An Excercise in Sales Compensation Design

September 23, 2011

1:07 pm

In Daniel Pink’s, book “Drive.” he explores a new motivational system for business–one based on autonomy, mastery and purpose.  It is a brilliant book filled with brilliant concepts on system for right-brain conceptual workers.  Sorry, I’m a sales guy at heart, so I can say this:  we sales folk are left-brained, show-me-the-money, greedy pirates, and the old motivators of doubloons and treasure are still the reason we fly the old Jolly Roger.

So what are the basic concepts of a well-designed sales compensation plan?  The goals of the plan should align with the revenue, profit, customer acquisition and strategic marketing plans of the company.  Simple plans that just pay on revenue or profit usually fall short on motivating critical behaviors necessary for carrying out the growth strategy of a company.  However, complicated plans create find-the-loop-hole challenges that a crafty salesperson worth their weight in booty will exploit.

From the moment your compensation plan is released, your sales force will study the plan, like pirates studying a treasure map.  Remember the mortgage meltdown, caused by misaligned compensation plans?  These plans incentivized the sale of new mortgages no matter the credit-worthiness of the mortgagee and rewarded harmful behavior.  Do credit default swaps ring a bell? Bad incentive plans and greed lead to disaster.  You’re never going to be able to eliminate greed, and in fact, greed in a sales person is a good thing.  An ingenious comp plan exploits greed and is not exploited by it.

Evaluate your company’s growth and sales goals.  Create a plan that motivates behavior to achieve your company’s strategic goals, and then run through the “what-if” use-cases to insure that you haven’t created the next major downturn in the economy.

Just a few questions I ask when designing a compensation plan:

  1. What is your industry paying? What is the total compensation plan (when a sales rep meets quota), and how much of total compensation is comprised of salary versus incentive compensation?
  2. Are there multiple sales channels, and can you manage incentive to limit channel conflict?
  3. Do you allow the rep to discount, and to what extent will that affect profits?
  4. What are your strategic goals (non-revenue or profit-related)? For instance do you:
    1. have a list of company-making accounts you want to penetrate? If you were a manufacturer of pirate eye patches, would it make your brand if Captain Kid or Black Beard bought your product?  Would all the other pirates want one?
    2. want to smooth revenue, alleviating the 4th quarter hockey-stick revenue patterns of most companies?  How about a fast start program to incentivize people to move revenue forward?
    3. want to drive business toward a particular niche? For instance,you could concentrate on law firms by designing an incentive bonus for reps who land over 5 law firms with a minimum of value over $10K each.
    4. want the rep to sell to existing customers or drive them toward new business?
    5. pay the same rates for all products, or should they differ by the strategic importance and/or profitability of the product? Do you really want to pay the same rate for software with 98% gross margins that you do for services with 30% gross margins?

Let’s look at an example of how this would work.  Assume that the target income is going to be 50% base and 50% incentive with a total income of $200K if the rep achieves sales revenue of $2M and other targets.  $100K of variable revenue will be divvied up between commission and bonuses.  I would allocate approximately 30%, or $30K, toward the following strategic goals:

  • Five new accounts with a minimum revenue value of $75K – $10K bonus
  • A 1st quarter bonus if the rep achieves $500K in Q1 – $5K bonus
  • A 2nd quarter bonus if the rep achieves YTD revenues of $1M in Q2 – $5K bonus
  • A 3rd quarter bonus if the rep achieves YTD revenues of $1.5M in Q3 – $5K bonus
  • Target Account Bonus if the rep lands one of the five named target accounts listed in their territory. – $5K Bonus

That leaves $70 for revenue based commission, which I would allocate as follows:

Pay first $750K in revenue at 1.5% for a total of $11,240. Tiering a commission plan enables a company to recoup some of the salary investment from low performing reps. Pay the second $750K in revenue at 3.5% for a total of $26,500, and finally the last $500K of revenue at 7% for a total of $35,000.  This comp plan rewards higher performers and drives behavior to meet the company’s strategic goals.

Now this is just an exercise and is not meant to be an exhaustive primer on how to build a plan.  There are many intricacies in building a plan that drives maximum performance and won’t break the bank. Keep in mind that rewarding revenue at the expense of strategic goals, channel productivity and other factors are common mistakes that need to be avoided.

Be thoughtful in your design and run sample use cases to ensure that there are no major loopholes.  Annually release a written plan with territory assignments that is signed by each rep.  Write into the plan the ability for the CEO to make changes as needed, in order to make adjustments in case you experience unforeseen consequences like a highly discounted, less profitable deal.

Be thoughtful, purposeful and fair, and then send those pirates out to pillage and sail the seven seas.

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Glen Hellman (@glehel), is an angel investor, serial entrepreneur, and works for venture capitalists as a turn-around specialist. He is the Chief Entrepreneureator at Driven Forward LLC, frequently muses on his blog, Forward Thinking, and works with entrepreneurs to help them figure out what to do and get them to do it.

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