wikipedia

Every employer’s dream is to have their workers act like owners. They want their employees to be diligent and energetic, and to treat customers well. They want workers to look out for the top line and the bottom line—growing revenues and maximizing earnings. And they want their people to behave in an ethical, sustainable way.

But how do you get there? The principal-agent problem can’t just be wished away. For part of the workforce, companies address this issue by using a commission structure. Commissions are a common way to reward sales people—those responsible for generating revenues. One of the most common forms of commission structures is “on-target” earnings, where the employee earns a percentage of revenues based on achievement of specific sales targets. Usually, that percentage rises as sales go up.

But conflicts abound. If the certain rules aren’t in place, sales people will be incented to steal business from each other, rather than raise new revenues themselves. After all, if a customer is already doing business with the firm, changing who represents it doesn’t seem as hard as generating new sales. And the principal-agent problem may end up transferred to the employee’s relationship with the client.

In real estate, for example, brokers earn a percentage of the sales price. But sometimes the listing broker will offer an added bonus to buyer’s brokers in order to get more showings—and perhaps to create a quicker sale. But the actual purchasers may not know this. Are they being shown a property because it fits their criteria, or because there’s an extra incentive for their agent? Their time is valuable. As Ben Franklin wrote, time is money.

Source: Free Photos

It’s been said that you can’t pay a salesperson too much. Indeed, top performing sellers are often the most highly compensated individuals in a company, earning more than the executives. If the commission structure is right, that statement can be true. Owners should want to encourage and retain top talent. But if the incentives aren’t well thought out, the sales platform can feel like the rumble scene in a Mad Max movie—everyone out for themselves.

Incentive systems are like the weather at the beach. When they’re good, they’re very, very good. But when they’re bad, everyone runs for cover. It makes sense for investors to try to understand the sales culture of the companies in their portfolios. The last thing they want is an investment that eats its own.

Douglas R. Tengdin, CFA

Chief Investment Officer

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