Sales Compensation Planning

By:  Bob De Contreras

Last month we talked about the various growth phases of companies and how management needs to make decisions differently in each phase.  This month we talk about sales compensation planning required as a company grows from start-up to the first growth phase.  This is after the company has gotten initial sales traction and is now adding management and staff. A sales organization is being implemented or expanded with sales management and a sales team. In this article we will explore some examples to consider in setting your sales compensation plan, mistakes common in sales compensation plans and overview the basic steps taken to implement an effective sales compensation plan.  This article is part of a series focused on the need to vary the management approach in the different phases of company growth.

 The first step in sales compensation planning is setting the objectives of the plan.  Ask yourself: 

• Based on your overall cost and expense structure, what funding is available for sales compensation?

• How much is the total compensation for each position – base salary and commissions?

• What are the sales goals – revenue, new customers, existing customer order growth, expansion into new markets, etc.?

• What sales behavior do you want to motivate?

• What is the ratio between base salary and commission payments to total compensation?

 Some structural issues of the plan that should be considered: 

• Will it scale?

• Should sales commissions be caped or unlimited?

• How will sales management be compensated?

• What is the timing of the payout, relative to the sale/invoice?

• What is the appeals process?

 Some of the common mistakes companies make when implementing a sales compensation plan include: 

• Commission/bonus payout is not based on revenue, margin or overall cost and expense structure.

• The base salary is too large a percentage of the total compensation, so the sales team is not incented to sell.

• The sales compensation plan is a legal contract that can’t be changed without due process.

• The sales compensation plan does not provide the incentive for the right behavior.

• The accelerated commission/bonus paid for attainment after exceeding goal is set too high.

• There are too many components or measurements in the compensation plan.  It’s too complex for the sales people to understand.

• The compensation plan is designed by the sales manager/executive who has little or no experience in developing sales compensation plans.

• The time limits for commission payments are not specified.

• The type of revenue (i.e., product, services, maintenance, royalties) for which commissions are paid is not clear.

 Developing an effective compensation plan requires a thorough and accurate understanding of the objectives, limitations, and needs of the company to avoid problems and financial liability. Let’s look at an overview of the steps in developing your sales compensation plan.

 Total Compensation – an important step is determining the typical total compensation for each of your sales positions based on your product or service price and the yearly sales goal for each sales position.  Industry salary data can be used to determine this number. 

 Base Salary – Determine the base salary percent of total compensation.  Base salary is typically 50% to 60% of total compensation, but there are wide variances.   The base salary as well as total compensation must fit within your overall cost and expense structure.  In some large companies and/or short sell cycle situations, commission can be as much as 200% of base salary.  In these cases base salaries are set much lower than in the typical case.

 Establishing Affordability – based on the expected productivity of your sales people and the revenue goals for the year, determine how many sales people are needed. Then calculate the total expense for these people within your overall expenses for the year. This becomes the overall amount of money you can spend on sales people, including commissions, and will be the basis for quota setting.

 Sales Quota – One of the most difficult numbers to decide is the sales goal or sales quota.  Without a sales quota company objectives and company sales growth with not occur.  Often we talk about “stretch” goals. This is setting the sales quota higher than the expected attainment of the sales people.  Sales quota setting will be the focus of a future Paladin and Associates newsletter.    

 Sales Commission – Another base rule of thumb is that the sales commission at 100% sales quota attainment should be set to the estimated total compensation minus base salary.  When this number is calculated the company needs to confirm that it can afford this compensation amount, along with any commission for over attainment, within the overall cost and expense structure of the company. 

 Over Attainment Commissions – Sales compensation plans typically increase the commission rate at attainment beyond the sales quota to provide an incentive for continued sales growth.  The right number is determined based on what is affordable by the company within the overall cost and expense structure.  Doubling the rate is aggressive.  Increasing the rate by 25% is more typical. 

 Management Commissions – Should be tied to the attainment of the sales team the manager manages.  Since the sales person and the sales manager both get paid a commission on the same sales, the company needs to be sure that this is affordable within cost and expense structure of the company.  This does not imply that the manager and sales person commissions are the same amount.  The manager may have a higher base salary and lower commissions.

 In Summary – your sales compensation plan must be affordable by the company, be capable of achieving the company’s goals, be a motivational tool and drive the correct sales team behavior, reflect the total compensation you will pay each sales person who attains quota, and stand up to rigorous testing of various combinations of possible outcomes.  If you need help with the details and methodologies in developing a sales compensation plan or improving your existing plan, please contact Paladin and Associates.

Sales Compensation Planning Case Study

By: Bob De Contreras

 One of our clients asked us for help on his sales and compensation plan.  He wanted the plan to drive and motivate his sales team to meet certain company targets.  Specifically, product revenue growth, new client growth, growth in existing clients, and growth in consulting services revenues.  The company’s existing sales compensation plan was very simple because they were a start-up company who had just found sales traction and was entering the first growth phase. The sales compensation was simply 10% of gross product revenue.  The company had three sales people – the CEO and two sales representatives.  The company revenue last fiscal year was 2.5 million dollars.  The CEO was selling about 1 million and the sales team sold the other 1.5 million dollars.

 Our discussion went something like the following.

 We asked, “So, you are paying out about $150,000 in commissions – that’s $75,000 to each sales rep.  You said the base salary for each sales rep is $50,000.  That works out to be about $125,000 total compensation per sales rep.”  We asked our client how much he wanted to pay as total compensation to each sales rep and he said, “No more than $100,000.”

 We discussed if paying out $250,000 in commissions was affordable to the company.  Our client said no and asked why we were asking.  We replied, “Because if you start doing the CEO job and have to hire one or two more sales people to do the selling that you are personally doing today, that’s what the commissions are going to cost at 10% commissions.”

We talked about how the services sales were getting made today and he said that the consultants are doing their own selling and that he (the CEO) was doing the services sales.  He said that he needed the sales team to sell services, because he needed their sales skills to drive more services sales.  We asked if his cost and expense structure could support paying commissions for services sales if more services revenues were being made.  He said yes, and that they had already looked at the numbers.

 We wanted to know how many new clients they needed to sign on in the next year.  He said that to meet their growth plan, that they estimated that they needed to grow their customer base from 300 to over 400.  He added that their assumptions on being able to pay services sales commissions were based on this larger customer base.

 After discussing the above and a few more things we worked together to build a new sales compensation plan.  The sales and compensation plan we put together looked something like the following:

Things to note about the new sales compensation plan: 

• Higher company revenue objective

• Revenue objective uplifted to give a “stretch” sales quota

• Reduced commission payout percent of revenue

• Commission payout is on a sliding scale to motivate higher attainment

• Total compensation target reduced from $125,00 to $113,500 (total of all components of the sales compensation plan)

• Commission payout percentage accelerates after achieving 100% quota

• New quota on services sales paid at a flat 3% of services revenue

• New quota on selling new accounts paid on an increasing straight line dollar payout

 The new plan is moving toward the objective of $100,000 total compensation for the sales representatives; sales representatives are motivated to sell services and new accounts; sales representatives are challenged to attain a higher sales revenue on products and services; sales representatives can achieve the prior $125,000 total compensation by achieving only a small attainment over 100% quota.  This plan is a transitional plan and will change again next year by moving to the $100,000 total compensation goal, adding more granularity in the services commissions and tuning the goals based on experience this year.

 In summary, your perspective on the sales compensation plan above may be that it looks complex or easy, comprehensive or simplistic.  Every plan must be tailored to the company and the way the CEO runs the business.  Contact Paladin and Associates if you need help with the details on building your new sales compensation plan or an update to an existing plan.

Brought to you by:                                                         [BACK]

            Bob De Contreras                                                  
            Rich Kramarik