Sales compensation plan design and communication of plans should reward the sales force for the demonstration of desired behaviors and achievement of results in alignment with an organization’s sales strategy.
1.Setting Total Target Compensation (TTC)/On-Target Earnings (OTE) for Sellers
TTC/OTE is the annual amount the seller can make if they meet all goals/quotas.
- Companies determine whether target amounts should vary by sellers in the same job based on territory/revenue responsibility, time with the company, e.g., adding merit to an individual seller’s base salaries over the years, or paying all sellers the same base salary. Note: under some state pay equity laws, companies may need to be able to demonstrate why certain sellers receive higher payouts than others.
- When there are multiple measures, the measures are weighted to be consistent with what is important to achieving the company’s sales strategy and over what the seller has control.
- Setting and communicating TTC/OTE opportunity should enable the company to attract and retain the talent who demonstrate the desired behaviors and results needed to achieve the sales strategy.
2. Determining the Incentive Percent of TTC/OTE
Incentive Percent of TTC/OTE is commonly known as the mix of base and incentive.
- Identify those roles that are sales incentive eligible based on their responsibility in the selling process and consistent with the degree of sales persuasion:
- Seller Roles – Account Executive, Sales Engineer, Business Development Manager, Sales Development Representative, Account Manager, Outbound Sales Representative, Channel Sales Manager, Product/Overlay Specialist
- Non-Seller Roles – Customer Success Manager, Inbound Sales Representative, Marketing and Customer Service
- Variables that impact the percent of incentive are level of influence of sales, size of opportunity, number of customers, complexity of sale, time to complete sales.
- The typical range of incentives is from Total Incentive (0% base/100% commission) to Limited Incentive (90% base/10% incentive).
3. Identifying the Right Incentive Measures for Your Organization
- Sales incentive measures should be selected based on the company’s sales strategy, e.g., encourage profitable growth in new accounts and customer retention and expansion in existing accounts.
- The seller must be able to influence and/or have direct control over the measures being incentivized in their plan. In our experience, most organizations use less than three measures and more than three can be counterproductive.
- Revenue is the most used performance measure followed by bookings and gross profit for all individual seller types.
- In our experience, profit-driven measures are more effective at the management level than for individual seller roles.
- Activity measures should be avoided (or limited) in the payment of any sales incentive plans.
4. The Reasons to Use of Individual versus Team Measures
- Individual measures are when the seller is solely responsible for the achievement of their goals/quotas, while team measures could include a broader group of sellers partnering with another seller role, reporting to the same manager, a region, business unit/company level.
- In the purist sense, team measures should be avoided for most hunter roles; however, when they are included, it is usually for their direct manager’s team, and less likely at the regional or business unit/company level.
- Typically, the weighting of team measures should be significantly less than any individual measures in a plan.
- For account management roles and hybrid roles (combined hunter/farmer), the direct team measures are more common, and less at the region or business unit/company level, this mix may also be found with outbound inside sales roles too.
- Sales management roles are generally paid based on their team’s results, and some many also have some form of company results.
5. Making the Right Commission Rate Determination
- There are a variety of ways to determine the basis for the commission calculation:
- Percent of Sales without recognition of achievement level, product, or new or existing customer; these need to be combined with quotas for the seller to understand their target total compensation.
- Level of Achievement where the commission rate accelerates as achievement of quota increases.
- Commission by Product differentiates rates to encourage some products (usually more profitable or strategic) more than others; usually combined with level of achievement.
- Higher commission rates for New Customers vs Existing Customers to recognize the effort to obtain new customers (new/new) versus selling within existing customers (new/current); depending on the sales strategy, new/existing may be recognized at the same level if there is new product expansion or customer area expansion.
- Achieving desired Contract Length are also often recognized with additional commission or higher commission rate.
- Commission calculations can combine rate types, e.g., level of achievement and product type, to accommodate different quotas.
6. Understanding Incentive Payout Frequency Factors
- The frequency of paying sellers depends on many factors, e.g., contract terms, but in most cases, it is important to pay the seller as soon as the sale can be measured and paid.
- The amount of the incentive as a percent of TTC/OTE will impact the payout frequency; if the sales incentive is only 10% of their target total compensation, it is best to pay quarterly or annually, because the payout is too small after taxes are withheld. Otherwise, it is common to pay monthly if the target is at least 20% or more of TTC/OTE.
- The sales cycle will also influence frequency; short transactional sales are paid earlier than long sales cycles or multi-year contracts. In these cases, there are ways to structure commissions and bonuses to recognize when the sale is made with a payment and make installment payments when revenue is recognized over 12 months or more. The variety of timing payments are made include paying full amount up front; paying a portion up front, then remainder over time; paying over span of contract; paying on case-by-case basis
- The frequency of pay to the individual seller roles will vary based on the mix of base and incentive, but most commonly either monthly or quarterly.
7. Understanding Quota Setting Frequency
- In our experience, most organizations set quotas with annual quotas still being more prevalent.
- There is a trend to move to quarterly due to the volatile nature of the market and economy versus making mid-cycle adjustments to quotas during the year.
- The benefits of an annual sales cycle include alignment with annual business plans, not overpaying for inconsistent quarterly results, or having to use “hold backs”, which may not comply with some state laws and could be seen as a disincentive.
- Quarterly commission calculations against quarterly quotas can be balanced through annual true ups, cumulative commission payments, limited upside opportunity each quarter, or establishing a 5th quarter or annual performance measure to avoid overpayment.
8. Selecting the Incentive Mechanisms that Will Drive Performance
There are a variety of ways to use commissions and bonuses in designing sales incentives.
- Commission is a percent of the revenue or profit; commission plan designs are prevalent in most organizations.
- Bonus can be paid either as a percent of the base salary or percent of commissions earned as a reward for individual commission-based performance.
- Accelerators (or decelerators) can be used in both commission and bonus when the decision is made to pay a higher (or lower) rate for incrementally better (or below target) performance.
- Commission Tiers are various levels of commission rates aligned with quota/goals, usually paying less for underachievement of quota and/or more for achievement or overachievement; in our experience, three or more tiers are most effective.
- Multipliers can be used to increase (or sometime decrease) incentive earnings; after earnings from all measures are calculated, multipliers are recognizing an additional measure, e.g., individual earnings are multiplied by 10% if the sales team achieves its goals for the performance period.
- Caps can be demotivating to sellers but are often necessary to protect the company from windfalls; most individual contributor plans and management plans do not have caps. Instead, they have windfall clauses in the plans. In the case of windfall earnings, calculating the payout on a case-by-case basis versus limiting earnings on a per transaction basis. There are two types of caps: (1) maximum payout opportunity for an individual deal or for annual earnings, or (2) soft caps where at a certain point of achievement, the commission rate is reduced to the lowest rate.
- Minimums or thresholds can also be demotivating compared to plans that pay at the first sale (dollar one); most plans do not have minimums for individual sellers and management; in our experience thresholds are most common with revenue measures, where margins are low and therefore require minimum revenue achievement to earn any incentive payment. Thresholds and caps/maximums are more common for bonus than commission mechanisms.
- Leverage is the amount a seller can earn for achieving exceptional results, usually calculated as a multiple of the target measure. Leverage should be based on providing meaningful earnings opportunity for overachievement, typically 2 to 4 times the target incentive.
- SPIFFs can provide short-term programs rewarding only sellers for ad-hoc sales promotions. It is paid in addition to sales commissions and is intended to promote additional focus on specific sales objectives to encourage immediate results. The survey reports that 50% of organizations surveys spend less than 2% of the sales incentive budget on SPIFFS.
9. Ensuring Communication and Documentation is Given Needed Attention
- The best designed sales incentives can yield poor results if not documented and communicated in an engaging manner to the salesforce.
- Effective communication tools consist of summary plan description, calculators or online SPM (sales performance management) applications, overview presentations and individual meetings with management.
- In addition, the expectations of each sales role should be documented in job descriptions and in each seller’s employee performance review.
10. Aligning Sales Strategy with Performance Measures
- In summary, all features and components of sales incentive plan design reflect and support the sales strategy achievement through reinforcing desired behaviors and rewarding results with the right amount of a seller’s incentive compensation aligned to those results.
- The most effective quota setting approaches are a hybrid of top down and bottom up with the sales quotas/goals being both challenging and achievable.
- In setting quotas, consider that challenging and achievable quotas will yield a 60% probability of achieving quota, an 80% probability of achieving a minimum level of acceptable performance, and a 20% probability of achieving exceptional results. In our experience, individual seller plans set exceptional performance levels between 125% and 150% of quota and acceptable performance levels at 75% of target quota. For management, this range is much tighter, 90% at the acceptable level and 110% at the exceptional level, depending on the number of sellers on their team.
- In our experience, companies that test the distribution of the prior year can use the information to determine commission rate tiers for the new year.
- In considering the possibilities of the measures, mechanisms and plan features described in these Ten Fundamentals, the sales incentive plan should be simple (not simplistic) and well understood.
Wilson Group looks forward to partnering with you to address your sales incentive design needs. A typical scope includes:
- Assessment of the effectiveness of the current plan designs relative to the business strategy.
- Design of the incentive plans for each of your unique sales roles, including payout opportunity relative to performance, measures, incentive mechanisms (commission/bonus) and the impact of the changes.
- Development of finalized models in Excel that will enable the company to communicate, implement and administer the plans, or a referral to a Sales Performance Management (SPM) solution to automate and improve accuracy for your documentation, communication, and payment to your sales force.