“The minimum gross margin for commission is 40%. We pay a commission on any project with a 40% or higher gross margin.”
The is the rule for commission payment for salespeople in a company until they learned about net profit per hour.
Here is the job cost analysis for two jobs, one with a 40.27% gross margin and the other with a 40.51% gross margin.
One job earned $73.34 an hour net profit. The other paid the customer $21.37 an hour (it lost money).
This shocked the client. They couldn’t imagine two jobs each with the same gross margin where one made a profit and the other a loss.
The salespeople didn’t care. They made their commission whether or not the job actually earned a profit. In the second case the salesperson won and the company lost. It’s important that everyone wins or everyone loses. That’s fair.
In the second case, the sales person grossly underestimated the number of hours on the job. He estimated based on achieving a 40% gross margin. The actual selling price should have been at least $1,000 higher just to break even. (Net profit would be zero).
Paying commissions on gross margins is dangerous because gross margins don’t tell the whole story. Pay commission after overhead is calculated in job cost to ensure the job made a profit before you pay a commission.
The best way to pay commission is through net profit per hour. The company owner decides the minimum net profit per hour that the company has to earn and anything over that number is the commission paid to the salesperson…up to a maximum net profit her hour.
Paying through net profit per hour rather than a percentage eliminates “salesperson estimated hours” and real hours to do the job. Salesperson estimated hours are always lower that the real hours to do the job because they want a low price to win the work and get their commission.
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Ruth King is well known as “The Profitability Master.” She is passionate about helping small business owners become profitable and stay profitable. For over 40 years she has coached, trained, and helped contractors and others achieve the business growth and goals they wanted to achieve.
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