This is a true story. Names aren’t included for obvious reasons. Don’t ask.
Once upon a time a product-obsessed software entrepreneur who didn’t like sales hired a sales-oriented entrepreneur who liked selling software. It seemed like a match made in heaven, as they say. Both of them could focus on what they liked doing.
The company was just starting. The software guy owned it, and paid the sales guy’s salary, and they both agreed on some very attractive incentives for the sales guy if he could double sales to a million dollars in the next year.
So they agreed, and both of them went to work. As time went by, the product-obsessed software guy focused on his computer and the code, while the sales guy made calls in the next room. When the code was ready, they worked together to create packaging. They had somebody duplicate disks (this was before the Internet) and assemble packages. And the product launched. The sales guy made more calls, and a major distributor agreed to carry the product. Soon after, several major retail chains agreed to carry the product.
When the year ended, the sales guy had made his million dollar quota. And two months later the company was swamped in debt, broke, and threatened with bankruptcy. About a quarter of the million dollar sales had been sold into the channels, but not out of the channels to actual end-user customers. So it was coming back. And the distributors expected the broke company to buy the software back for what they’d been sold for, less a substantial amount for shipping and co-promotional marketing.
The worst thing was that the software packages didn’t sell well from store to end user. The sales guy got it into the channels, and the stores put it on the shelves, but people didn’t buy it. And channels don’t take those losses. They send the stuff back.
To compound that problem, neither the sales guy nor the software guy knew about sell-through reports. Had they asked, the stores would have given them advance warning that the stuff wasn’t selling, called sell-through reports. Then they would have known disaster was brewing, and maybe they could have slowed things down, changed the packaging, or at least known what was about to happen to them when the stores started shipping the product back to them. (Which is a great example of the old adage: you think education is expensive? Try ignorance.)
And the second worst thing was that the sales guy had done deal after deal to get product into the channel by offering distributors and retail chains deep discounts and special deals with freebies, like two units for the price of one, or 5 for 3, and so on.
So, although sales had in fact passed the the million-dollar mark, after the returns were netted out it was only about $750,000. Plus, costs had gone from about 20% of sales to almost 65% of sales. And the $250,000 received for the software that hadn’t sold through had been spent.
The compensation lesson: the sales guy had been offered a huge bonus for getting sales to $1 million. The gross margin had nothing to do with it. And returns weren’t even considered. So he met his numbers, and it was a business disaster.
The whole fiasco reminds me of one fundamental principle of compensation: whatever the compensation plan rewards is the behavior it encourages. If sales is all that’s mentioned, then sales — not management, not information, not optimizing your company’s position — is all you’re going to get. Do you give commissions on sales, or gross margin? Do you pay commissions when the sale is made, or when the customer pays? Do you have a return allowance that holds commissions up?
(Image: Losevsky Pavel/Shutterstock)
[…] few weeks ago, Tim Berry shared a business case study which serves as an invaluable lesson in cash flow management. Tim’s story involves a software […]
Great story, Tim. I’ve seen this scenario in different ways over the years.
For me, this is where the “balance” in the balanced scorecard approach comes in. If you focus on just one thing – even one thing like revenue that seems so good, who couldn’t argue for ever more? – trouble is likely to follow.
You need both financial and non-financial components. You need both revenue (net revenue) and expense; process effectiveness and customer satisfaction and loyalty; employee engagement and retention (of the high performers); short-term and long-term investments.
Well, you get the picture… Great article!
[…] This post was mentioned on Twitter by Enterprise City and Abel Creative, Kurt Nelson. Kurt Nelson said: RT @SalesBlogcast: True Story of Business Disaster With a Compensation Plan Lesson https://bit.ly/ef2Rl1 by @TimBerry > some good lessons […]