But according to a recent study issued by the Incentive Research Foundation, companies must look beyond the sales generated from incentive programs when determining their return on investment.
The study, Assessing the Impact of Sales Incentive Programs: A Business Perspective, conducted by Srinath Gopalakrishna, associate professor of marketing at the University of Missouri-Columbia, followed a hand-tool manufacturing company as it examined every business process, from procurement to human resources, to see how those processes were affected by a first-time incentive program for distributors. Gopalakrishna found that if the company had focused the incentive program's impact only on sales growth, it would have had a significantly negative.
Which was not the case at all.
Across the Company
For years, the company had been struggling with slow sales growth and increasing competition, but it had never tried using incentives to motivate its distribution channels because it believed that the effort would not be worth the investment. But the desire to increase sales and profitability led managers to overcome their resistance.
The company's goals for the period during the incentive program were to increase net sales by $1 million and to improve gross margins from 30.4 percent to 32 percent. Before deciding on how to design a program, the company reviewed the following areas to see how they might be affected by a successful incentive.
While acquiring new customers is the desired outcome of an incentive program, there could be a difference in the quality of those new accounts. For example, they might delay paying their bills, causing accounts-receivable and cash-flow problems, and ultimately harming the bottom line.
New customers could alter sales patterns. If they order products erratically, that could result in inventory problems with an adverse effect on cash flow, shipping schedules, and profitability.
The goal of any incentive program is to increase sales. That means producing more goods. High prices for raw materials and supplies to match the higher level of production could result if the company doesn't plan for those production levels in advance.
Production and Human Resources
It might cost more in labor to produce the extra goods. Adding more labor could result in the added expense of hiring and training new workers.
Gopalakrishna concluded that initiating the sales incentive — without considering inventory and accounts receivable — would require an additional infusion of cash and could reduce margins. In addition, the company would have to invest in procurement and sales to support expected gains in sales.
The company expanded its objectives beyond the net increase in sales to include improving the invoicing system, providing the manufacturer with shipping date flexibility, and increasing distributor knowledge of the products to support the sales objectives.
Program rewards were extended to nonsales employees in these targeted areas. For example, individuals could earn up to 600 points if they met a certain sales target, while employees in the accounts receivable department could receive 300 points if their accounts paid within 45 days. The awards included Caribbean cruises, high-end merchandise, and sporting event ticket packages.
The final numbers? If the company had only considered increasing sales as the objective of its program — and taken no other steps to address the effect of the increased sales on the company's other functional areas — the projected ROI from the program would have been negative 92 percent.
Instead, during the course of the program the company invested $360,000 to streamline its procurement activities and $210,000 to support its sales function. This resulted in “significant reductions” in the cost of goods sold as well as in administrative expenses, to the point that the incentive program resulted in a positive ROI of 84 percent.
“Developing an incentive program with a focus on sales growth alone is myopic,” Gopalakrishna concludes. “The effect of programs extends well beyond the sales function to other constituents and processes within the organization.”
In a Nutshell
A recent university study found that incentive programs got a much better return on investment when the goals of the program included improvements to business processes companywide.