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:
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
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:
Should sales commissions
be caped or unlimited?
How will sales management
What is the timing of the
payout, relative to the sale/invoice?
What is the appeals
Some of the common mistakes companies make
when implementing a sales compensation plan include:
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.
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
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
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
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
Reduced commission payout percent of revenue
Commission payout is on a sliding scale to motivate
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
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:
Bob De Contreras
RTBA | Cary | Greensboro | Raleigh | Research Triangle Park | North Caroliina
Contents © Copyright Research Triangle Business Advisors 2008, All rights reserved.