How do you assess and build a best-in-class sales compensation program? The answer: leverage is set at best-in-class sales compensation design building codes. Hi, my name is Rachel Parrinello and I’m a principal at the Alexander Group and one of our sales compensation practice leaders. In this podcast, I will share with you some common best-in-class principles, or otherwise known as guidelines, for eight sales compensation plan design components.
The eight components include:
- Eligibility
- Target Total Compensation
- Pay Mix
- Leverage
- Measures
- Mechanics and Pay Curves
- Performance and Pay-out Periods
- Crediting and Policies
These guidelines are industry agnostic and can be used to assess and design sales compensation plans for any sales representative job. Please note that these guidelines do not apply to income-producing jobs like real estate agents, mortgage brokers. Those jobs own their customer relationships and typically earn a market-set commission rate.
The purpose of the sales organization is to persuade your customer or partners to buy your offerings. Therefore, the purpose of the sales compensation program is to recognize and reward your sales reps for their persuasion accomplishments.
This insight is critical to many sales compensation guidelines, in particular the first component: Eligibility. Eligibility determines which jobs to participate on the sales compensation plan versus other incentive programs, like a corporate profit-sharing plan. Common guidelines for Eligibility include the primary job function must meet all of the following criteria:
- Significant customer or partner contact in a relationship
- Persuade the customer or partner to purchase a product or service
- Clear and quantifiable sales objectives
Here’s that best practice tip for you. Clarify your eligibility criteria and appropriately apply to all your jobs to ensure consistent and equitable application.
Our second component is Target Total Compensation. Target Total Compensation is a combination of base salary and target incentives set for each job level. Sample Target Total Compensation guidelines include the following: Have a clear and consistent pay philosophy to track and retain the right level of sales talent required by your sales organization. For example, we set our pay levels at the 50th percentile of the market or the 60th percentile of the market. A best practice tip here is define your market. Gather a custom report that includes 30 to 40 companies based on where you compete for product and talent. If this data is challenging to obtain, consider companies with similar sales motions or sponsor at custom pay level benchmarking study.
The third component is Pay Mix. Pay Mix is the ratio of base salary to Target Total Compensation versus the target incentive to Target Total Compensation. For example, if a sales rep with a 100,000 Target Total Compensation package and the 60/40 pay mix will have a base salary of $60,000 and a target incentive of $40,000. Common Pay Mix guidelines include: pay mix reflects the job’s degree of individual, customer or partner persuasion, and this means that jobs with more individual persuasion will have more aggressive payments. Consider your corporate pay philosophy and market benchmarks as you select the final pay mix for each of your jobs. At best practice tip here, build a global Pay Mix structure that accommodates each role’s persuasion and countries degree of risk tolerance to drive consistent application throughout your organization worldwide.
The fourth component is Leverage. Leverage is defined as a fixed ratio of the upside opportunity to target incentive pay to the 90th percentile performer. For example, if a sales reps target incentive is 10,000 and their plan has a 3x leverage, then the 90th percentile performer would earn $30,000. So what is the 90th percentile performer? Well, it’s not your top performer. If you lined up 10 sales reps based on their worst to best performance then the ninth sales rep would represent the 90th percentile performer. Common leveraged guidelines include: use a 3x leverage for direct selling roles, use 2x leverage for indirect sales roles or hybrid sales service or hybrid sales marketing roles. Companies generally vary these guidelines based on industry benchmarks and companies pay for performance philosophy. A best practice tip here is once you defined your target leverage, add leverage analytics to your sales compensation metric dashboard.
The fifth and most important component is Measures. After all, the Measure selected in the compensation plan will direct your sales reps, focus and their time allocation. There are many types of measures to choose from, and they generally fall into seven categories.
- Sales or units
- Margin
- Sales Effectiveness: There’s multiple types of sales effectiveness measures. These are generally a secondary measure. They could be product-focused. It could be a business-type focus like new or renewal. They could be account channel focus contract orders focus like multi-year or price and margin management.
- Business Effectiveness Measures: Like forecast accuracy or linearity. These are generally used in management sales compensation plans.
- Customer Impact Measures: Like customer satisfaction or loyalty. Not typically used in sales compensation plans, but mostly used in service organization plans.
- Activity Metrics: Like the number of leads or vendor selection
- Key Sales Objectives or Management by Objectives MBOS: These are usually individual or team-wide measures that can be set by management and change fairly frequently.
So let’s start with some measure rules. First, you should have three or less measures to keep focus and keep the plan simple. And second, if you do have multiple measures, make sure that each weight is at least greater than or equal to 15% of the target incentives so that each measure has impact. If they don’t have impact, then people will not focus on them.
There are multiple criteria to think about as you’re selecting your measures. First, the measures must align to the business strategy and desired behaviors for each job role. The reps must be able to influence their measures to drive accountability. Managers must be able to set quotas and targets for each of the measures. Operations must be able to systematically track the measures. And leaders should choose objective measures as opposed to subjective or compliance metrics. And last reps must be able to understand their measures and how they are calculated. Please know logarithmic calculations, please. A best practice tip here: understand your leadership’s fiscal year sales goals to drive alignment within the sales compensation plan.
The sixth component, Mechanics and Pay Curves, describe how the payouts are calculated. There are three common mechanic types: commission rate, individual commission rate, otherwise known as personal or base commission rate, and bonus formula. Sample mechanic guidelines include: use a commission rate when incumbents have equal pay levels and territories, otherwise use a quota-based mechanic like individual commission rates or bonus formula. When building pay-for-performance pay curves, make sure to adhere to the following guidelines: use Target Leverage, which we’ve defined earlier and excellence levels to calculate and back into accelerator rates. It becomes a very simple slope calculation exercise. Excellence levels, by the way, are the performance levels that you’re 90th percentile performer will achieve. Use thresholds to differentiate between persuasion versus order taking and provide unlimited upside opportunity. Frankly, reps do not like caps and it can impact your recruitment and retention if you have a sales compensation program with a cap. However, that being said, if excessive payouts are occurring in your organization, you must address it for not only financial reasons but also talent management reasons. Studies have shown that reps who are overpaid will leave the company if they’re unable to make the same amount of money in subsequent years. So apply the most appropriate protection practice. We start with a windfall policy. If that doesn’t work, move to decelerator rates. Then if that doesn’t work, we then move to deal caps or total payout caps.
Our seventh plan component is Performance and Pay-out Periods. Performance period is a period within which results are measured: monthly, quarterly, annual. Performance period guidelines include: first, you need to reflect the length of the sales cycle, so that time it takes a sales rep to start an opportunity and close it. Second, consider management’s ability to set realistic goals. So if you had a nine-month sales cycle, but management has no idea what’s going to happen the second half of the year, they may want to look at semi-annual performance periods. Third, minimize ability to push and pull orders, thus manipulating payouts. And last but not least, we want to align to the annual budget whenever possible. So even if the sales cycle is relatively short, if management can set annual goals, that is goodness. Because what it means is at the beginning of the year, your full budget can be fully allocated to every seller in the organization.
Pay-out frequency is what describes how often a pay-out is made. Common guidelines for payment frequency include: tying the pay-out as close as possible to the sales event. So you want to reward for those positive persuasion behaviors. Two, ensure proper cash flow. And then three, ensure the amount is significant enough to drive attention.
Our last component is Crediting and Policies. There are nine key credit events that can be used to measure success for each measure. They include in approximate order of timing:
- Sales milestones: number of demos or design wins or vendor selection
- Bookings orders
- Shipments
- Invoice billings
- Delivery
- Installation
- Payments
- Customer acceptance
- Recognized revenue: revenue that aligns to the generally accepted accounting principles or gap
A best practice tip here is your sales compensation plans should generally use a different sales crediting event than gap. After all, we don’t need all of our sales reps becoming mini accountants and understanding how certain deferred revenue applications are applied.
Common guidelines for sales crediting include: pay for persuasion. Again, we’re trying to tie payments as close as possible to the persuasion event to reinforce those positive behaviors. Two, minimize financial risk. So even though the persuasion event might be the order or bookings, if you have multiple bookings or change orders, you may think about events further on down the timeline, like delivered revenue or billed revenue. You must recognize, quote offsetting difficulties, as well as the ability to track and administer the crediting rule. And lastly, we want to make sure the source is a validated source and we’re not using self-reported crediting events. The program policy should be well defined and fair, and they include the following topics: management authority, including the right to change plan and dispute resolution processes; employee status changes, including new hires, leaves, promotions and terminations; quotas setting process and changes; sales crediting rules including situations that weren’t a double quota, double credit, as well as split credits; and windfall situations.
So that concludes our overview of the eight sales compensation component guidelines. Use these best-in-class component guidelines to develop a plan that tracks top talent, motivates higher levels of performance and ultimately drives profitable revenue growth. For more detailed information about our sales compensation component guidelines or other topics, please visit our website at agiinsightsexp.wpengine.com and/or contact us for more information. Thank you very much for listening to this podcast and happy designing.
