Sales Compensation 101

Sales Compensation 101

Article Highlights

    Sales Comp 101: Goals & Objectives in designing sales compensation plans

    Sales compensation and especially compensation plan design is one of those topics where there’s no shortage of opinions.  Everyone involved seems to have some thoughts in how it should be done.  The end result is often a plan that tries to satisfy the feedback from many but fails to deliver on what it should be.  Before getting too deep right away with Sales Compensation, here are some of the basic elements of a compensation plan.

    Sales Comp Basics and Definitions

    • Base salary: Defined as the salary paid, not including benefits, bonuses, or variable compensation. 
    • Variable compensation: Any combination of commissions (variable payments based on sales performance), bonuses (one-time payments for achieving specific criteria), or other incentives such as club.
    • Total Compensation: Often referred to OTE or On Target Earnings
    • Pay mix: Ratio of Base to Variable comp.  For example, a 50/50 Pay Mix is a comp plan that is split between half base and half commissions/bonuses. 
    • Variable Commission Rate: Sometimes referred to as base rate.  In a rate-based plan, the variable commission rate is calculated by dividing the On Target Commissions (OTC) by the quota.  If the quota is $1M and the OTC $75K, the commission rate is 7.5%.
    • SPIF: Sales Performance Incentive Funds are separately funded initiatives outside of a comp plan to reward specific behaviors.

    Goals of a Comp Plan

    So what is the goal of a comp plan?  What principles should one follow? There are many different types of comp plans, some varying by industry.  However, here are five rules of comp that I follow universally in the over 20 years of designing and delivering comp. I live by these as best in class that plans should adhere:

    • Alignment to Corporate Goals: Comp plans must be in sync with the strategic goals of the company to ensure everyone is rowing in the same direction. This will help alleviate a case where an executive questions the behavior of a sales rep in why they acted or sold a certain way. Reps will sell what is in their best interests as incented by the comp plan, as in comp drives behavior. One of the first places to check is their comp plan to access why.
    • Motivational: This is the heartbeat of any comp plan. The sales team should be fired up and continually driven to perform. Best in class reps are driven individuals who want to be on top. The comp plan is their fuel.
    • Simple: Pick two or three of the most important goals so that the Reps can quickly see what the plan is asking. If you can’t spot the 2-3 goals within 1-2 minutes of looking at a comp plan, the plan is too complicated. Keep it simple. Too many goals will dilute the financial impact of elements in the plan.
    • Administrable: Commissions teams need to be able to process the comp plan and efficiently administer commission payments. Overly complex plans invite errors that can end up as under/over payments. The last thing one needs is for salespeople to become shadow accountants. Their time is far too valuable – commission statements and payment must be transparent and accurate. It is also essential for commissions to fit within budget set forward for comp. This should be done within the sales motion of the business, be it monthly or quarterly.
    • Not a replacement for Sales Management 101: Along with #3 above, this is the biggest culprit in designing best in class comp plans. Too often sales management wants to include elements that either prevent or encourage certain behaviors. Forecasting accuracy is a common example. While no one disputes the importance of being able to accurately forecast, it doesn’t belong inside a comp plan. The best place to address this is within the framework of forecast reviews during the month & quarter. Managers should be coaching their team and asking why an opportunity might have an aggressive close date or amount. “Help me understand the June close date in SFDC?” The terms “happy ears” or “sandbaggers” are both detrimental behaviors. CFO’s don’t like surprises. Hence ongoing forecast inspection and coaching are paramount, not a rule tucked away in a comp plan.

    Best Practices for Pay Mix

    Sales Representatives:  Pay mix can vary from 100% variable (no base) to Base with only bonus structure.  Most commonly in technology sales which is the focus of the rest of this article, best practice is a 50/50 mix or 40/60 (40% base, 60% commissions).  You want a Rep to have some base to lessen risk but not be comfortable living solely on it.   A hungry Rep is a proactive, aggressive Rep.  

    Sales Managers:  60/40.  A slightly higher base than variable provides some insurance should the manager experience turnover.

    Sales Engineers:  80/20 mix.  By definition, Sales Engineers are not risk takers and they rely on others to achieve goals.  So don’t give them a sales rep comp plan that is more heavily geared toward commissions. 

    Variable Commission Rates

    There are different ways to structure commission rates. Having a 10:1 ratio of quota to OTE is a good rule of thumb. A $1.5M quota and OTC $75K in a 50/50 mix is a 10:1 ratio.

    Using this example:

    • Flat rate.  Commissions payout a flat rate from 0-100% of quota. Rate would be 5.0% for all deals up to 100% of quota.
    • Stair-stepped rates.  Commission tiers (stair-steps) from 0-100% of quota such as the one below.  This plan has further motivation for the Rep to graduate through the tiers as quickly as possible. The payout curve becomes more steep for each tier.
      • Tier 1:  3.3% for 0-30% of Quota
      • Tier 2:  5.0% for 30-70% of Quota
      • Tier 3:  6.7% for 70-100% of Quota
    • Accelerator rate(s):  Accelerators are applied to the 5% base rate in our example after hitting 100% of quota.  It’s important to reward the Rep to keep on selling once making quota, thereby making more commissions paid at a higher rate.  For example, payout at 1.8x after 100% of quota (1.8 x 5.0% = 9%).  Some plans might have two accelerators after 100%.  This also helps eliminate the behavior of shutting down and saving deal(s) until the next fiscal year. 
      • Tier 4:  9.0% for 100-130% of Quota (1.8x accelerator)
      • Tier 5:  13% for >130% of Quota (2.5x accelerator)
    • Another key aspect to the accelerator design is talent recruitment and retention.  Top performing Reps look for commission rates above quota, as they are used to making their number and expect to earn higher rates once over 100%. An attractive accelerator and especially two tiers above 100% is enticing to new recruits and retain top performers.

    Other Incentives

    There are other incentives that can be part of a comp plan, providing it makes strategic sense and fits in the budget. 

    Two examples are:

    • President’s Club: Most commonly an annual reward trip for the high achievers.  All Reps want to make Club every year (so does their significant other!).  Having the requirements in the comp plan is a straightforward and up-front way to communicate.  Details about the trip can be announced at a later date.  
    • Bonuses: Some companies want to emphasize certain milestones such as hitting quarterly objectives and/or annual achievement as a one-time payout.

    Conclusion

    When it comes time to distribute, recognize the phases that a Rep goes through upon receiving a new comp plan:

    • Skeptical.  Don’t be surprised if the initial reaction is “what is the company taking away from me that I had the previous year?”.  
    • Comparing both plans side by side and vetting the negative
    • Understanding what I am getting in the new plan that I didn’t have before 
    • As the final step – how can I “beat the plan” and make a lot of money?

    It is recommended to be upfront and communicate the plan differences.  Schedule a zoom meeting or see if you can get a time slot on one of the weekly sales staff meetings.  The key is to answer all questions right away so they understand the plan, sign and return it, and get back to selling.  You don’t want this to linger.

    Comp drives behavior and therefore it’s important to have the sales team well motivated to obtain results that align to the strategic goals of the company.  Assuming quotas were designed appropriately and cover the company number, then having Reps earning accelerators should be a good thing because the company is also having a good year. 

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