The Charlie Munger Principle Most Sales Leaders Ignore

Here is the transcription of the podcast episode "The Charlie Munger Principle Most Sales Leaders Ignore."

I just had dinner with four other really successful business owners. They all have businesses bigger than mine. Very sharp guys. And we were talking about sales compensation plans. And once we got to talking about it, I was kind of sharing like some things that, candidly, I just kind of take for granted because I've been in sales management and sales leadership roles for 20 years. When we got to talking about it, they were like, "Ah, you know, like a handful of these things like they hadn't... they hadn't thought about." And because I know they're very smart, very successful, just not from the sales world, and they found it helpful, I thought maybe you would find it helpful. So I'm gonna reshare a couple of these things that I shared with them when it comes to sales comp plans.

Now the main thing, like the foundation of everything that I think about when it comes to sales comp plans, is that the only purpose of your comp plan is to change behavior. Right? Like there's some first-level things that you need to do to make sure you attract the right people and shit like that, right? Like you've gotta make sure you're paying the good market rate, you know, look at what the on-target earnings are gonna be in your market for your industry, like make sure you've got a plan that's gonna attract people in. But when it comes down to brass tacks and what the incentive structure is within that on-target earnings—like what you're gonna commission, what you're not gonna commission, things like that—the only purpose of those things is to get the behavior that you want. It's to change behavior. That's why you make all of the strategic decisions that you make within your comp plan.

So you're going to pay more for the stuff that you want. You're gonna pay more for the harder stuff. You're going to disincentivize the stuff that you don't want them to do. So you're gonna pay high commissions for hunting and bringing in new people, right? You're gonna pay lower commissions for, you know, the easier, you know, if you pay on renewals, things like that. And likewise, you're gonna disincentivize other behaviors. Like so some comp plans are gonna have, you know, you don't get your commissions for 90 days in case somebody, you know, churns right away or something like that. Or you get chargebacks because they ask for refunds. The point is, the entire purpose of the plan is to change behavior of the person, right? Like you create this incentive system. And it comes back to like the late and great Charlie Munger, who I love, you know, he says, "Show me the incentive and I will show you the outcome." And that's what this comes down to. So you want to be really strategic with this.

That will include, you know, your base and commission balance, right? Like those are some of the strategic decisions you're going to make. Like how much do we want to guarantee on a base salary and then how much do we want to create on an incentive structure? You're going to... how much commission you're going to pay? You're going to... like on which results are we going to pay those commissions? And when are we going to pay those commissions? Like the timeline on when you pay those commissions actually matters. And what's not going to be paid, right? Or when it's not going to be paid anymore. Like all of those things factor into this, right? Those are your... that's your incentive structure.

And when I think about these plans, these are all the things that I'm thinking about. I'm trying to play through: What am I actually incentivizing here, intentionally or unintentionally? So if I do this, then what can we expect a rational person in this role who responds to this direct incentive to do? Not the other way around. Not "hey, what do I think that they ought to do and how do I..." Like really try to be objective with this. Like what is somebody in that role going to do and how are they going to respond to the structure that you've put in place? And have you been really intentional with where you're timing all these things? Like when you're going to pay commissions, when you're not going to pay commissions. Are you going to stretch those things out? Is it going to be an immediate incentive right after a transaction?

So the first thing that we really kind of talked about was long-term commissions. And it came up because one of the guys there owns a couple hundred gyms in the U.S. And they were... they're building a SaaS product and they're going to market with this new SaaS product that kind of powers the gyms. And they're hiring a salesperson. And they put in place like a very lucrative plan, but the big money really comes from a 12-month block, a 24-month block, and a 36-month block. So if the salesperson comes in and they're thinking about this in terms of, you know, a year from now, two years from now, three years from now, and they... they can kind of do the math on this and go "Wow, like in a few years I'm gonna be fucking crushing it. I'm gonna be making a shit ton of money."

And my feedback to him was: Like the challenge with that is the rational salesperson doesn't think like a business owner, right? Like the business owner is thinking in terms of longevity. The business owner is thinking in terms of "I want you to stick around and I want you to play the long game with how you're selling, so I'm going to put this carrot, this really, really big carrot here three years out from now." And candidly, that's how business owners think. That's how investors think. That's not how sales people think. The average rational salesperson is going to come in and say, "I want to be incentivized for the behavior that I did most recently. I want to be paid on the work that I've done most recently."

If I wanted to build a three-year plan for lucrative earnings, man there's a lot of other ways to do that. Hell, they might own their own business, right? Like they might be doing their own investments. And you can't necessarily expect the rational salesperson to understand the long-term value of something because most people are thinking in much more incremental terms, right? Like this is actually why equity is usually like a bad play for a lot of people unless they truly understand the value of it—and most people don't. Because equity is very expensive for the business owner, but it's not as tangible to the salesperson or to the employee. It's not as liquid. It's not like the resources that the average rational person uses on a day-to-day basis—i.e., cash—isn't available to them. And so they know... they may have this handcuff that's there, they may loosely understand the value that's associated with it, but really when it comes down to it, most people don't understand the true value of it. So the business owner is giving a really expensive thing that isn't fully valued. Complete misalignment.

Similar type of psychology goes into putting these like 36-month deals in. And we look at that, like as a business owner, go "Damn, like that's that's very, very rich. That's very lucrative. That's very generous." But that's not how it's going to be perceived. The other thing is: that's not going to change their behavior next week. Even if they see there's really big reward that they can get in 36 months... Say you've got a comp plan that's 50/50, right? Like you've got 50% base and let's call it 25% commissions now and 25% is on this lucrative stretched-out bonus plan. Then they... they still gotta eat, right? Like they still gotta pay their mortgage and their car payment and all the other shit. Like they're still thinking about day-to-day. And in the path to get to 36 months, that's what they're gonna really be focused on.

So my rule of thumb generally speaking when it comes to sales plans: Don't expect them to think like business owners, right? Like with really extended long-term plans that are generous to you and expensive to you frankly, and not as... not as valuable to the person. Misalignment. And reward the behavior closest to the behavior, right? Like the last thing you want to do is say, "Hey, that thing you did three years ago, now there's a huge payout for it," right? Like in a perfect case scenario what you'd be able to do is reward or incentivize the behavior that you want as soon as it happens, right? Like you... I would pull that money forward and maybe even reduce it significantly—so it's better allocation of your money—and it's more... it's perceived to be more valuable to them, right? Because if they're selling stuff today, giving them the incentive for that and the reward for that today is going to be more well received, right? Like it's going to be more valuable to them. And it's going to change their behavior. Expecting somebody to do something tomorrow or next week for something that they're going to get paid for three years from now is slightly irrational. That's kind of like my thought on the long-term commission: reward people closest to the behavior and not expecting them to think like you, right? So try to put yourself in somebody else's mindset when you're thinking about these incentive plans.

The second one was kind of the flip side to this because baked into that... somebody had a similar plan... but baked into that was like these long-term residuals. And the idea is: "Hey, I'm gonna have them hunt and build up this book of business. What happens is they're gonna be... they're gonna be incentivized to sell the right way and get people that are aligned and then take care of the customer. And so we're gonna add these long-term residuals into perpetuity that will build up over time." And I was like, "Dude, that's like... First of all, the residual three years from now doesn't change the behavior as much as you think it does, right? Like they... when they're thinking about that and they're going, 'Hey, I get 2.5% of that deal into perpetuity,' they don't... like the future value of that money is not as valuable to them, right? So it doesn't necessarily change their behavior very much today."

Okay, so like that's one... that's one problem. But the bigger problem with like long-term residuals, especially ones that go on into perpetuity, is disincentive long-term for you. It creates a complete misalignment because your costs as a business owner are going to continue to go up. You're going to continue to accrue those commissions and pay out those commissions. Their drive to do the hardest part of the work—which is the most valuable work, which is why it's rewarded usually the most heavily, which is go hunt and bring in new clients and new customers—their desire to do that, like their incentive to do that, is going to go down. Because the amount of money that they're making based on simply retaining people—which is the easier part of the job—continues to get more valuable for them. And the work, the hard work, that continues to get less valuable to them over time is now going to be less incentivized, right? Like I'm... why would I go do the hard thing when the easy thing is making me more money right now? And it's just like... it's just common sense, right? Like you can't actually... you can't blame somebody for that. Like that is ultimately... if that comp plan is quote "successful," in the long term you are creating a permanent misalignment and a very, very uncomfortable situation later. And it's just bad use of money, right? Like you're not paying the most money where the hardest work goes and the most valuable work goes—which is bringing people in—and you're continuing to pay it on the side.

Somebody... I know is gonna say, because I've heard this before: "Well dude, that's a problem I'd love to have. Like why don't I... let's address that when we get there. Like let's address that when we get there." And I like... I'll gladly pay them 300 grand later to manage a book of business. Like I would love to have that problem today. And like, you say that now. Like first of all, like you say that now. And... and it's not going to be one day. Like one day you're not going to wake up and be like, "Hey, I'm paying them 300 grand and they're not doing... they're not bringing in any new business anymore." It's going to be a process of getting there. Like there's going to be from here to there... there's just going to be like this accumulation of friction and tension that grows in the relationship as you watch yourself pay more money and that person get less results, right? Like that's going to... that's going to happen. And it's inevitable.

Second thing is like, candidly, I think it's misleading. I think it's fucked up to bring somebody in and say, "Hey, I'm gonna pay you this really rich plan, have them build up a book of business, and in the back of your mind be thinking 'I'm gonna fix it later.'" To me that's like... that's fucked up. So if you say it out loud and you go, "Well I'll just... I'll just fix it then," then you're misleading somebody. You're fucking with somebody's life for all intents and purposes.

So the long-term residuals... Like my rule of thumb: Incentivize the behavior that you want. Make sure that you're always incentivizing the hardest stuff the most. That you're spending the most money on the hardest thing and the most value. And that you're doing the opposite... like you're allocating your money smartly on the work that's not necessarily as hard.

And then the third thing that we talked about was my thoughts around like... you as a business owner want to own the relationship with people that you bring in, like new customers. And so I want to pay a salesperson to go hunt. And then I want, when the hunt is over and they bring in a new client, I want them to hand that over to a customer success manager, I want them to hand that over to an account manager. I want them to hand that relationship over to the business. And I want to pay very lucrative[ly] for the hunt. Like I want to pay a lot of money for somebody to go hunt. It is not easy work. It is hard. And it is hard finding really good people to do it very well. And it's hard to get good people to do it well with the customers that you want. So I pay very lucratively on the client acquisition side of things. But I want that relationship to end after the hunt is over.

And partly, yes, there's some aspect of that is to de-risk it, right? Like I want the relationship with the business. Like that's... that's an asset. Like that relationship, if it's managed and maintained by one person from introduction to conversion to managing in that relationship and that person accumulates like a significant amount of business and they own those relationships, it's risky. And I've been in... I've seen businesses like that and it is a... it can be a big problem.

But that's only part of it. Like it's not just a defensive play. To me it's more about alignment. Which is probably the theme that you're kind of hearing here. Alignment of effort and difficulty and value with the amount of money that you're paying. If you have somebody that's really good at hunting, you want them to hunt, right? Like you want to pay more money to go do that hard thing because finding more people to do that thing is really hard. So if I have good hunters, I don't want them farming. And really good hunters probably don't want to farm. But there are... there is some overlap. Like it's not binary. But I... if they have that skill set, I want them to either be utilizing that skill set or training other people to develop that skill set, right? Like I don't want them on the farming side because I can get more people to do that. Like it's just a... it's a skill misalignment frankly.

And because it's a skill misalignment, then it's a money misalignment for you. If you're now paying a hunter to farm, you're now paying hunter money for farming stuff. And frankly hunters should get paid more and do get paid more than farmers. So if you're paying hunting money for farming activity, again, misallocation of your money. And then misallocation of results, right? Because if I'm now paying you for... if I load you up with, as a salesperson or as a hunter, with things like the farming, the account management, the other stuff... well now the results on the other side inevitably get lower because your pie chart of the amount of time that you have to spend hunting is going to be less. The more successful you are in the hunt, the more you're now managing the accounts. And then at some point, kind of like the long-term incentives, now you're kind of like farming. Like you don't have time to go hunt.

So these are just kind of like freestyling on some of the comp stuff that we discussed in sales compensation mindset and strategy that, you know, a handful of really sharp business owners who just didn't come from sales thought was valuable to them or helpful to them. So I thought I'd recap it here, share it with you, and I hope it was helpful for you as well. Adios.