Sales Compensation Plan – Variable Compensation

The variable compensation portion of your sales compensation plan can be made up of three components:  commissions, bonuses and performance awards.  Commissions are earnings tied to sales.  The more sales your sales representative makes, the more commissions the sales representative earns.  Bonuses are earnings tied to pre-defined goals.  You may pay bonuses for surpassing quota, achieving target product levels or surpassing the company’s profitability threshold.  Performance awards are payments designed to reward superior performance, recognize contributions to achieving business milestones or otherwise compensate your sales reps for positive activities not otherwise recognized by commissions or bonuses.

Your business’s goals such as revenue, margin and product volume are usually assigned to sales representatives in the form of quotas.  Quotas become the basis for measuring performance and paying commissions, bonuses and awards.

Quota

Sales quotas are targets you set for your sales representatives, teams and management.  You can set quotas for revenue, margins, new customers, products or any goals you can think of.  Quota levels can be assigned based on sales rep ability, past territory performance, market expectations or any combination.  The key is to set quotas that are relevant and realistic.

Quotas should be relevant to the company’s goals.  They should drive actions that support the company’s targets.  Quotas should also be relevant to your individual sales representatives.  Assign quotas that make sense for each rep.  Don’t assign a small-to-medium business quota to a rep who has only large account responsibilities.  Similarly, don’t assign a new account quota to an established account manager.  Quotas not relevant to a rep or a territory work at odds with your company’s goals.

Quotas must also be realistic for them to have any meaning.  Your sales representative must believe he or she can achieve it.  Quotas that are set too high will either de-motivate your sales representative, or your sales rep will simply ignore the quota, discounting any associated commission or bonus opportunities.

Finally, quotas can be set for either total business generated or incremental business.  Incremental quotas require sales representatives to grow their territories year after year.  Sales that are lost must be made up with new sales before progress against quota can be achieved.  Incremental quotas place a high value on relationships and growing existing customers.  Total business quotas simply count all revenue or margin generated in a territory without regard to lost business.  Total business quotas are useful in new business development territories.

Commissions

Commissions usually make up the bulk of a sales representative’s variable compensation and typically are paid based on sales revenue generated by the sales representative.  Sales commission plans can be either absolute or relative.  Absolute commissions are a fixed amount or percentage tied to sales volume.  For instance, your sales compensation plan may pay commissions equal to 2% of revenue.  If your sales rep sells $100,000 of products or services, you pay the rep $2,000.  If your sales rep sells $500,000 of products or services, you pay the rep $10,000.  Whether your sales rep has a high base salary or a low base salary, you pay the same commissions for the same absolute volume of sales.

In a relative sales commission plan, commission payments are based on attainment against quota and the sales representative’s base salary.  This type of plan gives the company more control over the total commission payout per year.  When I worked for IBM, sales representatives were paid on a relative commission plan.  If a sales rep’s “base” salary was $100,000.  IBM paid that rep 65% of his or her base salary each pay period.  The rep had to earn the $35,000 balance through commissions by performing against quota.  IBM’s sales plan (commission plan) was fairly complex at the time.  Reps were paid by product, sales, installations and markets (i.e., mid-range products or small/medium business).  Each area had its own quota and quotas were weighted by importance relative to the company’s goals.  To simplify this example, let’s assume IBM paid strictly on sales against quota.  If reps achieved 100% of assigned quota, they would make 100% of their “base” salary.  Commission payments in this relative plan equaled [base salary] X [35%] X [sales/quota].  If a rep exceeded quota by 10%, the rep would earn 103.5% of his or her base salary.

Commission payments in a relative commission plan are governed by base salary and quota.  If you have a higher base salary, your commissions for a given transaction may be higher than a colleague with a lower base salary.  If you have a lower quota, you will earn more commissions for the same sales volume than a sales rep with a higher quota.  As a result of the effect these factors have on earnings, sales representatives participating in a relative commission plan focus more effort on increasing their base salaries through performance raises than sales reps participating in absolute commission plans.  Similarly, sales reps on a relative plan will focus much more effort on their assigned quotas than will reps on an absolute plan.

Capped versus Uncapped Commissions

To control commission exposure, some companies cap commissions or earnings.  They define an earnings level which they believe is competitive in a market and adequately (or handsomely) compensates the sales representative for his or her contribution to sales.  The rationale is that sales levels that exceed the cap are a result of the company’s reputation and market position, not the efforts of the sales representative.

Commission caps, unless they are unlikely to ever be reached, are generally de-motivating to good sales representatives.  Sales representatives dream of landing the ultimate customer, making the BIG sale, and getting the pot of gold at the end of the rainbow.  Caps on commissions or earnings rob them of these dreams.

If you are truly concerned about having to pay commissions on “bluebird” sales which come about regardless of the sales rep’s efforts, you can address that in the sales compensation plan’s administrative terms and conditions – to be addressed in an upcoming blog.

Commission Kickers

Commission kickers provide additional incentives to achieve goals.  Most commonly, commission kickers are used to motivate reps to achieve quota, emphasize specific products or focus on particular markets.  Kickers are additional commissions paid when the goal is achieved.  In the case of quota attainment, a commission kicker may pay 150% of commissions for all revenue generated over quota.  To emphasize products or markets, kickers may be paid on revenue generated in specific areas, such as small-to-medium sized businesses, for an identified time period, i.e., second quarter or the month of June.

Bonuses

You may pay bonuses to your sales representatives when they achieve specific milestones.  Or, you may pay bonuses on a regular calendar (quarterly or annually) based on milestones achieved during the time period.

Typically, bonuses are performance based.  Personal performance bonuses may be paid based on surpassing quota or landing targeted customers.  Corporate or team bonuses may be paid based on whether the company or sales team makes agreed upon targets.  Targets can be revenue, margin, earnings or any other goal that is important to the business.  The important point is to tie bonuses to achievement of professional, team or corporate goals.

Performance Awards

It’s important to recognize individuals who make outstanding contributions to your business.  In these situations, you will want to leverage the impact by making a public award.  Performance awards allow you to recognize key activities, individuals or accomplishments.  They are awarded at management’s discretion to motivate both individual and team activity.  A performance award provides both a monetary award and public recognition which is a powerful tool to create role models, motivate teams and drive behavior.

For more information, contact Wallace Management Group at (203) 834-0143 or email David Wallace.

© 2009, David P. Wallace

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