Chapter Five: What are the rules that govern commission plans?
Published: Jun 04, 2014
By: Mark Rawlins

Chapter One: How is network marketing different from other methods of distribution

Rules are what give the character to a compensation plan. They make it bitter as vinegar or sweet as sugar. If a company becomes known for front-end loading, it's because the rules encouraged and allowed or required it, not because the company chose one type of commission plan or another. So if you want to know why distributors of a certain company consistently act a certain way, you will almost always find your answer in their rules.

Commissions define what a distributor will be paid. Rules define what a distributor must do in order to be paid. A company makes two types of rules: the positive motivational rules that create incentive for distributors to continually grow their businesses, sometimes referred to as "the carrot," and the negative rules that define what the company will do to them if they get out of line, also known as "the stick." Companies should try to have as many "carrots" as possible and as few "sticks" as necessary.

The four kinds of rules
Basically, there are four kinds of rules:

1.       Rules that govern distributor advancement from rank to rank.

2.       Rules that define the qualifications a distributor must meet in order to receive the various commissions.

3.       Rules to ensure that distributors don't create legal or ethical problems for the company.*

4.       Rules to ensure that distributors maintain ethical behavior while building their organizations.*
*I will leave these issues to your attorney.

Rules are, of course, a way of life, but every rule a company sets creates a potential conflict with its distributors. A company must think them through carefully. I often see rules in companies' policies and procedures that were copied from another company, even though the reason for the rule doesn't apply to this company or is long gone. It also surprises me that even when a company is made aware of this, many will decide to leave the rule "just in case."

The rules of a plan affect payout to distributors just as surely as the definitions of the commissions themselves. Furthermore, the rules often have almost as much effect on the company's overall payout as the commissions percentages themselves do.

The rules designate the qualifications a distributor must meet in order to move up in rank, achieve a higher percentage on the group volume of his or her organization, receive a sales commission, or whatever benefits that distributor is trying to attain.

Each company sets up rules according to its own needs. However, a company's commission plan will almost certainly have to include two categories of rules: commissions qualification rules and rank advancement rules. Distributors want to be able to depend on a clearly defined set of rules that tell them what they have to do to be paid each month and what they have to do to advance in rank. Since these rules govern the way distributors build their businesses, the rules need to make sense, be fair, and most of all, be consistent.

It's important that the company not change the basic framework of rank advancement rules once they're in place. This is important, since distributors will build their businesses based on the rules a company has in place. For the company to change the rules is to destroy the value of the organization that a distributor has spent months or even years building. I think the day will come when top distributors won't build a downline unless they have some contractual assurances that a company won't continually change the rules that define the basic structure of the commission plan. Obviously, companies need the ability to make changes to deal with the economic realities of a changing marketplace, but under normal conditions there's no reason for the company to change the basic structure of the commission plan.

Basically, then, a company builds its qualification rules to set the distributors on the path the company wants them to follow, and then puts in a system of commissions that rewards them for following that path.

There are two kinds of qualification rules: those to qualify for rank advancement, and those to qualify to receive commissions each month. This is where the issue of having lots of ranks and lots of commission types creates a challenge for a company. The more ranks a company has, the more rules are required to advance from rank to rank and to qualify to earn each of those commissions. In addition, the commission plan description becomes more complex. The more complex the commission plan becomes, the harder it is to explain, the more time you need to explain it, the more confused people are, the more consumer service people the company has to employ-you see the problem.

Companies can help alleviate this situation by having a consistent method of advancing from rank to rank. The advancement rules must set up a logical, consistent system for commission payout for each rank, for achieving a rank in the first place, and for maintaining qualifications. In general, a company should make the rules as simple as is feasible to achieve the desired results.

Rank advancement rules

In most companies, the distributors advance in rank by building their organizations and increasing their downline sales volume. The best way to start creating the rules is to think about the various types of distributors and what they need to do as they grow their businesses. A company always needs to keep the top rank in mind as it defines the rules for the other ranks.

Another thing to remember is that once distributors reach the highest rank, it's tempting for them to quit building their organization. When a company defines the top rank, it needs to make sure that when people do achieve that rank, their earnings are in line with the respect the company wants the rank to command. For example, if a "4-Star Diamond" rank is the top rank, and some distributors at that rank that are earning only $2,000 a month, it won't command much respect. This is especially problematic if some 4-Star Diamonds are earning $2,000 and some are earning $100,000.

With these ideas in mind, let's talk about the specific rules companies use for rank advancement and commission qualifications. The ten most common qualifications are:

1.       Personal sales volume: In most companies, a distributor must have a certain amount of personal sales each month. Before defining this requirement, a company must take its product line into account; the requirement should be based on the number of people it would take to consume that much product each month. Sometimes, as a distributor becomes a sales leader, this requirement rises. However, as they achieve the highest ranks, this requirement does not normally continue to rise; often, it drops back to the initial requirement.

2.       Group volume: The first big question is, "What is my group?" Companies that use group volume as a qualification have a rank in their commission plan that is defined as a group or leader rank. It's also often called a "breakaway" rank because it's earned when the distributor breaks away from his sponsor's group. In most companies, a distributor's group volume includes anyone for whom he is the first upline distributor who has not achieved this group rank.

3.       Level volume: This is the amount of sales volume within a certain number of levels in a distributor's downline organization. There are several variations of this qualification. For example, sometimes compression is used.

4.       Organization volume: This is the volume a distributor's entire downline develops. It can be a very useful method of qualifying distributors for the higher ranks of a plan. One common addition to this qualification is not to allow more than a certain percentage of the qualification to come from any one leg of a distributor's organization: for example, one million dollars of sales volume with no more that $300,000 from any one leg.

5.       Downline rank achievements: A company can require that in order to be a 2-Star, distributors must have three 1-Stars somewhere in their organization.

6.       Number of downline legs of a certain rank: For example, require three separate downline legs, with at least one 3-Star somewhere in each downline leg

7.       Number of downline legs of a certain rank: For example, require three separate downline legs, with at least on 3-star in each downline leg.

8.       Number of first level distributors: There are four ways that a company counts first level distributors for purposes of qualification.
a. The number of actual first level distributors.
b. The number of qualified first level distributors.
c. The number of qualified first level distributors, but apply compression as first level distributors are counted.
d. The number of qualified distributors of a specific rank or higher.
For example, to qualify for to become a 4-Star, a company may require a distributor to have five first level distributors of rank 3-star or above.

9.       Personal sponsored/sales volume: This is the amount of sales volume of the personally sponsored distributors or consumers.

10.   Monthly Autoship volume: Many companies are now promoting Monthly Autoship programs, and so, part of their qualifications is the amount of sales volume generated by the autoship orders of personally sponsored/enrolled distributors of a distributor. These are orders that once placed, are automatically shipped to the consumer each month. Companies typically create this qualification in conjunction with a reduction of a personal volume requirement or a group volume requirement. In other words, a distributor can do the regular qualification OR do the reduced qualification along with the autoship qualification.

11.   Trained and certified: This requirement can be very valuable in ensuring a knowledgeable sales force. However, it's the least used of all the requirements.

Once a company decides what qualifications to use, it's important to build consistency as a distributor moves from rank to rank. A distributor shouldn't have to build one way to become a sales leader and then change methods to get to the next rank. A company shouldn't, for example, have the rules for all ranks encourage distributors to build their downline deep, and then switch to having them build their downline wide in order to advance to the top rank.

In most cases, a distributor needs to sponsor a number of people in order to find a few good leaders. One of the great debates that has raged in the industry for years is how wide an organization a distributor should build while building deep. This debate is more than academic. When companies design their plans, they create the rules that will allow the distributors to achieve the top ranks. In many companies, distributors achieve the top ranks by creating ten to twenty first-level sales leaders. If a company creates a rule like this, its distributors will have to sponsor a lot of people in order to be achieve the top rank.

Once a company decides which qualifiers to use, the next question it must consider is whether a distributor must reach the qualifications to achieve a rank within a month or within several months, or whether those qualifications are going to accumulate forever. Here's a quick list of the pros and cons for each approach.

1 month - All the volume to achieve a certain rank has to be earned in one month.

  • Pros:
    • Creates a sense of urgency and commitment.
    • Allows someone to advance more quickly.
    • Helps companies increase sales volume quickly.
  • Cons:
    • Sometimes this is so tough to accomplish that the requirement drives away good leaders.
    • Can encourage front-end loading.
    • Can create frustration if the distributor misses qualification by very little and has to start over the next month.
    • Distributors often hold orders until they're sure they've met the requirement, thereby frustrating their consumers.

Multi-month - A distributor can accumulate volume to achieve a rank advancement over a several-month period.

  • Pros:
    • Still some urgency, with less of a penalty if a distributor makes a mistake.
    • Encourages distributors to build a consistent business.
    • Rank advancement qualifications can be more closely matched up with monthly commission qualifications.
  • Cons:
    • Companies tend to set much larger requirements, which can penalize fast growing distributorships.

Accumulative - A distributor can accumulate volume to achieve a rank advancement over any period of time.

  • Pros:
    • Encourages building a loyal consumer base.
    • Least prone to front-end loading
  • Cons:
    • The company has to protect the salespeople and be careful not to allow consumers to "eat their way" to the top rank.
    • Does not create any sense of urgency to "get it done."

Reversion

The next issue a company faces is: once the distributors achieve a rank, do they always have that rank? Or can they be reduced in rank if they don't maintain certain qualification? Reduction of rank is called "reversion." If a plan allows for reversion, the company must have a rule about how long a distributor can hold a rank without qualifying before they're reduced in rank.

Companies must consider this type of situation when building their commission plan. How long can a distributor carry a rank without qualifying? If the requirements are too strict, distributors may quit, or they might wind up with garages full of product. If the requirements are too lax, a company may wind up with an organization full of uncommitted leaders. A company must create just the right balance.

Some companies have implemented reversion rules that turned out to be far too severe. A distributor of several years might have a difficult few months, and a too-strict reversion rule might take him completely out of the tree, basically taking away his organization and forcing him to start over. Such rules can induce anxiety and anger rather than motivation. Another consideration is that applying compression to the payout process eliminates many of the effects on the upline commission payout that created the reasons for having a very strict reversion policy because it temporarily bypasses the unqualified distributors, thus improving the payout for the upline. Again, it's important to be balanced. Strict reversion rules have pretty much disappeared, and most companies now let unqualified distributors maintain rank for at least a few months before reverting them.

Another issue is:
if they retain the rank, are they always paid at that rank, not paid at all, or is there a third option of allowing them to qualify to be paid at a lower rank than their permanent rank? It has become a common practice to allow a distributor to qualify to be paid commissions at a lower rank than their permanent higher rank.

Monthly qualification rules

In most plans, monthly qualification rules determine the rank at which distributors are paid each month. A company can use the same types of qualifications that it uses for rank advancements. However, these requirements are typically lower than they were for achieving a rank.

In most companies, the lower ranks (in the example I've been using, these would be 1-Star through 3-Star) usually only have a couple of requirements: a personal volume requirement and possibly one or two others. Once a distributor achieves the rank of sales leader (4-Star), the requirements start to become more complex. In addition to personal volume, a group volume requirement is very common. Also, structure requirements start to become very common as well. How it defines group volume and the amount of the monthly group volume required for rank advancement is one of the most crucial decisions a company must make. If the group volume requirement is too low, the salesperson won't make enough money to make their distributorship economically viable. If the volume requirement is too high, the distributors can burn out, end up with garages full of product, and sell their excess product for ten cents on the dollar over the Internet.

In many plans, group volume is the base unit for paying sales management commissions, known as leader or generation commissions. These are the backbone of many commission plans. The amount a sales leader and dream-builder will earn in a plan is often as much a function of the size of the group volume requirement as it is the percentages paid on that group volume.

So what is an appropriate group volume requirement? The factors to take into account are:

1.       How much product will the average family of consumers use in a month?

2.       What percent of potential consumers are likely to purchase the products?

3.       Is it a consumable product or a one-time sale?

4.       How easy is it for distributors to breakaway and no longer be part of the group volume of their sponsor?

In a company with highly consumable products, group sales volume requirements of around twenty households of usage tend to work reasonably well. I've seen companies with qualifications as high as ninety households of usage, which seems to be too high. Salespeople couldn't sell that much product. In order to maintain their qualification, distributors ended up buying product they didn't need each month.

Other rules to consider

Here are a few other rules that have been very effective in protecting both companies and distributors:

Product buyback: A few years ago, the Direct Selling Association (DSA, at www.dsa.org) instituted a policy that required its member companies to buy back any product purchased by distributors for one year and charge no more than a ten percent restocking fee. This great policy protects distributors. However, one way that distributors can abuse the policy is to purchase product to qualify for a commission and then return the product. To combat this abuse, most companies replace defective product only with new product or give the distributor a cash refund only if the distributor is terminating the distributorship. It seems harsh, but, as a practical matter, has worked out to be fair to both parties.

Changing sponsorship: Some companies allow a distributor to change his or her sponsor under certain circumstances. This policy is almost always a bad idea. It leads to downline poaching and counter-poaching, and the company ends up refereeing the situation. No matter what the company decides, someone is always mad at them. I've seen companies say, "We'll allow you to change sponsors if your upline isn't supporting you," but that's like when I get in the middle of a fight between two of my kids and ask, "Who started it?" Entire management teams can become 100 percent consumed by this problem. In the end, most companies stick with the policy that a distributor stays under the person who sponsored him. This rule allows management to spend their time doing what they're supposed to do: run the company.

Distributorship terminations: When distributors terminate their distributorships, most companies don't allow them to sign up again for between six months and one year. The reason for this rule is to prevent a distributor from terminating just to get around the changing sponsorship rule.

Only one distributor per household: Distributors often sponsor someone else in their household as a way to stack additional levels into their downline and pick up additional commissions, or to get around the sponsorship change rule. If the plan has effective anti-stacking mechanisms in place, this rule is probably not necessary. Sometimes a husband and wife travel in different circles, and so it may be justified to let them have separate distributorships.

Summary

It's amazing to me how often companies agonize endlessly over the details of the percentages of their commission plan and then just copy the rules from another company without much thought, never realizing that the rules make the plan. If you want to understand a commission plan, you must understand its rules. If you do not understand its rules, you do not understand the plan.


2003, Mark Rawlins. Reprinted with permission from Mark Rawlins. No part may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording or by any information storage and retrieval system, without permission in writing from the author.