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a good training program, and an adequate compensation plan are practices that help eliminate expense account padding.
Methods of Controlling Expenses
First, management must decide whether the company will pay for sales reps’ field-selling costs or have the reps pay their own expenses out of their earnings. Almost all firms pay for travel and business expenses if salary is an element in the compensation plan. If the sales reps pay all their own expenses, chances are that they are compensated by the straight commission method.
Salespeople Pay Own Expenses
Salespeople who are compensated by straight commission usually pay their own selling expenses. Management usually figures into the commission a certain percentage of sales for the field sales function. It offers the total amount to the sales rep and says, in effect, “What’s left over after you pay your costs is yours.” The main reason for this is that some people paid a straight commission might be tempted to cheat on an expense account during periods of lean sales. Also, from management’s standpoint, the plan is simple and costs nothing to operate.
There are also at least two reasons reps themselves prefer to pay their own expenses. First, such a plan gives them freedom of operation—they don’t have to explain their expenses to management. Second, many reps gain income tax advantages when paying their own expenses. They can deduct more expenses than if their earnings and expenses are separated by the company.
When salespeople pay their own expenses, however, the results may not be what management wants. A company loses considerable control over its reps’ activities. For example, the reps are not likely to travel long distances to call on and entertain prospective new accounts who do not offer immediate sales potential.
Unlimited-Payment Plans
The most widely used method of expense control is the unlimited-payment plan, in which the company reimburses sales representatives for all legitimate business and travel costs they incur while on company business. There is no limit on total expenses or individual items, but reps are “required to submit itemized accounts of their expenditures.
The main advantage of the unlimited-payment method of expense control is its flexibility. Cost differentials between territories, jobs, or products present few problems under this plan. Flexibility also makes the plan fair for both salespeople and management, assuming that reps report their expenditures honestly and accurately. Furthermore, this plan gives management considerable control over the sales reps’ activities. If sales executives want a new territory developed or new accounts called on in out-of-the-way places, the expense plan is no deterrent.
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However, an unlimited-payment plan may not allow management to accurately forecast its direct selling costs. The unlimited feature is an open invitation for some people to be extravagant or to pad their expense accounts with unjustifiable items. The plan offers no incentive for a salesperson to economize.
It is debatable whether the unlimited-payment method leads to more or fewer disputes between management and the sales force than other expense-control systems. The unlimited feature should reduce the number of disagreements, but friction may arise if management questions items on the expense reports. Probably a manager’s greatest need in an unlimited-payment plan is to establish a successful method of controlling the expenses. Certainly a sales manager should analyze the reps’ expense reports to determine what is reasonable and practicable.
Limited-Payment Plans
A limited-payment plan may take either of two forms. In one form, the plan places a limit on the amount to be reimbursed for each expense item. For example, a company may pay a maximum of $140 a day for lodging, $7 for breakfast, $12 for lunch, and $25 for dinner (or $44 each day for food). In the other form, the plan provides a flat sum for a period of time, such as a day or week. One company may allow $180 a day; another firm may set its flat sum at $900 a week. Management may set the same limits in all its territories, or it may establish different limits to account for territorial cost differentials.
Setting limits on expense payments has some advantages. Limited-payment plans are especially suitable when sales reps’ activities are routine and travel routes are repetitive. Then the expenses can be more accurately forecast. These maximum expense forecasts then aid in budget planning. Also, knowing in advance what the limits are should reduce expense-account disputes between management and the sales reps, particularly if both parties perceive the limits to be fair.
The manager’s major problem in administering a limited-payment plan probably is establishing the limits for each item or time period. Management may study past reports to determine the mileage sales reps typically cover each day. It may examine hotel and motel directories to establish limits on lodging. A separate study should be conducted for each territory to ensure that the plan reflects regional cost differentials. Also, management should monitor the program to ensure that the limits reflect a territory’s current structure. Sales reps should be included in these various deliberations, because limited-pay plans are good only if the sales force believes the limits are equitable.
Companies typically encounter several other problems in limited-payment plans. High-caliber salespeople may object to limits on expenses because they feel that the company does not trust them. Also, the system can be inflexible. A sales rep may have some unusual expense, such as an entertainment item he or she could not escape without losing the account. If entertainment is not an allowable expense, the rep may not be reimbursed. Some companies avoid such inflexibility by allowing these unusual expenses if they are reported separately with an explanatory note.
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An Ethical Dilemma
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Many companies control their sales reps’ travel and other business expenses by using some form of limited-payment plan. That is, management will set a maximum amount that the company will reimburse for specific items such as lodging, meals, entertainment, and laundry. Typically, reps do not have to furnish receipts for certain kinds of items—local transportation, for example—or for items under the maximum limit.
Sometimes under these limited-payment expense control plans, the salespeople’s expense accounts do not record what really happened. A rep may overspend the dinner limit by $10 and then make it up on the report by adding to an inexpensive breakfast or lunch. One rep padded his taxi expenses (where no receipts were required) to make up what he overspent on food. He claimed that there was no way he could eat properly in that city on the limited amount set by the company. In other cases, reps may underspend the limit on meals or entertainment, but their expense accounts state that they spent the maximum allowed. The reps claim that they should be allowed to economize in order to earn extra money, so long as their job performance and customer service do not suffer.
Question: As a means of getting around the controls built into limited-payment expense plans, are any or all of the above-described practices ethical?
When management sets limits for each item, the plan may be hard to control. Reps may switch expenditures among expense items—that is, they may attempt to recoup money spent in excess of the limit for one item by padding the claim for some other item. Also, the plan cannot prevent a cheater from economizing on some expenses and then padding the account up to the allowable limits.
Combination Plans
The advantages of both the limited and unlimited plans can sometimes be realized by developing a control method that combines the two. Management may set limits on items such as food and lodging, for example, but place no ceiling on transportation. Another combination method is an expense-quota plan. Under this system, management sets a limit on the total allowable expense, but the ceiling is related to some other item on the operating statement, such as net sales. For example, a quota of $2,000 may be set for a month because monthly sales are expected to be $40,000. Expenses can be tied to sales even more directly by allowing sales representatives a monthly expense account not to exceed 5 percent of their net sales. The compensation plan can play some part in this expense-control system by paying a bonus if the rep keeps expenses at an amount under quota.
relate sales force expenses to net sales. In this method, management has some control over this direct selling cost. Furthermore, the reps have some operating flexibility within the total expense budget. Reps who have been made expense-conscious are not likely to be wasteful.
Control of Sales Force Transportation
One significant selling expense with little room for discretion is the cost of transportation. Transportation expense decisions are usually clear-cut because they are based on the costs and the nature of the selling environment. The rep who covers Manhattan must use taxis, buses, and the subway; a car would be next to useless. Without a car in Los Angeles, however, the rep goes nowhere. The situation largely dictates the transportation required. Some aspects are open to managerial control, however.
Ownership or Leasing of Automobiles
Since most sales travel is done by automobile, a car has become almost standard equipment. Management may provide company-owned cars or leased vehicles, or salespeople may use their own cars. No one policy for car ownership is best under all conditions. The final decision rests on a consideration of the following factors:
· Size of sales force. With a small sales force, a company achieves simplicity and economy either by having salespeople use their own cars or by leasing cars for them. Only when its sales force is large does a company generally find it advantageous to own the cars.
· Availability of centralized maintenance and storage facilities.
Great Britain 17.5% Norway 22%
France 18.6% Sweden 25%
Holland 17.5% Denmark 25%
Germany 15% Spain 15%
Austria 21.2% Italy 19%
Most cars of the size that Bales reps are likely to rent have standard (not automatic) transmis-
Renting cars in Europe for sales force transporta tion can be a lot more expensive and troublesome than in the United States. Gasoline prices in Eu rope run $4 to $5 for a U.S. gallon. On aut o rentals, the value-added tax—a form of sales tax—in vari ous European countries is as follows: sions and no air conditioning, even in Greece, Italy, Spain, and Portugal. Besides the costs and car equipment, sales reps should be alert for other potentia l surprises. In Spain, for example, retail stores, including nonair -port rental agencies, typically close for three hours at lunchtime. Obviously, this must influence a rep’s planning for an auto pickup or dropoff . Sometimes the rental location is difficul t to find. It is likely to have a small store front and the cars are parked in an underground garage or at some nearby location. Customer service overseas may be of a differ ent level than that in the United States. The cars may not be as clean, nor be in the condition that you have come to expect.If a company maintains centralized vehicle storage and repair facilities, it is in a good position to furnish the sales force with cars.
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· Unusual design required. Some companies require that the cars used by their salespeople be a special color, have a specially constructed body, or carry some form of company advertising. Sometimes the vehicle must double as a sales car and a delivery truck. In these situations, the company should furnish the cars.
· Control of car’s operating condition. If the company furnishes the car, management is in a better position to demand that it be kept presentable. The company probably can provide cars that are newer than the average salesperson’s own car. However, sales reps may take better care of their own cars than they do of company-owned or leased vehicles.
· Personal preferences. Some people are financially able and willing to furnish their own cars for work. When sales reps must provide the cars, however, management runs the risk of losing good applicants. Some reps may not want to drive their own cars for company business, or they may not have suitable cars.
· Annual mileage. A rep’s average annual mileage influences the automobile ownership decision. The more miles driven, the more advantageous it becomes for the company to own the cars. The point of indifference varies depending on the cars used and the company’s auto-expense allowances. Suppose the company pays a flat 30 cents per mile auto allowance and that management has calculated the cost of owning the preferred model to be $4,000 a year, plus 10 cents a mile. Under these circumstances, the point of indifference would be 20,000 miles.
If the salespeople covered less than this mileage, management would probably encourage them to own the cars.
· Operating cost. It is hard to say definitively which of the three alternatives—employee-owned, company-owned, or company-leased—offers the lowest operating cost. It depends to a great extent on rental costs, number of miles driven, and method of reimbursing the sales force. It also is difficult to measure some indirect costs of company ownership, such as the achninistrative expense of operating the system.
e Investments. If the company is not in a strong financial position or does not want to make the investment, it can lease cars or have the salespeople provide their own.
· Administrative problems. One major administrative question that comes up when the company furnishes cars is whether they should be available for the reps’ personal use and, if so, to what extent. Most companies allow reps to use company cars for personal transportation. Management may or may not suggest some limits. If a company adopts a no-limit policy, reps may choose not to buy their own cars, or they may use the company car as a second family car.
Use of a company car for private purposes is another indirect monetary payment, the same as group insurance or a paid vacation. Some businesses ask the rep to pay for the gas when driving the car for personal use. Others pay all expenses for both business and private use. Some ask that operating expenses be paid only on long personal trips such as vacations.
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Leasing is the easiest way to put the sales force on wheels. The sales executive does not have to be a transportation expert, and the firm avoids the problems of buying the car, maintaining it, and later reselling it. Marko Foam Products, a California firm that leases a fleet of 45 automobiles, says that the company has saved $2,000 to $3,000 per automobile since it started leasing.11
The IRS’s policy greatly encourages companies to lease automobiles, particularly the more expensive models. Whereas lease payments are deductible, almost without question, the IRS often contests (in audits) depreciation deductions for expensive company-owned cars. Leasing also minimizes a company’s record-keeping chores.
Reimbursement Plans for Employee-Owned Cars
Salespeople who use their own cars on company business are often reimbursed for the cost. Three separate types of expenditures are involved in owning and operating a car. One type is variable costs, which are generally related directly to the number of miles driven. Examples of variable-cost items are gasoline, oil, lubrication, tires, and normal service maintenance. A second class of expenditures is fixed costs, which tend to be related to time rather than miles driven. Fixed costs include depreciation, license fees, and insurance. The third group, miscellaneous expenses, is difficult to standardize. Typical items are tolls, parking, and major repairs. Usually miscellaneous costs are not incorporated into one of the ordinary automobile expense-control plans. These items are listed separately on the expense account.
Salespeople may be reimbursed for using their cars on company business by some kind of a fixed-allowance plan or by a flexible-payment method.
Fixed-Allowance Plans
One general type of fixed-allowance plan is based on mileage; another is based on a period of time. Under the first, the employee is paid the same amount for each mile driven on company business. The flat rate per mile is used by more companies than any other major plan, although there is a trend toward more flexible methods. Under the other type of fixed-allowance plan, a flat sum is paid for each period of time, such as a week or a month, regardless of the number of miles driven. The reimbursements cover both fixed and variable automobile costs.
Fixed-allowance plans have several advantages. They are generally simple and economical to administer. Salespeople know in advance what they will be paid. Also, if payment is based on a flat allowance for a given period of time, the company can budget this expense in advance. People who drive few miles (5,000-10,000 per year) prefer it because they can generally make money under such a plan.
The criticisms of fixed-allowance plans are so severe, however, that we wonder why they remain popular. Generally speaking, the plans are inflexible and may be unfair—some salespeople may benefit, while others lose. The fixed sum for a given time period can be reasonably good only if everyone
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FIGURE 10-6 Example of results of flat-rate-per-mile plan under varying annual mileages
Variable
Payment to
Costs at
Representatives
Annual
Fixed
21 Cents
Total
Per-Mile
at 40.5 Cents
Gain or Loss to
Mileage
Cost
per Mile
Costs
Costs
per Mile
Representatives
10,000
$8,000
$ 2,100
$10,100
1.01
$ 4,050
-$6,050
20,000
8,000
4,200
12,200
.61
8,100
-4,100
30,000
8,000
6,300
14,300
.48
12,150
-2,150
40,000
8,000
8,400
16,400
.41
10,200
-6,200
50,000
8,000
10,500
18,500
.37
20,250
+1,750
travels in a routine fashion and costs are the same in each territory. Similarly, the flat-mileage allowance is equitable only if all reps travel about the same number of miles in the same type of cars under the same operating conditions. These conditions are highly unlikely and unrealistic.
Consider the inequities introduced, for example, by variations in the number of miles driven. In the operation of a car, some costs are fixed regardless of the number of miles driven. Therefore, the greater amount of driving, the more miles over which to amortize the fixed costs. In other words, the fixed costs per mile decrease as the total mileage increases. Under a fixed allowance per mile, every additional mile works to the financial benefit of the sales reps. An example is outlined in Figure 10-6. Assuming annual fixed costs of $8,000, variable costs of 21 cents per mile, and a mileage allowance of 40.5 cents, the results are shown for various annual mileages. A sales representative who drives 10,000 miles per year receives $4,050, when the total costs are $10,100. Thus, the rep’s earnings are reduced by $6,050. At the other extreme, a representative who drives 50,000 miles gets $20,250, which is a gain of $1,750 over actual costs. If the representative were paid a fixed sum per month, similar inequities would result but in reverse. That is, a payment of $400 a month would benefit the low-mileage traveler at the expense of the person who drove many miles in a year.
Flexible-Allowance Plans
To avoid the inherent weaknesses in a fixed-allowance system, companies have developed several flexible-allowance plans.
A graduated-mileage rate plan pays a different allowance per mile depending on the total miles driven in a time period. For example, one firm pays 30 cents a mile for the first 15,000 miles driven in a year and 20 cents for every mile over 15,000. Mileage allowances are graduated downward to reflect the fact that total costs per mile decrease as mileage goes up. Although a graduated plan corrects some of the faults of a flat-rate method, it usually does not consider differences in territorial costs and types of cars.
Under a plan that combines an allowance per time period with a mileage rate, management figures automobile allowances in two parts. Thus, the differences between fixed and variable costs of owning and operating a car are reflected in the payment. To cover fixed costs, the company makes a flat payment for each given time period, such as a week or a month. In addition,
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variable costs are reimbursed by mileage allowances, which usually are flat rates although they could be graduated. For example, one company pays * $500 a month plus 20 cents a mile; another pays $350 a month plus 20 cents
a mile over 750 miles a month.
A widely recognized and respected plan was developed more than 50 years ago by the founder of Runzheimer International, a management consulting firm that specializes in employee mobility issues, headquartered in Rochester, Wisconsin. This company typically divides the United States into several geographic regions and then computes the total annual costs, which include ownership and operating expenses for cars in each of these regions. As an example, Figure 10-7 shows the cost allowances for a midsized car in St. Louis, Missouri, as of May 2006.
In some respects, the Runzheimer plan gives the same results as the graduated mileage system in that the more miles driven, the smaller the per-mile allowance. However, the Runzheimer plan is much more accurate because payments reflect variations in types of cars, miles driven, and territorial operating costs. For a midsized car in 2006, for instance, the annual fixed costs varied from $11,114 in Detroit down to $7,131 in Sioux Falls, South Dakota.12 In summary, a Runzheimer plan seems to be the most equitable and accurate method available for paying salespeople for the use of their cars.
Other Methods of Expense Control
Selling costs loom large in the expenses of most firms. Top executives may worry about the cost of sales force compensation, but they are even more concerned about their reps’ field-selling expenses. At this point we shall note
FIGURE 10-7 Runzheimer Annual Vehicle Costs for a Midsized Four-Door Car in St Louis, Missouri
Annual Fixed Costs
1. Annual vehicle costs $8,600
2. Insurance 1,800
3. License and registration 150
4. Personal property tax 398
5. Total fixed costs 10,948
6. 71.4% of fixed costs 7,816
Operating Costs per Mile
7. Miles per gallon 23
8. Fuel price per gallon $2,118
9. Fuel and oil per mile $0,102
10. Maintenance per mile $0,062
11. Tires per mile $0,020
Standard Cost Reimbursement
A. Fixed cost per month $651.33
B. Operating cost per mile $0,184
Source: Runzheimer International Web site, www.ninzheimer.cora/bvgc/htmlAi8vssprintJitm , March 10,2006
