Breaking the Rules
Can effective sales compensation design break best practice rules?
Sales compensation is a complex pay program crafted to reward sellers for sales outcomes. Sales compensation designers apply a set of uniform principles to each unique job to arrive at the best incentive plan design. Are there circumstances when these principles are not appropriate and sales compensation designers should consider a non-traditional solution?
Design Principles, Rules or Guidelines?
Designing an effective sales compensation program is a challenge. However, plan designers can improve plan designs by using a set of accepted principles. This approach helps to avoid mistakes and misalignment between the job’s sales mission and its supporting pay program. But are these principles hard-and-fast rules? Certainly not. They are not rigid, nor non-voidable rules. There are just too many diverse circumstances requiring a flexible approach. Let’s classify these rules as guidelines. Better yet, let’s consider them center-practice guidelines. What does this mean? When making design decisions (i.e., pay mix, upside, number and types of measures, and quota methodology), center-practice guidelines offer the preferred design choice. One that many others would select, too. Are center-practice guidelines the same thing as best practices? Well, no. The implication of best practice means that all other choices are inferior. A practical observation recognizes that a suitable solution does not need to align with center practice and another design might be fully workable. From your own personal experience, you know that many rule-contrarian designs work in an effective fashion.
So, does this mean we can do anything we want? No. Following the preferred center-practice guidelines is always the better choice except in select cases. In these situations, sales compensation designers might adopt nonconventional practices to better serve the company’s needs.
Let’s review some classic design principles, and then explore when and how plan designers can modify these center-practice guidelines. Determining the right eligibility, mix/leverage and measures rests on numerous sales compensation center-practice guidelines. There are other policies for crediting, quotas, sales contests and employment status changes, for our purpose here we will focus on eligibility, mix/leverage and measures.
Breaking the Rules
The following examples are suggested “center-practice guidelines.” However, at times, these guidelines can pose a challenge for universal application and don’t work in all cases.
Let’s examine each of these “rules” and reveal when sales compensation designers might consider alternative solutions.
Eligibility. Only jobs that influence customers to act in a positive economic fashion should be eligible to participate in sales compensation plans. Pay should be tied to individual results.
Influence customers: The principle of “influencing customers” provides an important distinction between selling jobs, and those who have customer contact but are not responsible for persuasion. However, this rule stumbles when work practices and accountabilities are non-assigned, fluid and collaborative. Start-ups tend to operate in this manner during their early “discovery” stage. A companywide team award during a challenging discovery phase might be a better solution. Job-defined sales compensation plans can wait until clearly defined sales jobs emerge.
Pay individuals: Sales compensation plans reward individual contributions. However, when a team of resources are working to win a customer contract, a team incentive would be a better reward. Beyond collective sales teams are groups of employees. Should they be on sales compensation plans? Probably not. But, during periods of cultural confirmation or a shared business imperative, a companywide bonus could provide a shared reward for accomplishing a corporate-wide goal.
Mix and Leverage. The degree of persuasion required for a sales job determines its pay mix. i.e., more at-risk pay for more influence. Leverage suggests a 3x opportunity where the best performers (90th percentile) earn 3x the at-risk portion.
Mix: Sales compensation designers divide target total compensation (TTC) for a job into two components: base pay and target incentive expressed as a portion of 100%. For example, a 60/40 mix assigns 60% of the TTC to base pay and 40% to target incentive. However, there are no fixed/calculation rules about setting pay mix. Factors affecting pay mix include the company’s view about the role’s influence, market practices and the application of pay mix among all the sales jobs.
Here are some trending examples of pay mix: Account managers have a pay mix around 65/35; hunters 50/50; and strategic account managers 75/25 or 80/20. These examples show that the “influence of the sales role” affects the degree of pay mix. For example, why is the strategic manager pay mix 75/25? Why is the pay mix not more aggressive? In this example, the strategic account manager may have a high TTC, but customers are driving the purchases and the strategic account seller facilitates their purchases. The conclusion: Designers have a significant amount of flexibility to set pay mix by job; just ensure all pay mixes for all sales jobs share the same logic and application of policy.
Leverage: Leverage determines the upside earning potential for over quota performance. Expressed as a multiple of target incentive, it helps sales compensation designers set payout rates so the best performers (90th percentile) earn 3x the at-risk component (added to the base pay). For example, a TTC of $100K and a pay mix of 70/30 would allocate 70% of the TTC to base pay and 30% to target incentive. The best performers should be able to earn $160,000 ($70k plus $90k). The 3x rule is attempting to replicate labor market practices. However, there are companies and industries that do not follow this payout expectation. Some only offer 2x the target incentive, others up to 4x the target incentive. The ultimate answer for how much to pay best performers is comparison to labor market competitors’ pay levels at the 90th percentile. If they pay less than 3x or more than 3x, adjust your pay plan to be competitive with the labor market.
Measures. There are numerous principles for measures: no more than three measures, only output measures, no activity or input measures, only measures the seller can influence, no corporate measures and avoid MBOs (management by objectives).
Three Measures: Most companies use three or fewer measures in their sales plans. Why no more than three? The logic suggests that more measures dilute the focus of the incentive plan making all measures less important as more measures are added. Is this practical in all cases? In some instances, designers need additional measures to capture the business impact of the selling job. As an example, a selling role that is responsible for existing accounts (growth, reducing churn and sustaining pricing) and new accounts (number of new accounts and average order size) might warrant all five measures. In other cases, a company uses a “scorecard” of results, operations, behaviors and activities. A scorecard fuses together these objectives into a unified reward program. Scorecards work for some organizations.
Output Measures: One of the holy grails of incentive design is rewarding for sales results and similar output measures like profitability, product mix or new revenue from new accounts. Input measures (number of new leads) or activity measures (number of calls made) are important metrics for some sales jobs. But do these efforts lead to recognized revenue? Should salespeople be paid for doing something rather than getting something? Consider the sales development representative job, which identifies qualified sales leads for sellers to pursue. Incenting both the number and eventual close rate of the leads may be an appropriate practice for this job.
Direct Influence Measures: Because sales compensation is a “pay-at-risk” program, the ethical conclusion is to use performance measures the seller can affect. This would preclude the use of companywide measures. However, sometimes the company needs to embrace a strategic imperative, such as customer satisfaction as captured by net promotor score or a similar broad-based measure. Should these measures be part of the sales compensation plan? Preferably not. However, when a new value system needs companywide adoption, this measure might play a role in the sales compensation plan.
Avoid MBOs: MBOs or KSOs (key sales objectives) have sellers and managers agreeing to a set of specific, unique seller objectives. Often, maligned because of their excessive administrative burden and potential for manipulation, the center-practice guideline suggests avoiding them. However, the use of MBOs/KSOs may be appropriate for strategic account managers when the sales progression success is important as measured by specific tasks and milestone accomplishments unique to the strategic account.
Conclusion
Sales compensation rules, err—center-practice guidelines—provide a strong foundation for designing effective sales compensation plans. However, sometimes, practical considerations play a role in “breaking” such rules.
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