Executive Summary

A well-known hand-tool manufacturer based in the United States had never tried incentives with their distributor network because they did not believe “they would be worth the investment".  In their first-ever incentive program, their goals were to:

  • Increase incremental Net Sales by $1 Million
  • Increase gross margins from 30.4% to 32%

An in-depth analysis of the internal and external environment in which the company operates was conducted.  Based on this analysis, the objectives, rules and awards were put in place for an ROI Incentive Program. 

Over a period of nine months, the following program results were achieved:

  • Net sales incrementally increased by $1,440,164.00
  • Gross margins increased from 30.4% to 35%

The incentive program yielded the following Return on Investment (ROI):

Total Incremental Improvement:             $ 1,604,815.00

Total Incremental Costs:                            $    545,637.00

Total ROI:                                                      $ 1,059,178.00

(To determine the Return on Investment for this program, all additional incremental revenue and costs were calculated, including increased operational costs and incentive program costs.)

The complete details, including additional results gained outside of the original goals, are documented below.

BACKGROUND

 

Company Overview

The company is a well-known United States based hand tool manufacturer.  Management was well aware of years of slow sales growth and ever-increasing competition.  They had never tried an incentive approach, other than simple cash discount incentives, to motivate their distribution channel to sell their products.  To be successful, they knew that they would need to reach both the distribution site owners and the front line staff at those distribution sites who interact with customers daily.

Situation Analysis

To formulate an effective incentive program, research needed to be completed, including:

  • business cycle analysis
  • review of the financial statement
  • survey of employees
  • review of competitors
  • review of the industry

The business cycle analysis indicated areas where processing procedures were not being performed to standard and could not support additional work flow without causing harm to the product quality.  In addition, new product releases were severely behind projected schedules resulting in late or cancelled customer orders throughout the period.

The financial statement analysis indicated a trend of extended accounts receivable and inventory turns, reliance on a line of credit to support accounts receivable and inventory growth patterns, while expense controls were used to maintain profit levels.

The employee survey indicated a lack of understanding, by this group, of the company’s mission, annual objectives and plans for future growth.  The survey also indicated that employees felt they did not receive sufficient support from the company in order to effectively perform their job.  Employees also felt, to a large degree, that they were not recognized for their job performance by company management.

The competitive review found that of the three major competitors, two had achieved sales and net profit growth at a rate equal to 4% above the subject company.  The third competitor had achieved just under 2.5% growth in these same areas.

The industry review indicated that this industry, over the previous 3 years, had experienced growth factors equal to 8%, 6% and 5% respectively.  Future growth projections for 2003 were predicted to be in the 4-6% range.

Company Objective

It was clear to see why the subject company desired to implement a sales incentive program.  Management was well aware of the slow growth, especially in light of competitive companies, of sales over the last three years.  Management’s objective was to increase sales, utilizing a properly structured incentive program, to achieve higher sales growth and to measure and record the Return on Investment from this higher sales growth.  The specific goals included:

  • Increase incremental Net Sales by $1 million
  • Improve gross margins from 30.4% to 32%

SOLUTION

After a review of initial research, a sales incentive program was deemed to be inappropriate, given that: 

  • A projected financial analysis indicated that sales growth without consideration for both inventory and receivables controls would require additional infusion of cash and may reduce already low margins.
  • New product development cycles were a drain on cash flow to the subject company and were creating opportunities for competitors to gain entry into the distributor base.
  • Both accounts receivable and inventory levels have a negative impact on cash flow. A projected increase in sales indicated a need for additional cash to support this negative trend.
  • Employee surveys indicated a need to address employee compensation, training and development issues.

In order to establish a solid base from which to build a successful sales incentive program, the subject company needed to address their internal issues first.  During a six-month period, the following action items were put in place to allow the development of a sales incentive program:

  • Process improvement training was provided to all employees.
  • New product development teams, consisting of both engineers and marketing/sales employees were formed.
  • New accounting software, designed to improve both the physical look and reporting features of customer invoices was installed.
  • Sales training was conducted to enhance the ability of the sales team to deliver a better understanding of how the subject company’s products relate to the potential for higher profit margins in their distributors business.

Program Design

The incentive program would actually be made up of two separate programs, one for distributor owners/decision makers and one for counter staff at distribution centers.  The first group was motivated to increase their sales/purchase volumes of products, improve their invoice aging, and provide the manufacturer with shipping date flexibility.   The second program motivated distributor counter staff to increase their knowledge and understanding of specific products in support of their distributor’s sales objectives.

Incentive Awards

Each of the two programs had clearly defined and communicated rules and methods for earning points.  The owner group had prizes including Caribbean cruises, while the counter staff program included a number of NFL-based prizes (merchandise, tickets, Super Bowl parties, etc.).

Best Practice Rules Structure

Achieving prizes was designed to be neither easy, nor impossible.  Distributors who followed a simple game plan would be elected into the “Hall of Fame. “

Two complementing set of rules were developed – one set for the owner/decision maker group, and the other set for the counter staff group. 

The owner/decision maker group’s rules were centered around performance targets for:

  • Sales Volumes
  • Accounts Receivable
  • Ship Dates
  • Distributor Counter Staff Education

The counter staff rules were all centered on completing activities that would increase their product knowledge of the manufacturer’s product attributes.

RESULTS

The incentive program was big success, exceeding original goals and achieving additional results as well.

Over a period of nine months, the following original program results were achieved:

  • Net sales incrementally increased by $1,440,164.00
  • Gross margins increased from 30.4% to 35%
  • Accounts receivable were reduced from 59 days to 45 days (company wide, incentive group A/R days was 32 days)

ADDITIONAL RESULTS

Beyond Original Scope of Goals

  • Cost of Goods Sold was incrementally improved from a projected 69% to 64% of sales
  • Gross margin was incrementally improved from a projected 30.4% to 35%
  • SG&A expenses was incrementally improved from a projected 28% to 26% of sales
  • Net Income incrementally improved from a projected 2% to 10%
  • Inventory turns were improved from 89 days to 70 days
  • New product development cycles were reduced from an average of 19 months to 10 months.
  • Cash flow increased, during the incentive period, by $328,000.00 per month
  • Interest costs on lines of credit were reduced by 75%

The hand tool manufacturing company was thrilled to learn that their initial hesitation about incentive programs was not well founded.  Their decision to give it a try proved most worthwhile, with final results as follows:

Total Incremental Improvement:             $ 1,604,815.00

Total Incremental Costs:                            $    545,637.00

Total ROI:                                                      $ 1,059,178.00