What does a Good Sales Compensation Plan look like?

Sales compensation is a topic that always grabs people's attention.  We get called all the time by CEOs and Owners wanting us to help them design a sales comp plan that will help them "motivate sales people" and drive sales.   When I say "sales comp plan" I also mean "commission plan, "bonus plan" or "incentive plan."   There are probably 1,000 ways to design these comp plans.  Should you use commissions or bonuses?  Do you pay from dollar one or make them hit some percentage of goal before you start paying them?  When do pay them – upon invoice or upon collection?   For recurring revenue (like a sold a subscription to a SaaS service), for how long do they get paid?  Forever?  There are so many variables, that it makes your head spin.

Regardless, a comp plan should be aligned with the company strategy and should give the sales person direction as to where to spend their time.  So how do you design a comp plan that will do all those things?  Here are a few simple steps:

  • Start by deciding how much the sales person should make if he or she is at 100% of their goal.  That assumes that they have a goal and the goal is reasonable and aligned with what the company needs.  The goal is commonly set around:
    • Revenue – this is common if the sales person does not control pricing/margin
    • Gross Margin Dollars – common if the rep does have pricing/margin control
    • Growth – common for sales people with a book of business that is expected to grow year over year (target could be 20% growth and could be expressed in Revenue dollars, Gross Margin Dollars or even as a Percentage Growth)

I am continually surprised around how many companies don’t have goals for their sales people.   In our opinion, it’s a must.  For this example, let’s use a round number – let’s say that “at goal” a sales person should make $100,000 and we are setting our goal at $2M in revenue.  This a great starting point.

  • Next, subtract out his/her base pay.  What should the base pay be?  Good question.   That varies by industry, role, whether they are inside or in the field, by their years of experience, your philosophy (do you want to be on the top of the market to get the best talent, in the middle, or as low as you can be), and probably a dozen other items.  The biggest driver is probably “What the market will bear.”  So, in this example, let’s say the market dictates a base pay of $60,000.   That means we have $40,000 to play with in Variable Pay.
  • We will divide up this variable pay number to align with company strategy and goals.  Think about where you want the sales person to focus their time and effort.  For instance, if the company needs to diversify its client base and needs new clients, then we probably want to emphasize new client revenue over existing client revenue.  If the goal is current customer growth, then we align accordingly.  Other common factors to focus on include goals around market focus, product focus, target account focus, etc.   Determine where you want the sales people to spend time.  Our example might look something like this:
    • 75% of their time on New Clients
    • 25% on Existing Clients
  • Apply our focus to the comp plan.  This can be simple math.   Of the variable pay ($40K), we determined that we want the rep spending 3x more of their time and effort on New Clients vs. Existing. Therefore, the commission rate should be 3x for new. In our example, this could look like 3% commission rate on new accounts (need to define specifically what counts as new) and 1% on existing accounts.

Alternatively, we could apply this same math with bonuses as opposed to commissions (when they reach $1M in new business, they get a bonus of $30K). Or apply the same math to quarterly pay rather than annual pay (bonus of $7500 per quarter if they get $250K in new revenue), or mix and match commissions and bonuses. Now you can see how the possibilities are endless.

The ultimate goal of this approach is that you are aligning a company focus with the comp plan and using revenue goals and total comp goals as a starting point to determine the mechanics.  Here are some other best practices when it comes to designing sales comp plans:

  • Keep it simple – a sales person should be able to pick up the comp plan and immediately know what makes them the most money.  In our example above, they get paid 3% on new and 1% on existing.  This is very clear to most sales people that they should be more focused on new clients.
  • Don’t default to paying the same commission rate on all sales – there is a trend in the market that companies pay a much lower commission rate on sales until a certain threshold is reached   (some don’t pay ANY commission until you reach a certain percentage of goal or quota).  The thinking is this – if a sales person isn’t selling much, they are probably not even covering his/her base pay.  Why would you pay them more money in the form of commission or bonuses on top of that?   Calculate the breakeven point (how much do they need to sell to cover their own direct expense) and then start paying a larger commission rate after that.  Common thresholds to start ramp up commission rates are around 70%-80% of goal.
  • Review the comp plan every year.  Determine if it is driving the desired behaviors.
  • Set the expectation that the plans will change.  A comp plan is in place to drive a certain result for a certain period of time. Make sure the plan changes as the company’s goals and strategy changes so they stay in alignment.
  • Evaluate the goals you set every year.  Make sure they are realistic and align with company goals.

This brief article is just a drop in the bucket for all the different ways that compensation can be designed.  Our intent is that it gives you some different things to think about as you design your next plan.  If this is “clear as mud” to you and you want to learn more, please contact us.  We would love to help.

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