DESIGNING SALES COMPENSATION PLANS
Your sales compensation plan has a direct impact on growing your business, keeping your
customers satisfied and having a competitive advantage. This article will provide you with
clear steps to designing an effective sales compensation plan for your sales force.
Linking the Compensation Plan to Business Objectives
Understanding the Business Strategy – It’s a good idea to start with a confirmation
of the company’s current business plan. Collect and catalogue any written statements of
financial, product or customer goals. Next, proceed with interviewing senior
management in the business unit under review. These interviews will provide you with a
good understanding of future expectations for corporate objectives. Next, review all the
performance measures in the current plan. This will enable you to assess how well the
current measures are contributing (or not contributing) to desired corporate objectives.
Determine Criteria for Success – Once Business Strategy is identified, you’ll want to
identify specific sales goals. In doing this, first,
Identify which sales goals are most important within the context of your business
Usually, you will use some combination of new customer account growth, overall
revenue growth, gross or net profit, and/or customer satisfaction.
For example, in an attempt to reach new customers, you may find that barriers
to entry in a new market segment may require the addition of distributors or
other new channels to augment existing direct sales staff.
Next, identify a quantitative measure of success. You might target a percentage
of “new sales revenue” that must come from “new channel distribution” sources
without compromising your sales staff’s production capacity.
Finally, check to ensure your success criteria don’t conflict with other sales or
business goals through interviews with sales leadership and key sales
II. Establishing the Compensation Plan Design Team
Cross Functional Approach - Key members from Sales, Marketing, Finance, Human
Resources and Information Technology all contribute to designing an effective sales
compensation plan. Be sure to include all known opinion leaders to ensure buy-in.
Rules of Engagement – At the initial design meeting, the rules of engagement should
be discussed and finalized. The rules of engagement are behavioral operating
boundaries and serve to keep the team focused on the charter’s objective during periods
of conflict or as project deadlines loom. For example, before a major phase of the
design can be completed, rules of engagement should include a rule that will determine
what decisions require executive sponsor approval and what authority rests solely with
the design team.
For more detail on cross functional team design and engagement rules, you can refer to:
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III. Assessing Existing Plan (Assuming existing plan exists)
Measuring Plan Objectives to Actual Outcomes - First, compare forward-looking
statements of performance goals for individuals and the firm (e.g., Sales Forecasts for
the upcoming period, Sales Incentive Scorecards from Sales Leadership, and Quota
statements for leading sales reps) to actual sales performance. Next, compare actual
sales compensation to actual sales volume to ensure there is a strong positive
Achievement of Payout Objectives - is another way to see if the “payout levels” have
been reached to the desired extent. To measure this, many companies compare the
“distribution” of sales incentives to the “percentage of quota” achieved by the sales reps
in question. Typically, two-thirds of your sales reps would be expected to achieve quota,
with a fraction of that group exceeding quota. If 90% of your sales rep achieve quota,
and 50% exceed quota, you may find that sales achievement expectations are too low.
Reaction of the Sales Force - Although it is not recommended that you include the
sales force in the design team, you should interview key sales reps for their opinions on
such issues as, efficiency of interaction with internal sales operations team or product
management staff, how the “actual” sales role compares to the design, and so on.
Feedback from these interviews will give you very important data on how the real
experience of your sales force compares to the sales program design, and if any
modifications should be considered before moving on to the new design phase.
IV. Designing the New Plan
After Phases I to III are complete, you can begin designing the new plan. Essential
components include: New Plan Objectives, Sales Job Definition and Plan Design
New Plan Objectives – After reviewing your firm’s business strategy and new sales
goals, write a short summary statement that explains the plan’s linkage to the company
strategy as well as a summary of the plan’s objectives and guiding principles. A guiding
principle may include the following statement: “exceeding the performance standards
will set the basis for recognizing excellence in sales achievement”. Stretch goals are
built into the performance expectations of the compensation plan. Therefore, sales reps
can expect to be rewarded above the industry average for outstanding accomplishments.
Define Sales Role(s) – Write a job description that incorporates each role’s basic
purpose, essential sales functions, and job requirements for successful selling. The job
description should identify how much (if any) activity is dedicated to: 1) Customer
Identification, 2) Customer Persuasion To Buy and 3) Customer Service.
Design of Plan Elements -
Eligibility should be determined first, and restricted to sales employees who directly
influence customer decisions to place sales orders with your firm. To ensure the
right sales employees are in the plan, you should assign responsibility to evaluate
proposals for new plan participants while periodically (annually) reviewing
participation levels to an impartial group (e.g., HR).
The next step is to determine the “absolute level” of pay per sales role or Total
Target Compensation. Total Target Compensation is based on comparing
minimum, target and above target pay levels for incentives as well as base salary
with your peer companies using external market data on comparable sales positions
in other organizations. Typically, you should match internal job descriptions with
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Design of Plan Elements (Cont’d)
available market based descriptions in order to set desired pay levels according to 3
competing factors: 1) Budget (How much can the firm afford to allocate for TTC), 2)
Internal Equity (relative value of each job to achievement of firm’s sales goals) and
3) Market Data (external competitiveness desired to attract and retain sales talent).
The following prominent consulting firms provide sales compensation surveys for
purchase or on a participation-only basis:
Next, you should determine the desired Compensation Mix and Leverage. The
“mix” is the split of Target Total Cash into 2 components: base salary and target
incentive (commission or bonus). It is important that this step comes after sales job
design because the level of “Customer Persuasion To Buy” in each sales role (See
Define Sales Role above) is directly linked to its mix of incentive pay and base salary
The “Leverage” equals the target upside earnings potential one can earn for sales
results that dramatically exceed the target performance level. The most common
leverage is 3x target incentive. The ratio of individual sales performance (which
performance?) to a given leverage multiple depends on the difficulty of exceeding
sales target. Mix and Leverage can be adjusted after initial performance outcomes
are analyzed to ensure pay levels are in line with desired performance, cost of sales
and external market benchmarks.
Next, select and weight your Performance Measures. You should select 3 or
fewer measures for your plan. Weight the measures depending on their respective
importance to the current period’s overall business goals. Almost all sales incentive
plans have some form of sales revenue measure, with a profit measure included only
if the sales person has some control over pricing negotiation with the customer.
Performance measures will be closely tied to the company’s objectives for what they
want to accomplish in this sales year.
Finally, construct the Sales Incentive Formula based on the target incentive value,
target performance value and leverage multiple. A typical commission formula is
constructed as follows: target incentive / target performance = commission rate.
For example, if the target incentive is $50,000 and the target performance is
$1,000,000, then the “commission rate” would be .05%. Each sale would generate a
commission of .05% of the sales order value for the sales rep. The actual sales
incentive formula should reflect the unique business financial metrics of your
company’s product or service
Other potential Plan Features include Maximums, Minimums/Thresholds,
Accelerators and SPIF’s. Using a Maximum or Cap on incentive pay is used by
companies to preclude excessive earnings for unexpected, large orders not obtained
through the sales rep’s efforts. A related design principle, so-called Performance
Thresholds - are used to avoid paying for the same sales in recurring years.
Thresholds (minimums) are set at or above the sales forecast level that is considered
recurring revenue. Thresholds also serve as performance messages from
management as to the minimum level of achievement expected and can weed out
underachievers. Accelerators are often used when cross selling or up selling are
desired. Finally, a SPIF is a special performance incentive fund (in addition to the
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normal incentive) that is used for motivating sales reps to overcome a sales
downturn or sell a new product.
This article summarizes standard concepts as well as the necessary process steps you’ll
need to design a sales incentive plan for your firm. Each firm, however, is different, and
you may want to consult with a sales compensation consulting firm that can help you
further align your design with corporate goals and organizational culture.
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