Thursday, May 8, 2014

Understanding commission systems in disaster restoration

Understanding commission systems in disaster restoration.

The following white paper is not an endorsement of commissions as a payment program for a restoration company – rather it is an explanation of the process and a description of how to structure these programs.  Often, restoration companies have compensation programs in place and the incentive programs are tailored to meet the expectations and needs of the individual company.  It is important to consider existing compensation structure, current performance levels, company culture and company margins into consideration when defining and implementing compensation programs. 

There are number of options for compensating project managers in disaster restoration that will help reward and drive performance.  The first thing that needs to be done in this discussion is to define the position of project manager.  In my vernacular this is the person that is responsible for estimating and signing projects, overseeing production (they may and often do utilize the assistance of a superintendent to provide daily project management), marketing and relationship building with key accounts.  The project manager is responsible for revenue volume, job profitability, customer service, quality control and collections for completed projects.  Given this general job description, many companies create incentive plans and commission structure in order to drive performance.

Utilizing a commission is a bold move and should offer the greatest opportunity for the project manager and offer the greatest risk reduction for the business owner.  In investing the theory of risk is the greater the risk, often comes the greatest opportunity for gain.  I like to maintain this risk reward relationship in compensation programs.  In a full commission program, the employee takes the greatest risk since their compensation is entirely dependent on their performance.  This offers some degree of protection for the company since you are paying after the employee produces and ideally collects profits for the company.

There are a numbers of ways to figure the compensation when paying on a commission basis.  The following is a recommendation on figuring and paying a commission.  Many times the project manager is working in conjunction with a superintendent or an administrative assistant and the commission needs to take into consideration these other positions.  I will discuss the parameters of payment, discuss job costing expectations, and review the potential areas that might impact the program.

Compensation structure and parameters:

  • ·      Commission will be based on produced job margins.
  • ·      Some companies offer a different commission structure for different types of projects knowing that different job types produce different margins.  It is the opinion of the author that the margins can effectively be averaged over a 30-day period and commissions paid on a blended mix of work, produced margin. For example water, mold, cleaning and reconstruction.
  • ·      The revenue less job costs and commission should allow for an acceptable net profit for the company. 
  • ·      The commission can be paid as a percentage of revenue or a percent of gross profit.  Paying a percent of gross profit offers the most predictable result for the company.  That being said it might be easier to pay a percent of revenue based on achieving expected margins.  For example at most commonly achieved margins, 10% of revenue often equates to the same result as paying 25% of the gross margin.
  • ·      All commissions should be paid based on completed, closed and collected jobs.  Some may make progress payments but this does not allow accurate knowledge of the achieved margin since the job is still in production.  This statement needs clarification since the term progress payment assumes that the job will meet margin at the end of the job.  Progress payments simply consist of a draw on margin.  The draw should be less than the anticipated margin in order to minimize the impact of missing the target job profitability. 
  • ·      Some companies pay commissions based on individual jobs.  I like to pay based on the average of all jobs completed during the period being reviewed.  This mirrors how the company makes money - not job by job rather the accumulation of jobs.  I recommend paying commissions every month.  This closely ties the incentive to the activity that produced the result.

Definition of job costed items:
·      Companies will figure job costs differently – the important issue is to be consistent and when performing your overall company budget you assure that after commissions and job costs you protect your company net profit margin.
·      Standard job costed items.
o   Direct labor including actual labor burden (withholding, worker’s compensation, vacation and insurance) are essential costs to include.  All labor burden should be figured since using a subcontractor would preclude all the withholding.
o   Direct materials
o   Subcontracted labor
o   Rented equipment (from outside sources.)
·      Typical costed items
o   Production superintendent and related costs
o   Program fees related to the specific job (i.e. TPA fees.)
o   Production vehicles.
o   Shop dumpster and unallocated inventory and shop supplies.
·      Options – these items can be added to the job costs but are not typically.  If they are then the overhead is lower and the margin expectations would be commensurately lower. 
o   Franchise fees related to the total revenue of the job.
o   Unallocated labor expenses – meetings and shop maintenance.
o   Estimator (project manager) vehicle costs.

Payment considerations:

  • ·      Commissions should be paid when cash is received.  Partial payments may be considered but will be reconciled at the end of the project.  Ideally monthly payments will be made and reconciliation reports run routinely. The monthly payment can serve as a draw on future commissions.
  • ·      Commissions can be figured job by job or can be summed every month based on the total of completed jobs – i.e. total revenue and total costs for all the jobs.
  • ·      Company may define a base draw on salary in order to maintain an appropriate income to the project manager.
  • ·      Company may choose to change the draw on an annual or as often as quarterly basis based on earned bonuses.  Company will frequently hold surplus funds to cover future shortfalls in monthly earnings.

Compensation details and rates
·      There are two potential rate schedules to consider. Each of these will protect the company net profit when balanced with a reasonable overhead budget.
·      Total compensation covers payments for project manager, superintendent and any dedicated administrative support.
·      Compensation as a percentage of revenue.  Total % available to be paid for all sales and production staff to be 10% of revenue or less.  If company provides superintendent and administrative support then total revenue should be near 6% or less of total revenue for the project manager. 
o   In the event the PM writes and runs the entire project then the full amount of bonus may be allocated to the PM.   This amount can be influenced based on the achieved gross profit. 
o   This sliding scale should be based on the produced margin.  The top margin should be reserved for exceptional production margins. 
o   The standard gross profit should average 40% or better based on direct labor plus burden, materials, subcontractors and rentals.  There should be a base qualifying level of margin in order to qualify for bonus. 
o   The base incentive level should be somewhere between 25-32% based on typical margins, job types, volume and more.
o   Cutting corners or compromising the quality of the project in order to obtain margin should be considered a serious violation and should carry some level of consequence.
·      Compensation as a percentage of net profit.  This offers a stronger correlation to the company financial statements.  It may be harder to figure – or at least take an extra step but is a more accurate method of calculating margins. 
o   The qualifying gross margin is similar to the numbers discussed above.
o   The company should allocate between 17% and 25% of the gross profit margin.  This sliding scale should be based on the produced margin.  The top margin should be reserved for exceptional production margins. 
o   Other payment terms and conditions from above will apply for the payment considerations.

·      The following production expectations will dictate how many people are involved in the sales – production team. 
o   Single member, write and run sales and production should produce between $600,000 and $1,000,000 annually.  The top number may be a stretch for most to achieve but it is attainable.  The bottom number is a minimum expectation. 
o   A two-person team should be able to produce a minimum of $1,000,000 and should start to max out at over $1,500,000. 
o   A three-person team should produce a minimum of $1,500,000 and can often achieve greater than $2,500,000 in production. 
·      The actual number of people involved will be dictated by the revenue and ultimately the profits generated by the team keeping in mind the compensation ranges above.

An effective commission structure can help drive desired profits and reward exceptional performance.  It can also be a challenge to obtain a company focus when paying based on commission.  You will have to work hard to avoid the lack of effort on non-compensated company needs.  Your company culture will dictate whether you gain the discretionary effort of your staff.  However paying in commission is ultimately the best way to highly compensate your sales and production team and reward them for their efforts in helping the company meet net profitability goals. 

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