Bonuses vs Commissions: A Field Study

- 1 - Laurence J. Pino
Sunil Kishore, Raghunath Singh Rao, Om Narasimhan, George John
2013
Bonuses Versus Commissions: A Field Study

The Authors
Sunil Kishore
Partner
McKinsey & Company
PhD, Marketing and
Economics
University of Minnesota –
Twin Cities
Om Narasimhan
Professor of Marketing and
Deputy Head of Dept. of Mgmt.
London School of Economics
PhD, Business Administration
(Marketing)
University of Southern Calif.
Raghunath Singh Rao
Associate Professor in Business
University of Texas - Austin
McCombs School of Business
PhD in Business
University of Minnesota – Twin
Cities
George John
Professor & General Mills/Gerot
Chair in Marketing
University of Minnesota
Carlson School of Management
PhD, Marketing
Northwestern University

Purpose of the Study
Design of appropriate incentive programs is axiomatic for companies which are
reliant on a sales force to sell its product and service lines. While extensive theoretical
literature, particularly premised on principal-agent models, addresses various incentive
compensation programs – Prendergast (1999) for studies in economics; Albers and Mantrala (2008)
for studies in marketing – there is very little empirical work addressing the efficacy of
incentive programs companies use in actual practice. According to Joseph and
Kalwani’s 1998 survey of Fortune 500 companies, 95% of the firms used plans that
featured a quota with two forms of pay coupled with those quotas: the payment of a
lump sum bonus upon reaching quota; or payment of ongoing linear commissions paid
on sales over and above the quota. Known empirical studies, however, have not

Purpose of the Study
addressed the implications of bonuses versus commissions with respect to three key
functions: its relationship to salespersons ability, intentional manipulation of sales
timing, and modification of action when not all tasks are incentivized equally. The
authors seek to examine the empirical data not based on whether bonuses are
preferable to commissions, or commissions are more optimal than bonuses, but to
compare the resulting behaviors based on bonus and commission programs equivalent
to each other.
The authors examined the following research questions in a quasi-experimental
model:
1. What are the productivity consequences of bonus plans compared with
commissions in terms of the overall effect as well as differences across agents?
2. How does the presence of a bonus as opposed to a commission influence sales
timing behavior?
3. How does the bonus or commission plan effect multi-tasking behavior?

Empirical Setting for the Study
The authors convinced a division of a large pharmaceutical firm to shift its
incentive program from a bonus plan to a commission plan providing the opportunity
for a before-after quasi experimental design. While the firm sells drugs in multiple
therapeutic classes with a dedicated sales force for each class, the authors worked
with the sales force for one of those therapeutic classes.
Relevant to the Study were the following:
• There were three sets of actors: Salespeople, pharmacies and distributors.
• Salespeople were required to call on both doctors (“Doctor Visits”) which would
provide an informative selling environment, although not immediately booked as
sales, and pharmacies (“Pharmacy Visits”) for persuasive selling which did in fact
produce quantifiable sales.
• While all salespeople in a particular territory were incentivized equally based upon
the original bonus or, thereafter, the commission, free riding in multiple territories
(Hardin, 1968) did not appear to be an issue to the company in that peer monitoring
tended to dampen the free riding consistent with prior research (Hamilton, Hamilton,
Nickerson, and Owan 2003; Knez and Simester 2001).

Empirical Setting for the Study
• To the extent that competition in the pharmaceutical issue with respect to
prescription drugs does not appear to be based on price, nor is any one company
large enough to influence prices at the market level, the critical driver of demand
appears to be “sales force management,” which makes this Study particularly
meaningful.
• In order to best illustrate how the use of bonuses and commissions affects
productivity, timing games and multitasking, the bonus and commission structure
was designed to be equivalent to each other in terms of its economic impact; and,
the actual salary in either case was a constant. Hence, at play was very specifically
the effect of a bonus or commission on each of those three effects.

Conceptual Framework of the Study
Productivity and Sales Ability
With respect to the first area – productivity – the mathematical
formulas would suggest that whereas output should remain
constant under the bonuses program at higher salesperson ability
levels, it increases dramatically under commissions. The most
significant change is for the segment at the lower end where
salespeople respond under a commission structure with a
significant increase in productivity. In addition, high ability sales
agents also increase productivity investing additional effort
because there is no earning ceiling. The conceptual framework
for Productivity is identified in Figure 2 following.
Timing Game Models
With respect to timing game models (Oyer, 1995), the
conceptual model would suggest that if there is little chance of
reaching the quota either under a bonus or commission structure,
there is very little possibility that the sales agent will pull sales
forward into the current quarter, instead, opting to push sales out
into the next quarter.

On the other hand, in the event the salesperson has in fact reached quota, it is at
that time there is a divergence between the two groups. Under the bonus structure,
the salesperson has little incentive to provide for additional productivity; on the other
hand, under the commission structure, the salesperson has every incentive to increase
productivity to the extent that the salesperson is being compensated on a commission
basis for every additional sale above quota. Table 2 identifies that conceptual model.
Multi-Tasking Behavior
With respect to the third area of conceptual evaluation – multitasking behavior –
there would appear to be relatively little modification in the multitasking behavior if
quota has not been achieved.

If quota is achieved, there is a significant difference between the salesperson
under the bonus structure who shifts activity to Doctor Visits which do not produce an
immediate measurable economic effect, to a salesperson under the commission
structure who focuses on Pharmacy Visits which will have an immediate economic
effect.
Note Table 2 for the full results of the conceptual model.

In this Table, which relates to the three primary focal points of the Study:
Increased Productivity regressed against ability (result 1), Timing Games (result 2),
and multitasking (result 3), Table 2 summarizes the anticipated conceptual results
of each one of those.

Data and Methodology
Data
The data are pulled from an almost complete history of incentive plans and
payment, monthly output, and quarterly quotas for 458 territories during a three-year
period of time from April 2007, which was the beginning of the fiscal year, through
September 2008, reflecting results from a preintervention period of 18 months in
which a bonus plan was in effect and October 2008 through March 2010, on a
postintervention period of 18 months in which a commission plan was instituted. The
entire 36 months resulted in 14,000 monthly observations on both output and visits.
Methodology
The authors created a mathematical model which addressed each of the areas
associated with the conceptual framework of the Study and ran regressions directed
to each of three areas: productivity and sales ability, timing game models, and multi-
tasking behaviors. In each of the three areas, the conceptual results were affirmed at
a least a p < .01 level.

Results
The authors evaluated the results as follows:
Result 1. The switch from a bonus plan to an equivalent commission plan
improved sales productivity by 24%.
Result 2. The switch had heterogeneous effects depending upon the ability level
of the salesperson; the switch from a bonus to a commission plan increases
productivity the most at the lower deciles of ability, less so at the higher deciles
of ability, although still improved, and least in the middle deciles.
Result 3. Timing games will occur under a bonus plan which affect the company
deleteriously, whereas timing games under a commission plan will tend to
benefit the company.
Result 4. While a bonus plan is inferior to a commission plan in the areas noted
above, it is actually better than a commission plan in engaging salespeople to
focus on tasks which are not directly incentivized.

Implications & Conclusions
The authors’ results are noted. In addition:
1. With companies similar to the focal firm, where productivity is highly correlated
to sales agent activity, commissions, as a form of incentivization, clearly
improves performance over a quota system to the extent that it incentivizes
continual marginal behavior that produces continuously marginal income to the
sales agent. The quota has the effect of requiring a minimum standard in
exchange for a salary, but the incentive above quota is a continual vertical line
measured against performance resulting from activity.
2. While the authors do not specifically identify shorter horizons for incentive
payments, as did Misra and Nair (2011), it is both intuitive as well as observational
that monthly, rather than quarterly, quotas combined with commissioned
incentives, results in increased productivity in activity and sales revenue.
3. While the Study reran regression models on single-person territories as opposed
to both single-person and multi-person territories, and found no significant
changes, it is not clear that providing a quota with a commission structure on a
single-person level is not more beneficial than on a territorial level.

Implications & Conclusions
4. While the results of the Study contributed to the literature from an
academic standpoint for researchers interested in sales force productivity,
within a purely managerial context, a commission structure for focused
sales task portfolios is better than lump-sum bonuses in achieving more
consistent selling results.

Bonuses vs Commissions: A Field Study

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Bonuses vs Commissions: A Field Study