How to Build a Win-Win Sales Compensation Plan in 5 Simple Steps
October 18, 2016
The ability to attract and retain talent is important across all business sectors but perhaps even more critical in sales given how hard it is to find sales reps that reach their quota. Statistics indicate that less than 40% of salespeople actually achieve their quota, and even less do so on a consistent basis.
For companies looking to build a high performance sales team, the need to recruit and retain top performers is critical. One of the most effective ways to do this is by creating and instituting a compensation plan and pay level that is above market and handsomely rewards top performance.
It is certainly true that in today’s workforce employees care about more than just money. Factors such as career advancement opportunities, work life balance and company culture all play a role. And when it comes to attracting and retaining sales superstars, it is absolutely critical to offer more than a “competitive” compensation plan. However, trying to determine the right mix of base, commission and bonuses can keep business leaders up at night.
While a compensation plan that pushes a candidate’s immediate and future earnings by more than 20% will help recruit top performers, long-term success for both the employer and employee cannot be realized if compensation plans are not aligned with the company’s larger financial goals.
After decades of working with world-class sales organizations, here are 5 great tips we’ve developed to help create a win-win sales compensation plan and how to determine the right recipe for your unique company.
This acronym for “Keep it simple, stupid” was started by the U.S. Navy in 1960 and has been applied in business ever since. As noted by Harvard Business School Senior Lecturer Mark Roberge, “Salespeople should not need a spreadsheet to calculate their earnings. If too many variables are included, they may become confused about which behaviors will lead to the largest commission check. They might throw the plan aside and just go sell the way they know best. The opportunity to drive the desired behavior through the compensation plan is lost. Keep the plan simple.”
2. Develop on Target Earnings (OTE) Above Market Value
This is the total salary, including base, commission and bonuses that a salesperson will make if they work for you and reach their quota. If your OTE is less than what your competitors are offering, forget about attracting top talent. As leading sales expert Andris Zoltners correctly states, the key to arriving at this number comes down to understanding two elements: the salesperson’s role in demand creation and the labor market value, specifically your industry’s norms such as growth, competitive intensity, and profitability. Most plans are based on profit margin. You have to start with the top line revenue, derive the margin and then you can determine what your cost of sales is going to be. For example, if you sell $3 million worth of product or services and have a 30% profit margin, the gross profit is $900,000. A general rule of thumb is that sales is 10% of gross profit. In this example, you have $90,000 to play with for sales salary and commission.
3. Use Length of the Sales Cycle to Weigh Base vs. Commission
When trying to concoct a formula to make up the OTE, it is very important to understand the length of your sales cycle. For example, if your sales cycle is short and consistent, a heavier dose of commission is plausible. However, as this article from Harvard Business Review points out, it may take Boeing sales reps more than a year to close a single sale with an airline. For complex sales like this, we recommend a structure that is roughly a 50/50 split between base and commission.
4. Don’t Cap Commissions
Putting a cap on commissions is a common practice in large multi-nationals to prevent reps from receiving huge fortunes for closing sales. We respectfully disagree with this practice, and we are not alone. Sanjog Misra, of UCLA, and Harikesh Nair, of Stanford, published a study that analyzed the sales compensation plan of a Fortune 500 company that puts a cap on commissions. The study found that the cap was hurting overall sales by 8%. The next year, the company implemented the study’s recommendation to remove the cap, and as a result, companywide revenue rose by 9%. Bottom line, if the salesperson can afford several Porsches, they have probably earned the company a Learjet.
5. The Best Laid Plans Often Go Awry, Make Adjustments
The 2016 Alexander Group Sales Compensation Trends Survey, which had 152 sales departments participate, found that more than half of the companies made adjustments to their sales compensation plans mid-year and more than 90% will make changes next year. The best-laid plans of mice and men often go awry. By regularly reviewing your sales compensation program and introducing adjustments that respond to your evolving market, you have an opportunity to maximize its effectiveness.
Have your own tips for structuring sales comp? Let us know in the comments.