I recently received an e-mail from a reader asking how to compensate salespeople. The answer depends on the type of sales they perform.

For example, if the salesperson is selling new construction, the compensation method will be very different than if he or she is selling commercial service contracts or replacements. In new construction, you have a very thin profit margin on which to compensate. However, the sales volume can be huge.

In service contracts and replacement sales, the margins are higher, but the overall volume is lower.

The best salespeople want to be on straight commission. They realize that they can make the highest income levels on such a plan. They have confidence in their selling abilities. If these people don't have industry experience, they will ask for a draw or a salary for a specific period of time; usually no longer than 90 days. Your risk is the 90-day period that you are supporting them

Most salespeople want a salary and a vehicle allowance if you don't furnish a company vehicle. If you decide on a salary, don't make that salary too comfortable. Salespeople should not be able to pay all of their living expenses on the base salary. If they're not hungry, they won't sell.

Establish a base gross margin. If sales fall below this figure, then no commission is paid. If you compensate only on sales, then the gross margin could be 2 percent and you still would have to pay commission. Everyone loses in this case.

Next, establish the commission that you will pay. This may be based on gross sales or gross margin. The gross-margin percentages should be higher than the gross-sales percentages. Many times, it is an increasing scale based on gross margin - higher the gross margin, the higher the commission.

For example, if your baseline for replacement sales is 30 percent, you might pay a 1 percent commission on sales if the gross margin is up to 32 percent; 2 percent commission up to 35 percent, etc. This ensures that you won't go below a break-even gross margin.

The cost of sales

Many people have asked about the break-even point to determine whether salespeople are generating enough sales.

To figure this out, you must determine a salesperson's total cost. This includes his or her salary (if any) or draw (the maximum amount you would allow), benefits (including health insurance, workers' compensation, retirement, vehicle allowance or cost of the vehicle provided), training classes, and marketing and advertising expenses to generate leads.

Many contractors forget about the marketing expenses. However, at a minimum, you will pay for business cards and some direct-mail letters. In reality, to ensure that your marketing efforts are generating results, you need to track these leads and the closing rate of the sales generated.

All of these elements add up to the total sales cost for one year.

Then you determine a salesperson's average sales commission. If you have a commission scale, assume the average commission percentage. If you have a fixed commission, use that.

To calculate the salesperson's break-even sales, use this formula:

Subtract the commission percentage from the gross margin, and then divide by your overhead cost. In other words, take the total cost and divide it by the gross margin minus the commission paid.

For example, if the total cost was $100,000 and the gross margin a salesperson sells at is 35 percent with a 4-percent commission, the minimum amount he or she must sell is $100,000/31 percent = $322,580.65.