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Direct Salesforce Versus Independent Reps: A Strategic Choice Across a Business

Life Cycle

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 Direct Sales force versus Independent Reps: A
Strategic Choice across Business Life Cycle

Pankaj M. Madhani , Ph.D.

ICFAI Business School (IBS)

Introduction
The sales force represents a significant investment for most organizations. For example, U.S.
companies alone spend an estimated $800 billion on their sales forces each year (Zoltners, Sinha
& Lorimer, 2008). Sales force compensation costs represent a large percentage of total costs for
most sales organizations. To improve profitability, many sales organizations have begun to
closely scrutinize the role of their sales force and its overall compensation costs. In this situation,
an important issue for human resource (HR) manager is that of properly designing pay structure -
how much of that pay should be fixed (salary) versus variable (commission).

The structure and composition of a sales force varies widely from one sales organization to
another. If organizations adapt to changing circumstances, they are likely to be more successful
(Duncan & Flamholtz, 1982). The organization must adjust its overall systems to fit with the
changed external and internal environment (Madhani, 2010a). Accordingly, sales force
compensation strategy of the sales organization should in turn be adjusted to support the changed
business life cycle and structure of the sales organization as well as external environmental
factors such as customers, territory and competitive response. Rebalancing of fixed and variable
pay in compensation structure offers HR managers enough flexibility to deal with market
variability and organizational changes such as business life cycle stages. Business life cycle
stages are likely to be a key determinant of compensation strategies and their effectiveness in
achieving organizational goals.

A sales force structure of an organization must be well organized if it is to sell the products and
services efficiently and effectively to satisfy customer needs. Sales force structure decisions
influence how customers see the organization and affect the selling skills and knowledge level
required of salespeople, which in turn affect recruitment, training, and compensation structure of

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Electronic copy available at: http://ssrn.com/abstract=2505942

the sales force. Each sales organization must structure its sales force to fit the unique needs of the
organization and its management (Aspley, 1956). If the sales force structure is adaptive, the
sales organization can react quickly to market dynamics without a major structural overhaul and
disruption of selling process. The effective sales force structure adapts to evolving business
needs. As sales force structuring is considered as an art, sales organizations do not have
scientifically developed algorithms for optimal sales force structure decisions. (Madhani, 2012).

Direct Sales force versus Independent Reps

Sales outsourcing refers to shifting a sales organization's sales activities in part or as a whole to
an independent third party (Ross, Dalsacem & Anderson, 2005). By outsourcing of a sales
function sales organization uses external resources to limits its risk exposure. Turning fixed costs
of a sales organization into variable costs is one of the most important reasons why sales
organizations outsource the sales function. Sales employees who contract their services are
called indirect sales force, manufacturers’ representatives or independent reps whereas, those
who are employed directly by the sales organization are often called in-house or direct sales
force. Independent reps or agents represent almost 50% of the business-to-business and upper-
channel sales (Barrett, 1986) and over 37% of all customer contacts by manufacturers (Churchill,
Ford & Walker, 1997).

Sales organization with complex, heterogeneous, high margin products with long sales
cycle are more efficient with direct sales force. Similarly, a large number of
geographically distributed and widely dispersed customers, frequently ordering small
quantities, may be more efficiently served by several reps than by direct sales force.
Use of direct sales force is associated with large size organization, larger average orders, more
complex products requiring technical service and less standard products (Anderson, 1985). If the
product is of low unit value, standard, well-accepted in the market, ordered in small quantities
and/or frequently re-ordered, reps may be the best choice (Powers, 1991). The reps are better
choice when the product is new and has no established demand, or the product is infrequently
purchased (Hawes, Strong & Winick, 1996). There is a considerable debate on reconsideration of
direct sales force vis-à-vis reps in a sales force structure (Taylor, 1981). Hence, this research
looks into this aspect and studies impact of business life cycle on choice of sales force structure.

Sales force Structure across Business Life Cycle: An Introduction

Choosing the proper sales force structure of direct sales force versus reps depends on
customer or product characteristics as well as stages of business life cycle also. Stages
of business life cycle lend sales organizations themselves to direct sales force, w hile
others to reps or indirect channel partners. The more influence a salesperson has on
the sale, the more important is a direct sales force for the sales organization.

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Electronic copy available at: http://ssrn.com/abstract=2505942

 High
Growth
stage
Growth and Profit
Potential Maturity
stage

Start-up
stage

Decline
stage
Low

Independent Direct
Reps Sales force

Sales force Structure

Figure 1: Growth Potential and Profit Potential across Business Life Cycle

(Source: Matrix developed by author)

As shown in Figure 1, start-up and decline stages of the business life cycle are characterized by
low growth and profit potential while growth and maturity stages of the life cycle are
characterized by high growth and profit potential. Accordingly reps are preferred in start-up and
decline stages while direct sales forces are preferred in growth and maturity stages of the
business life cycle. In start-up stage of business life cycle, there is lot of uncertainty. Business
risk is a central determinant of an organization’s value in terms of the present value of the risk-
adjusted future profit. It is affected by various parameters such as price, variable costs, operating
costs and the stability of demand (Halil & Hodgin, 2003). Business risk has a negative impact on
the operation or profitability of a given organization. A business risk can be the result of internal
conditions as well as some external factors. Internal conditions such as higher operating fixed
costs affect an organization’s value by increasing the variability of returns. When it comes to
external factors that can create an element of business risk, one of the most predominant risks is
that of a change in demand for the goods and services offered by the organization (Madhani,
2010b).

As business risk is high during start up and decline stages of business life cycle, sales
organizations should keep low operating leverage (Figure 2). The degree of operating leverage
(DOL) is a function of the organization’s cost structure in terms of the relationship between fixed
costs and total costs. An organization that has high operating leverage (high fixed costs relative
to total costs) will also have higher variability in earnings before interest and taxes (EBIT) than a
similar organization with low operating leverage. The more operating leverage (fixed costs/total
costs), the more profits will vary with changing sales revenues.

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In growth stage sale organization’s operating income is increasing at increased rate whereas
uncertainty and business risk is moderating. Similarly during maturity stage, uncertainty is low,
and business risk is also low. While in decline stage uncertainty and business risk is high again.
Hence during period of low business risk, high operating leverage is preferred while during
period of high business risk, low operating leverage is preferred. Accordingly reps are preferred
in start-up and decline stages while direct sales forces are preferred in and maturity stages of the
business life cycle. Deployment of reps will decrease operating leverage for sales organization,
as reps work on commission only basis. As direct sales force represents fixed costs for a sales
organization, its deployment will increase operating leverage.

Independent Sales force Direct

Reps Structure Sales force

High
Low High
Growth
Stage

Operating leverage
Business Risk

Maturity
Stage

Start-up
Stage

Decline
Stage
High Low

Low Sales Revenue High

Figure 2: Relationship of Business risk and Operating Leverage across Business Cycle

(Source: Matrix developed by author)

By reducing the business risk, the cost of capital of the organization is also reduced, thus
increasing the economic value of the firm (Madhani, 2009). Hence, the reps are most preferred
choice for the sales organization in uncertain environment (Williamson, 1979).

Types of Direct Sales force: Generalist versus Specialist

Effective sales force structure design involves finding the right balance between generalized and
specialized sales roles. Generalists sales force are typically deployed in sales organizations that
are either in their start-up stage of life cycle establishing their presence in the market or trying to
cut costs in the decline phase of their business life cycle. During start-up stage of life cycle, the
reps have a strong influence on the sales. However, for large accounts that buy on contract,
reps are usually less effective than direct sale force (Anderson & Trinkle, 2005). Hence, sales

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organizations may employ a small contingent of in-house direct sales force to service very large
or key sales accounts, while permitting smaller accounts to be serviced by reps. Most start-up
sales forces are comprised of a relatively small number of generalist direct sales force who sell a
narrow product line to a limited number of target market segments along with larger proportion
of reps (Figure 3).

Similarly, during decline stage products are more efficiently handled by reps or
channel partners since their costs are lower and less fixed. During growth and
maturity stage of life cycle direct sales force is preferred. As businesses grow during
growth stage of life cycle, the sales forces have to call on prospects in a broader set of markets as
their product portfolio expands. This presents sales organizations with two challenges related to
sales force: specialization as well as size.
Independent Sales force Direct
Reps Structure Sales force

High
Big Big
Growth
Stage

Maturity

Sales force Size

Sales Revenue

Stage

Start-up
Stage

Decline
Stage
Small
Small

Generalist Specialist
Type of Sales force

Figure 3: Sales force Size and Structure across Business Life Cycle

(Source: Matrix developed by author)

In a generalist sales organization, each representative or account manager sells an organization’s

entire, but usually limited, product line to customers who typically are all in the same industry,
thus providing a single point of business contact to customers. Generalist sales force would be
expected to engage in all types of sales activities for all of the products and to sell to all of the
customers. While specialist sales force would be expected to engage in a limited set of selling
activities for only a portions of the organization's products and would be selling only to a certain
group of customers.

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Sales forces specialize in different ways such as by product, customer, geography or function
within the sales process and industry vertical. Specialization by industry vertical is
recommended when a sales force with deep industry knowledge represents a
competitive advantage over a generalist sales force with similar offerings. When sales
organizations plan specialization, choice of appropriate methods should be dictated by overall
sales strategy of the organization and stages of business life cycle. Product specialization is
most effective when vast knowledge is required to sell the product in the market.
Product specialists are technical experts who know the products inside out.

Customer specialization makes sales force structure more market driven and focus on
select group of customers. Specialization by geography is the least complicated
specialization and focuses on geographic territories. Sales force specialization by
functions is illustrated by the delineation between the “Hunter” and “Farmer” roles of
the sales force. Hunters typically focus on new sales, while farmers cultivate current
customer relationships to drive revenue growth. Depending on stages of business life
cycle, a sales force may contain a mixture of generalist and specialist sales force.

Sales force Structure during Various Stages of Business Life Cycle

Start-up Stage
In this stage, the primary responsibility of the salesperson is to overcome initial customer
resistance to the new product and the focus is on communicating product performance. Hence, a
higher level of product knowledge is required by the salesperson to explain the benefits of the
product to customers (Madhani, 2011). When product demand is uncertain, employing a direct
sales force is a risk as it happens with sales organizations in start-up stage of business life cycle.
Hence, deployment of reps can help sales organizations in better management of business risk as
reps; if they do not perform as expected; their compensation costs in the form of commission are
minimal.

A new product launch by sales organization always carries a certain level of business risk as
profitability projections are low and liquidity positions are strained. Hence, by engaging reps for
new product introduction, sales organizations can obtain a trained sales force immediately and
virtually with no fixed cost. Sales organization in start-up stage of business life cycle are
challenged to grow the business, yet often have limited funding and face considerable
uncertainty about the future. In this stage of business life cycle outsourcing is preferred option
for sales organization. In this stage, reps are likely to be more effective than direct sales force as
they are skilled, experienced and create synergy for customers as they offer multiple product
line. Reps visit a wide range of customers to get them more interested in the product and are
responsible for looking at the early adopters, as they may be willing to pay a higher price. Reps
can afford to call on small accounts because they have multiple lines thereby absorbing high
travel time between different accounts. Reps have established contacts and relationships and are
less expensive to sales organizations relative to direct sales force.

Reps are better options for small, seasonal or volatile products with - environmental uncertainty,
and sparse territories where high travel costs may not warrant direct sales force. Start-up sales
organizations can enter markets rapidly by working along reps that have sales expertise,
influence over sales channels, and relationships with potential customers. Reps have experience

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that the start-up sales organization cannot replicate quickly enough, such as established customer
relationships or product and market expertise by employing direct sales force. Hence,
deployment of reps also helps the start-up sales organization to learn about the market in order to
build its own direct sales force successfully in the future.

Growth Stage
The growth stage is characterized by a rapidly growing organization, expanding its niche in the
market. By this stage, the organization has achieved a degree of success; the previous concern
for survival has largely been overcome, and the organization is actively involved in exploiting
expansion opportunities. During the growth stage, the organization focuses on selling and
increasing product demand and market share in the market. Large new investment is likely in this
period. During this stage, the organization is growing in products, customers, sales volumes,
geographic contact and number of sales employees.

The sales force structure that works during growth stage of a business life cycle when the
business is growing is different from what works, during start-up stage. In growth stage when
sales volume is high enough so that overall cost of direct sales force is less than the cost of reps,
direct sales force is preferred. In this stage, as products are established in the market, repeat sales
become a larger proportion of overall sales, customers will require service and support, adding to
sales force’s workloads. As such selling and supporting tasks grow beyond the salespeople’s
capacity to perform their jobs, they are likely to drop the customers, products, and selling
activities that are most difficult to manage. Unfortunately, what they drop may be lucrative or
strategic opportunities for the business. At this point, companies need to set up specialist sales
forces (Zoltners, Sinha, & Lorimer, 2006).

Maturity Stage
Direct sales forces classically are used by mature sales organizations with great effectiveness as
they are most effective at selling compatible products to one market. Hence, sales organizations
are frequently structured into autonomous divisions or profit centers, each with its own line of
products and may have its own direct sales force, responsible only for its product line. However,
if such profit centers simply cannot afford the fixed costs of a direct sales force to provide the
necessary market coverage for introducing new products in particular segment they may deploys
reps. As the size and complexity of the organization increase, it needs multifaceted, versatile and
high performance sales employees to face a more competitive environment (Chen & Hsieh,
2005). Hence, such sales organizations may opt for direct sales force if, it can attract and hold
sales force talents, market is highly concentrated geographically, it has very few customers or
sales volume is large enough that sales organizations can afford to employ large direct sales
force. Sales organizations monitor and manage their own reputation as it is one of the factors
affecting the structure of the sales organization (Weiss, Anderson & MacInnis, 1999).

The maturity stage is the relatively flat period in the business life cycle that follows the rapid
growth period. An organization at the maturity stage of the business life cycle is experiencing
slower but more consistent growth in its market. In this stage, organizations have stability and
efficiency as their goal. As organizations mature, they focus more on defending their existing
product niches. In the maturity stage, products and services start to lose their advantage,
competition intensifies and profit margins erode. In this stage, organizations emphasize retaining

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customers, serving existing segments and increasing the efficiency and effectiveness of the sales
force. During this period, the organization has achieved the greatest economies of scale in its life
cycle and is able to generate steady and predictable profits. In the maturity stage of business life
cycle, the environment becomes more stable and predictable in comparison with the growth
stage.

Decline Stage
Although the maturity stage can be extended through proper management action, internal and
external factors or both may force the organization at any time to enter the decline stage
(Whetten, 1980). During this stage, the organization begins to stagnate as markets dry up and
product demand decreases. The decline stage of the business life cycle is characterized by a
decrease in organization’s resource base. In this stage, organizations are experiencing reductions
in market share, reduced product demand and even financial losses because of a variety of
reasons, such as ineffective management practices, changes in market environments or stiff
competition. At this stage, organizations’ strategies emphasize retaining and serving existing
customers and segments.

Some of the most obvious signs of the decline stage include declining sales relative to
competitors, disappearing profit margins and debt loads that continue to grow year after year.
When a renewal or revival of the organization is not likely and further decline is inevitable, sales
organizations can only ensure that they remain profitable for as long as possible. In this situation,
organizations should use their salespeople to service the most profitable, loyal and strategically
important customers while discarding unprofitable product lines or territories.

In this stage, the size of the sales organization’s direct sales force was reduced substantially, and
remaining small group of direct salesforce began to focus exclusively on value-based selling to
large, most profitable and strategically important customers or product lines. By using less-
expensive selling resources, sales organizations can continue selling efficiently to some customer
segments. Hence, to preserve profitability sales organizations utilize reps or selling partners to
cover some market segments at less cost. In this stage of business life cycle, improving the
efficiency of sales forces are critical. Sales organizations use generalist sales force when repeat
sales are not the major portion of the sales. Hence in this stage, sales organizations shift their
sales force structure by moving from specialty sales force to generalist sales force.

Direct Sales force versus Independent Reps: An Economic Analysis

The direct sales force of a sales organization is difficult to set up, slow to get up to speed and
treated predominantly as a fixed cost comprising of salesperson, sales managers and information
systems. Overhead cost of the direct sales force includes base salaries, taxes and other fringe
benefits such as vacations and medical coverage, training costs, travel and other selling expenses
and sales management overhead. On the other hand, as reps are paid commission on realized
sales they represent variable cost for the sales organization. Outsourcing turns largely fixed costs
of a sales organization into mostly variable costs as commissions paid to reps are a fraction of
sales. Thus, if the product doesn’t sell, costs are minimal. Using reps avoids the significant fixed
capital costs and ongoing costs of building and running a direct sales force.

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The decision of a sales organization whether to engage direct sales force or reps is generally
influenced by the cost of serving the same level of sales. Sales organizations use reps until their
sales are large enough for them to afford a direct sales force. The convergence of direct sales
force cost and commission paid to reps plays an important role in the initial decision of sales
organization to use direct sales force or reps in the sales force structure as it analyze a path of
least total costs. Such convergence is viewed in the terms of selling cost and sales revenue and is
stated by following formula:

Where:
OHd = Overhead cost of the direct sales force
Cd = Variable pay (Commission) of direct sales force
Cr = Commission of Reps
S = Sales revenue during life cycle of a business

As shown in figure 4, sales revenue changes across life cycle of a business. During start-up as
well as decline stages of a business life cycle, sales revenue (Ss or Sd) remain on lower side.
Similarly, during growth as well as maturity stage of life cycle, sales revenue (Sg or Sm) remain
on higher side. Sales revenue during growth and maturity stages are considerably higher
compared to start-up and decline stages of business life cycle (Sm > Sg > Sd > Ss).

Business Life Cycle Stages

Start-up Growth Maturity Decline

Where
Sm = Sales during maturity
stage
Sm
Sg = Sales during growth
Sales Revenue (S)

Sg stage
Sd = Sales during decline
Sd stage
Ss = Sales during start-up
Ss
stage

Time

Figure 4: Typical Stages of Business Life Cycle

(Source: Chart developed by author)

When this relationship is diagrammed as shown in Figure 5, it can be seen that the cost of reps
(Cr) rises in direct proportion to increases in sales (S) as sales costs of reps are primarily in the
form of commissions (Cr). Figure 5, represents the convergence of direct sales force cost and
commission of reps for mix pay plan (variable pay along with base salary) of direct sales force.
For mix pay plan, the cost of direct sales force includes sales overhead, such as base salaries and

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overhead costs of sales support (OHd) as well as commission (Cd) paid to the direct sales force.
The two cost lines would converge at point ‘O’, where the cost of the two sales force strategies
would be equal (OHd + Cd = Cr). The point ‘O’ is also called as indifference point and shows
equilibrium of the sales commission (variable pay) paid to the reps versus selling costs
associated with a direct sales force in a sales organization.

Cr
Sales Compensation ($)

Break Point
D
O

Cd
Where
Sg = Sales during growth stage
OHd
Sm = Sales during maturity stage
Ss = Sales during start-up stage
Sd = Sales during decline stage

R Ss Sd S Sg Sm

(Low sales revenue) (High sales revenue)

Sales Revenue ($)

Figure 5: Sales Revenue (S) of Sales Organization across Business Life Cycle
(Source: Chart developed by author)

Therefore, based on a purely economic decision, during period of low sales such as in start-up or
decline stages of business life cycle, sales organization would use reps to gain sales at a lower
cost as denoted by line RO and would continue using reps as long as their commission costs (Cr)
remained lower than the costs associated with a direct sales force (OHd + Cd). As shown in
figure, the least cost paths are RO and OD where cost of direct sales force is OHd + Cd.

Once the sales organization’s sales volume is high enough as in growth and maturity stages of
business life cycle that the commission or variable pay paid to the reps (Cr) for that volume are
greater than the total fixed cost and variable costs (OHd + Cd) that the sales organization
estimates for a direct sales force, the sales organization should switch to a direct sales force as it
is more economical. Hence, if sales exceeded point ‘O’, then the sales organization would
convert sales force structure to a direct sales force to maintain the lower economic costs as
denoted by line OD. Hence, after break point ‘O’, sales organization will switch over to direct
sales force as cost line OD represents least cost path. Hence, when sales revenue is high (as in
growth and maturity stages of business life cycle) and above break point, direct sales force is
deployed and when sales revenue is low (as in start-up and decline stages of business life cycle)
and below break point, reps are used.

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Sales organizations should be large enough as in growth and maturity stage of business life cycle
to deploy direct sales force for intensive coverage of all geographic markets. Otherwise they may
be spread too thinly for optimum territory coverage. Hence, when sales organizations in start-up
stage or decline stages of business life cycle can't afford fixed costs of a larger direct sales force
to give the intensive coverage, reps are better choice as they operates on a pure commission plan
(‘pay for results only’) and also enhance cash flow and profitability. This single evaluation,
however, reflects only the economic aspect of the sales force structure decision to deploy direct
sales force or reps. However, all organizations should not choose direct sales force or reps in
sales force structure based on these criteria only. Other important non economic factors in
selection of sales force structure are their relative performance in sales coverage/sales generation
and the costs/revenue effects during the process of switching from reps to direct sales force and
vice versa.

Direct Sales force versus Independent Reps: An Economic Approach

As calculated in following illustration, considering reps instead of direct sales force in the sales
force structure of a sales organization has resulted in an increase in variable costs, a decrease in
fixed costs, along with a decrease in operating leverage. Reps (who work on commission or
variable compensation) also help to reduce breakeven point (BEP) which results in the sales
organization being able to be profitable faster. Hence, the break even quantity and operating
leverage will be lower for the sales organization that has used reps instead of direct sales
employees in its sales force structure, as calculated in following example. If cost of coordination
with reps is not considered then fixed costs of sales organization will be zero and subsequently
BEP will also be zero.

Illustration
To illustrate, impact of sales force structure on operating leverage and BEP assume that a sales
organization considers both options of employing direct sale force and reps as shown in Table -1.
Sales organization in ‘direct sale force’ option, employs internal sales employees on mix pay
plan (fixed pay:$22,000 & commission: 2%) while in another option of ‘reps’, sales organization
deploys independent reps on commission only basis (at 13.94% commission on sales). The
indifference point or break point occurs at sales volume of 60,000 units. At this point, cost of
direct sales force and cost of reps are equal (cost to sales ratio will be same for both the options)
(Scenario 1, Table 1). Below this point, cost of direct sales force will be higher than cost of reps
(Scenario 2, Table 1) while above this point cost of reps will be higher than cost of the direct
sales force (Scenario 3, Table 1). As reps are self-employed, there are no overhead costs
attributable to the sales organization. ‘Reps’ option of sales organization has a lower DOL
(degree of operating leverage), lower marker risk and its profits vary less with changes in sales
volume.

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 Table 1: Sales force Structure and Financial Performance: Various Scenarios

Scenario 1 Scenario 2 Scenario 3

Sales force Sales Organization Sales Organization Sales Organization
Structure (At (Below (Above
Indifference point) Indifference point) Indifference point)
Step Direct Direct Direct
No. Calculation Sales Reps Sales Reps Sales Reps
force force force
60,000 60,000 30,000 30,000 120,000 120,000
1 Unit sales (Monthly)
24 24 24 24 24 24
2 Unit selling price ($)
12 12 12 12 12 12
3 Unit variable cost ($)
22,000 0 22,000 0 22,000 0
4 Fixed pay (salary) ($)
150,000 0 150,000 0 150,000 0
5 Selling overhead ($)
172,000 0 172,000 0 172,000 0
6 Total Fixed cost = (4) + (5) ($)
2 13.94 2 13.94 2 13.94
7 Variable pay (%)
28800 200800 14400 100400 57600 401601
8 Variable pay = (1) x (2) x (7) ($)
0.48 3.35 0.48 3.35 0.48 3.35
9 Variable pay /unit = (8)/(1) ($)
12.48 15.35 12.48 15.35 12.48 15.35
10 Total variable cost/unit = (3) + (9) ($)
11.52 8.65 11.52 8.65 11.52 8.65
11 Unit contribution Margin = (2) – (10) ($)
691200 519200 345600 259600 1382400 1038399
12 Contribution margin = (1) x (11) ($)
0.48 0.36 0.48 0.36 0.48 0.36
13 Contribution margin ratio = (11)/(2)
748800 920800 374400 460400 1497600 1841601
14 Total variable cost = (1) x (10) ($)
920800 920800 546400 460400 1669600 1841601
15 Total cost = (6) + (14) ($)
1440000 1440000 720000 720000 2880000 2880000
16 Total revenue = (1) x (2) ($)
EBIT (earnings before interest and tax) = 519200 519200 173600 259600 1210400 1038399
17
(16) - (15) ($)
DOL (Degree of operating leverage) = 1.33 1.00 1.99 1.00 1.14 1.00
18
(12)/(17)
Decline in EBIT on 20 % decrease 26.63 20.00 39.82 20.00 22.84 20.00
19
in Sales = 20 x (18) (%)
358333 0 358333 0 358333 0
20 BEP (Break Even Point) = (6)/(13) ($)
0.639 0.639 0.759 0.639 0.580 0.639
21 Cost to sales ratio = (15)/(16) (%)

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 (Source: Calculated by author)

A critical requirement of such economic analysis is a complete and precise estimation of the total
fixed costs associated with the direct sales force as well as accurate forecasting of sales revenue.
In the earlier illustration, it is assumed that a direct sales force can achieve an increase in sales
volume with no increase in the number of sales people. Such analysis is a cost based steady-state
analysis. It means that sales organization had either considerable slack resource at the beginning
or a large improvement in the sales organization’s selling efficiency over a time. In reality, cost
curve will not vary directly with sales as considered in the illustration. Essentially, fixed costs of
sales will increase with increase in sales. Fixed costs are not fixed at a given level in perpetuity
(Guiltinan, 1974). In fact, fixed costs are only semi fixed. They are fixed within a range of
relevant factors such as sales volume or the number of customers. As the relevant factor
increases or decreases, the associated fixed cost becomes unfixed as investment must be made or
reduced and is fixed again at the new higher or lower level.

Direct Sales force versus Independent Reps: Strategic Choice at Indifference Point
As calculated in Table 1, at indifference point there is no difference in choice of direct sales
force or independent reps as cost to sales ratio will remain same. However, magnitude and
timing of cash flow will have major impact on liquidity position of the company. Independent
reps usually bear all sales expenses and are the manufacturer's exclusive salespeople for a
defined set of customers (Anderson & Schmittlein, 1984) and usually do not take title or
possession of the product, which is usually shipped directly to the buyer or user by each
manufacturer (Heide & John, 1988). Also, they are not paid when they receive the sales order
but they are normally paid in terms of commission when the product is shipped or when the
organization is paid. However the direct sales forces are paid by sales organization every month
in terms of base salary, whatever the sales in anticipation that they will perform. Hence,
deployment of reps sharply improves cash flow position of the company compared to direct sales
force. Especially for long selling cycle, this can be a significant difference for a sales
organization with the direct sales force, as they are paid salary, before the sale actually takes
place. In reality, these amounts of commission and salary paid during different time interval are
not the same, given the time value of money. Hence, this opportunity cost results in decrease in
cash flow for a sales organization on deployment of direct sales force as explained below with an
illustration.

Illustration
A sales organization is selling complex, technology intensive, big ticket item to a government
organization. The selling cycle for this product is long and takes 8 months to close the sell. The
selling price of a product package is $0.5 million. The sales organization is evaluating the
options of “direct sale force” (D) versus “reps” (R). In option D, sales organization is hiring sales
employee at annual salary of $60,000. While in option R, 10% commission is paid to reps on the
realized sales. The weighted average cost of capital (WACC) for the sales organization is 14%.

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Option D

A A A A A A A A A A

Time-line
0 1 2 3 4 5 6 7 8 9
PV = $47,483

Where A = Annuity
= $60,000 /12
= $5,000 (paid to sales force as a salary in the beginning of each month)

Present value (PV) of this cash flow (annuity due) is given by following formula:

Where i = 0.14/12
= 0.01167
and n = 10

Hence, PV = $47,483

Option R
$50,000

Time-line
0 1 2 3 4 5 6 7 8 9
PV = $45,042

PV of reps option can be found by following formula:

Where FV (Future value) = $50,000

i = 0.01167
and n = 9
Hence, PV = $45,042

As rep is paid commission amount in full 30 days after the sale, payment to rep is considered
only after 9 months. However, with the direct sales force, this amount is paid as salary at
beginning of every month, before the sale actually takes place, say, after 8 months. The
difference in the cash flow in this simplified example is $2,441($47,483 - $45,042): a 5.42 %
difference. Although sales organization spends the same nominal amount $50,000, the payment

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timing is different and hence it causes improvement in cash flow. It means as sales organization
is able to pay its sales force more slowly, it is a positive for cash flow and improve cash flow of
the organization. The lesson here is that all dollars paid out are not the same; their value depends
also on when they are paid out.

Discussion and Research Implications

To succeed in the long term, sales organizations must re-evaluate their sales force structure
across the business life cycle. Sales force structure decisions are important for a sales
organization as consequences of such decision errors are likely to affect a sales organization not
just in current year, but for many years to come. Sales force structure is related to
compensation management, distribution channels, territory management. No matter
how well sales organization hire and train their sales force, inefficient sales force
structure during life cycle of the business will prevent sales forces from reaching full
productivity.

It is hard for sales organizations to isolate the effect of the sales force from all the other effects in
the marketplace that might cause sales to go up or down. These effects include pricing,
advertising, sales promotions, along with changes in distribution, market needs, and competitive
behavior. However, the sales force is a strategic lever of the sales organization for improving
sales growth, market share and profitability. Sales force represents expensive and important
HR assets for the sales organization, as it requires full productivity to be competitive
in the market place. Management of sales force structure is a key factor and if implemented
correctly, can act as a catalyst in synergizing the efforts of a sales force leading to many positive
outcomes for the sales organization in terms of increased revenue; reduced compensation cost
and enhanced profitability.

In times of recession and/or cost-cutting, the use of independent reps typically increases. After
the economic downturn of 2001, Intel, Texas Instruments, Cirrus Logic and Hunt Wesson have
switched from direct sales force to reps for some or all of their major product lines. Also many
companies chose to use reps after spinning off a division (e.g. the semiconductor operation for
Motorola; the Airpax for Phillips (Knowledge@Wharton, 2002). Cherry Electrical Products,
Waukegan, Illinois based company has very fruitful experience working with an outsourced sales
force. They estimated that building direct sales organization from the ground up would cost them
a total of $5.7 million for a direct sales force compared to the $2.6 million they paid in reps’
commissions (Foster, 2004).

A sales organization's decision whether to serve a sales territory with a rep or a direct sales force
is evolutionary in nature as an organization and its market change, the appropriate configuration
of the selling function changes (DuBois & Grace, 1987). Hence, even a sales organization that
had initially ‘appropriately’ selected reps may find that changing circumstances have made a
direct sales force more preferable in the sales force structure. There are many strategic issues in
selection of sales force structure: fixed versus variable cost to sales ratio, type of sales territories
(Dominant versus marginal), availability of trained and experienced sales force, product
characteristics and order size, short term versus long term selling approach, channel relationship
and stability of relationship (Madhani, 2012).

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Conclusion
Sales force structure refers to the differing roles that internal sales force (direct sales force) and
external selling partners (independent reps) should play. Sales force structure is critical for the
sales organization because they determine how quickly sales forces respond to market
opportunities, influence sales people’s performances and affect sales organization’s revenues,
compensation costs and profitability. A sales organization that does not link evolving sales force
structure as it passes through different stages of business life cycle is placing itself at
considerable risk in implementing an effective sales force management and compensation policy.
Although, sales organizations devote considerable time and money to manage their sales forces,
few focus much thought on how the sales force structure needs to change over the life cycle of a
business.

ABOUT THE AUTHOR

Pankaj M. Madhani Ph.D. (pmadhani@iit.edu) earned bachelor’s degrees in chemical
engineering and law, a master’s degree in business administration from Northern Illinois
University, a master’s degree in computer science from Illinois Institute of Technology in
Chicago, and a PhD in strategic management from CEPT University. He has more than 27 years
of corporate and academic experience in India and the United States. During his tenure in the
corporate sector, he was recognized with the Outstanding Young Managers Award. He is now
working as an associate professor at ICFAI Business School (IBS) where he received the Best
Teacher Award from the IBS Alumni Federation. He is also the recipient of the Best Mentor
Award. He has published various management books and more than 200 book chapters and
research articles in several referred academic and practitioner journals such as The European
Business Review. He is a frequent contributor to World at Work Journal (published 3 articles)
and Compensation & Benefits Review (published 13 articles). His main research interests include
sales force compensation, corporate governance, and business strategy.

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