How to Design A Sales Compensation System That Works
Updated: Dec 5, 2019
High Impact Results Driven Sales Managers invest the time to create well thought out clearly written compensation programs for their salespeople, sales teams and if it applies, a sales manager who also sells.
Many Sales Compensation Programs are well-intentioned but not well designed. Let me share some of what I've learned, in my 25 plus years of experience.
Read on if your current compensation program is not motivating your sales team to produce the expected results
The right compensation program will reduce turnover of your top salespeople and bring about greater sales results from your sales team. Let's take a quick look at the compensation guidelines that can help Results Driven Sales Managers to deliver these desirable outcomes.
Thecompensation plans that work best for a professional salesperson must have a strong incentive factor to bring about the greatest sales results.
Take a quick Quiz
1. True or False: The higher the compensation, the better.
2. True or False: Compensation isn't that important to most salespeople.
3. True or False: Compensation is always relative.
4. True or False: Base salary is usually more important than % of commission.
The answers are False, False, True, and False
How to Create Compensation Programs For Salespeople That Are Not Crappy!
The right-based compensation plan for a professional salesperson must have a strong incentive factor to bring about the greatest sales results.
Consequently, as a Results Driven Sales Manager, you will always want to get your sales professionals to be motivated by the potential of a bonus or commission structure as their primary engine for personal sales results.
The amount of salary versus performance-based commissions and bonuses will vary based in part upon the base salary you need to pay to attract top salespeople.
FACT: Good salespeople will embrace compensation tied to performance!
Top-level performing salespeople are inclined to have a “What's in it for me? Attitude.” If they have no financial incentive for sales performance, they are likely not to be as motivated to achieve their best sales results.
Good salespeople will not be afraid to be compensated in large part based on their sales performance attaining reasonably achievable results. Mediocre salespeople often resist a compensation package in which performance results are important.
Remember the 80/20 Rule
When a mediocre salesperson is given a compensation program that is heavily weighted with performance-based results, it will lead to one of two outcomes, both good. You will find that either the mediocre salesperson rises to the challenge or the salesperson will give you clear evidence that the salesperson should not be working for your organization. This is not a bad tradeoff.
Your challenge is to create a compensation that is heavily weighted towards performance-based incentives. If you build a program that can drive even small improvements to your average sales perfomers or, under-performers the cumulative effect can be huge.
You need to be flexible to change the package if it becomes clear that it needs changing because the quota needed to earn a bonus turns out to be not reasonably attainable
.To be effective, the quota must be realistic yet challenging.
The “50/50 Rule.”
The simplest and most effective approach to this complex subject is what is often called the “50/50 Rule.” The rule is simply that compensation programs for sales professionals will bring about the best sales results if the salary is no more than 50% of the total reasonably expected and reasonably attainable annual compensation.
This type of 50/50 sales compensation program has been successfully working in a broad range of types of organizations and sizes of organizations.
"When the focus and goal are clear - incentives work great."
That condition is certainly in play for incentive programs, contests, rewards, and awards. But are the focus and goal always clear? When salespeople take sales assessments, one of the questions often asked is by how much they exceeded or missed their quota or goal. The data shows that a significant percentage of salespeople don't have a goal or a quota
That condition is certainly in play for new companies and start-ups who are finding their way, finding a market, finding partners, and have no existing revenue stream. A salary is an appropriate way to compensate the first salespeople on board in this scenario.
If we look at the data from the 450,000 salespeople who have been assessed by Objective Management Group, the percentage of findings that show lack of money motivation (especially among higher-income earners) has been increasing each year. It's not that they aren't money-motivated anymore, as much as they aren't as money-motivated as they were earlier in their career when their money-motivation got them to their current income level.
The bottom line for your salespeople is that everyone is different.
Everyone is motivated by different things and for those who are clearly motivated by money, and where you have a clear goal and focus for them, their compensation should and must be commission-based.
When you have people who are motivated more by recognition, awards, competition, time-off, public service, or philanthropy, your compensation program should be flexible enough to compensate them in an appropriate manner too.
Sales Performance Quotas
Many programs provide no bonuses for the salespeople until certain results take place, such as saying that each salesperson has a quota of X number of widgets to sell each month and that bonuses are paid on sales above that amount. Take the time to identify what constitutes the “right” and reasonably attainable target or quota for sales employee performance results in your organization.
The quotas may differ with each salesperson. You may decide to give each of your salespeople a specific quota that connects to past experience of that specific individual salesperson if there is one. If you have no past experience for a salesperson, match the quota to a reasonable sales results directly in line with had been experienced as an average by the salespeople in the department.
The best sales bonus serves to engage and inspire the salesperson to stretch. It may or may not be money. Your salesperson, for example, may respond best to the daily visualization of earning a bonus of a cherry-red Porsche sitting in her driveway.
Determine if your sales quota should be based on arbitrary guidelines that apply the same amount to everyone on the sales team.
Your sales staff compensation package should be tailored individually to your individual company sales staff members to create maximum motivation from them. What is motivating to a high performing salesperson may be so out of reach for another that it is not motivating.
One of the best ways to demotivate a sales team is to establish quotas and then never deviate from them, regardless of whether they turn out to be reasonably achievable. The reason may be because of changes in circumstances such as new competition or downturns in the marketplace.
In such cases that it turns out that the quotas are not reasonably attainable, quotas may need to be revised downward, too. On the other hand, you may need to set more aggressive targets to match changed positive conditions, such as if the economy or marketplace picking up or enhancements in your products or services.
That problem is the biggest reason why it is so important to create an effective compensation plan.
Let's take John, who is being paid a $75,000 base salary and earns commissions of 10% on the revenue generated in the territory. If the territory generates $1 million in sales, John gets $100,000 in commissions, and his total compensation is $175,000. It's also important to note that John spends most of his time on 20 great accounts and has little time left over for the other accounts in the territory, and he no longer prospects for new business.
The company has decided to split the territory, hoping that a new salesperson will hunt for new business, and John will have time to do the same. As part of this change, John will lose 10 accounts, worth $500,000 in revenue, to the new salesperson, and initially, his total comp will be reduced by $50,000! John will not be a happy camper. How could this have been avoided?
First, this is simply an example - one example - and not the only way to create a sales compensation plan. However, this example will illustrate the most important component to be changed.
For the sake of argument, let's assume that the following compensation plan was given to John when he started selling at this company. To make it simple, let's retain John's $75,000 base salary but explain that the salary pays him to manage and service his existing and future accounts. In addition to his base salary, he will earn 20% on the gross profit of new business (first year) he generates with new customers and 20% of the gross profit on the growth of his existing customers.
So if he has $1 million in existing business and grows it by 20% to $1.2 million, and the company's gross profit is 30%, his commission on existing customers is $12,000.
Later, if you decide to take accounts away or reduce the size of the territory, it has a far less significant impact on earnings.
The aim here is to get “buy-in” on sales goals that make sense from your point of view and the perspective of the salesperson. To do this, it is best to create your compensation program, including your quotas, for a salesperson in concert with the salesperson. When you do this, he or she has a personal stake in achieving it.
To some extent, this may involve some level of negotiating between you and the salesperson as to what is reasonably attainable.
Different Approaches To Compensation
1. A compensation approach that is aimed at incentivizing salespeople to reach a minimum amount of sales by not giving any commissions on their sales until their total sales revenue goes over a specified “base” amount.
2. An approach that is aimed at rewarding the best sales performance by giving a bonus to the salesperson on the team who posts sales that are higher than that of anyone else in the sales department. This kind of goal can be particularly effective with highly competitive salespeople who want to be known as best.
3. Create a type of incentive compensation program that is structured to encourage specific behaviors by the salespeople. The following are examples of how specific desired behavior can be encouraged by a compensation program.For example, you might pay your salespeople $1,000 for every new customer they obtain or 15% of upsell and cross-sell revenue.
These plans are easy for reps to grasp which typically drives good results. And because the output is directly tied to salary, reps are usually highly motivated to perform. In addition, you don't have to set a quota — instead, you can set benchmarks or recommendations, but ultimately, you're only compensating reps for what they sell.
However, this structure doesn't take into account market penetration or the number of opportunities. For example, one rep may be getting twice as many leads as their peers, but they'd both be treated equally.
Additionally, you'll need to carefully consider what's best for the overall company when determining the commission. If you're trying to drive the sales of a certain product line, you'll need to compensate reps accordingly (hint: reps will often do whatever is most lucrative for them, regardless of greater business objectives).
The compensation plan can drive the salesperson to push the sale of specific products or services that have higher gross profit-better profit margins than other products or services that they could sell.
4. A type of compensation program that influences the desired behavior to sell particular products that are moving slowly are overstocked merchandise or are last year’s models. A bonus is given for selling this type of merchandise. This bonus sometimes referred to as a “spiff,” is a reward to salespeople for making the kinds of sales you want to generate. The behavior you want your compensation program to influence may be an administrative type behavior that you want to encourage.
5. Some compensation programs encourage signing new accounts by paying a higher commission for brand-new accounts
6. A compensation program that provides financial incentives that reinforce and reward the revenue-producing behaviors that are critical throughout the entire sales process, not just “closing” such as a reward for the salespeople meetings a minimum number of new prospects each month
7. A program that provides incentives for new initiatives and/or new and better ways of doing what has been done
8. Sales Accelerators. A sales accelerator kicks in when one of your reps is hits a specific amount over their quota. This type of payoff is exponential for your reps — they may end up with a huge commission check if they have a highly successful month or quarter (so be aware of your resources and budget). For example, if a rep hits 110% of their quota by the end of the month, you'd pay them 1.0x on their performance above 100%.
9. Sales Decelerators. Sales decelerators have the opposite effect as accelerators — they penalize under-performing reps. A decelerator may kick in between 40% and 60% of their quota. In other words, if a rep only hits 60% of their quota, their performance would be multiplied by a decimal (like 0.5) to calculate their compensation.
10. Clawbacks. A clawback kicks in when a customer churns (i.e. stop using your product or service) prior to hitting a specific benchmark. They cause the rep to lose their commission and are common among subscription companies in an effort to keep customer retention rates high.
11. Sales Performance Incentive Fund or Sales Contests, Sales performance incentive funds (SPIFs), or sales contests are ways to incentivize high performance among your salespeople.These tactics are often used to change behavior and include monetary (such as a $500 cash prize to the first rep who closes 10 deals of a certain product) or non-monetary (a nice dinner for every team that increases their retention rate by the benchmark percentage).
These sales incentives and contests should run for short periods of time — about one to four weeks total. If you run them any longer, reps will lose the necessary sense of urgency for this tactic to work. Also, keep your sales contests limited. The more behaviors you reward, the likelier your team will be pulled into conflicting directions ... making it difficult to drive specific outcomes.
12. Territory Volume Commission Plan. With a territory volume commission plan, sales teams work with prospects and clients in clearly defined regions. Your reps are paid on a territory-wide basis versus individual-sale basis. Once the compensation period is complete, the total sales are split among the reps who worked that territory.
This type of compensation plan is a good fit for team-based sales organizations where each rep works towards a common goal and focuses on a specific territory or region. To attract reps to this type of plan and grow your sales teams, you may offer them an attractive commission paired with a well-developed territory.
How can your compensation reward the behavior you want?
Sales Team Rewards
The focus of this part of this program has been on the sales results of individual salespeople. However, don’t ignore team rewards. Team Contests are a great way to raise personal sales expectations. Team-based incentive programs work best if they can bring about peer pressure within the sales team to earn team-based incentives.
At a team performance review session, the Sales Manager of an organization told the sales team that if all members of the seven-member team reached a (minimum) level of sales for the next month, each member of the team’s would receive a specific very generous bonuses for the month The team members put pressure on each other, particularly the weakest of the salespeople, to be sure that all of them started using the tracking software!
Develop a compelling minimum sales goal that each member of the sales team must hit for the team to get a team bonus.
Compensation For New Sales Employees
It is not reasonable to expect a new salesperson to get top-level sales results while he/she builds up his or her base of business and is learning your system. The compensation program may be different for a new salesperson because it takes a while to get prospects into the pipeline and then to the close.
So, in addition to a base salary, consider a draw versus commission arrangement that will meet living needs and past earning experience, while the new salesperson is getting the needed experience and building a pipeline needed to become a top performer for you.
But note that the draw should be considered only for the beginning period of employment. The draw should be eliminated when sufficient time has taken place for the sales cycles needed to build up a pipeline and start closing sales with those who have gone through the sales cycle of your company.
Be sensitive to the combined base salary and draw needed to meet the expectations of the market of qualified new sales applicants
Compensation For A Sales Manager Who Also Sells
Different considerations need to be in play in the case of a sales manager manage/oversee a small sales team, typically five or fewer people, and who also is responsible for personally generating sales.
Some call this type of position a Hybrid Sales Manager.
The percentage of time doing personal selling versus managing other salespeople varies based on the expectations you have of the Sales Manager.
You will want to come to an understanding with this Hybrid Sales Manager that he or she will be spending a certain predetermined portion of his or her time managing, motivating and training the other members of the sales team. This is the time that the Hybrid Sales Manager will not be able to generate income for him or her self from making personal sales.
Let's say that your target is for your Sales Manager is to spend 25% of his/her available work time managing other members of the sales team, with the balance of his/her time – 75% – going to personal sales/business development activities. In this example, 25% of the Sales Manager's compensation should come in the form of Sales Manager salary and bonuses or commissions tied directly to the team's performance. This may take the form of a salary and draw versus bonuses or commissions tied directly to the Sales Manager's sales team results.
Common Compensation Mistakes
Before leaving this area, let me point out to you the following common compensation-related mistakes you will want to avoid.
The 100% Salary Arrangement Mistake
The most common mistake with salesperson compensation programs is a compensation program that closely resembles a 100% salary arrangement. This is usually a program with both salary and guaranteed non-refundable draw that is unlikely to have the commissions and bonuses exceed the guaranteed amount. If salespeople view the draw against future commissions as guaranteed income, it inevitably tends to reward complacency. This attitude inevitably leads to big problems.
This happened in one technology company had three salespeople who were each compensated with salary and no commissions. The business owner complained about the lack of growth in sales for his salespeople. The business owner was resistant to changing the compensation program but finally was convinced to build in a major performance-based factor while reducing the salary of the sales staff.
As part of the transition to the new compensation program, he guaranteed his salespeople that the combination of salary and commissions for six months would be no less than what each had earned as an average monthly income the previous calendar year. During the six months, there was no improvement in sales. However, in the next year the new compensation program was in effect, there was an increase in sales per salesperson that averaged 40% higher than the previous year.
More Mistakes to Avoid
1. Focusing on longer-term objectives without including short term rewards. Salespeople typically lose interest in long-term commission and bonus systems. Annual incentives are worthless.
2. Having a too generous amount you pay out in sales commissions that your business model does not financially lead your business to make a profit.
3. Not collaborating with the sales team on the compensation plan. Getting their input and buy in is essential to creating and effective program.
4. Bonuses are not attainable by means of actions that are within the control of the salesperson.
5. Bonuses or SPIFS that are not tied to realistic, clearly defined goals
6. Setting KPI's or objectives that are not realistic or achievable.