How Much Does Compensation Matter?
We sometimes talk about the three big expenses/outgo’s you have in the business: Cost of Goods (purchases), Compensation (payroll) and Other Expenses (overhead). In CI businesses, CoG is usually the largest about 40% of our revenue. Compensation can range from 25% to 50% depending on your habits to pay people. And, overhead expenses usually fall into the 15% of revenue category.
So what is the challenge?
Well, material purchases and overhead expenses usually are more predictable as a unit of cost. The cost of each does not change unit to unit. Compensation on the other hand seems to vary widely in the business almost daily; as productivity and the ability to bill work and even close sales changes.
We separate compensation into five discrete buckets: Owner compensation, Sales Compensation, Tech compensation, Admin/Support compensation and then Fringe Benefits (payroll taxes and other obligations to pay).
To achieve the 30% comp target goal for great CI companies, companies must exert very strong discipline to make it happen. Owner’s pay on the P&L should be about 3% (the owner can get paid more certainly by taking balance sheet distributions). Why 3% this is usually the cost it would take to replace his/her role in the business. Owner’s who sell will get an advantage in the Sales comp area if they do not take commissions or extra salary for selling.
Sales comp is a bit more complicated. The fully burdened before fringe cost here should be under 8% of Revenue; that is, both salary/draw and commissions considered. Most of the pressure comes with sales people who produce under $1M in Revenue and the unrelated sales work that they perform. The highest producers always have less job responsibilities and more clearly defined roles.
Tech compensation is perhaps the trickiest, since what they produce varies based on billable work performed. A good rule of thumb is for a tech to achieve $100K a year in revenue billing (labor revenue). At this level, they will bill about 1,000 hours against the 2,080 hours you will typically pay them. In aggregate, all billable techs should constitute about 12% of your total revenue without fringes. Oh don’t forget to include sub-contractors in this piece.
So owner, sales and techs have now accounted for 23% of the 30% target leaving; 7% for all other personnel to admin and support selling, installing and servicing.
Typical problems that get in the way include:
Owner’s take too much from the P&L; not taking enough just camouflages problems in other comp areas.
Sales people get compensated more than the 8% particularly when sales management is needed as well.
Techs perform at way below the $100K standard.
Support team costs creep well above the 7%.
Of course, when top line revenue is under pressure these ratios will be difficult to hold. It is important to pay for productivity; comp should ebb and flow with revenue and the company’s ability to install efficiently.
Having a strategy to compensation your people properly will be more rewarding to all in the long run and much less disruptive to the business.
We hope these guidelines help you assess what you are doing.