Guide To The Right Sales Compensation Plan
In this article you will learn:
For people in sales, the Compensation Plan is a major factor in choosing who to work for and how much effort to put into a job.
Because simply put, the compensation plan will determine how much each sales rep can earn in their job. But it is more than that.
Done right and properly set, the Compensation Plan can also influence how your people behave when facing a customer. It can determine how many of your salespeople will go the extra mile to get additional orders. It can create a buzz in and around your team and create an area of excitement when people see real results from their efforts.
However, done wrong a Compensation Plan can go in the other direction as well. This means that your people might behave unethically. There could be turmoil among your staff because of unfair compensation. Or your experienced sales reps might purposely sabotage any new hire to leave, with more compensation remaining for themselves.
As you probably already guessed, the Sales Compensation Plan is a major part of your overall Sales Management structure. As an entrepreneur or sales manager alike, designing the compensation plan will be a very important decision you have to make.
The Comp Plan will determine behaviour, goals and performance of your team. In this guide, I will show you how to create a right compensation plan for your business that will get you the outcomes you desire.
Being a frontline sales rep myself for many years, I have seen the common do’s and don'ts of compensating sales reps for their performance. In this article I will share them with you.
What is a Sales Compensation Plan
The Sales Comp Plan is the set rules and calculations you as the Entrepreneur or Sales Manager create in your business for rewarding your salespeople.
The compensation itself is a part of additional salary which every sales rep earns for selling one or more of your products.
It will determine how much each of your sales reps will, and can earn in commission. It also governs what exactly your salespeople will receive a commission for. Thus it will greatly affect behaviour, focus, activities and the overall outcome of your sales process.
The Compensation Plan also will influence the kind of people you get on your team, and even more which of them will stay on your team for the long run.
Hard work and effort should be rewarded accordingly, and at the same time people will want a chance to excel in their careers. Last but not least, for salespeople the amount of income they are able to generate with your Compensation Plan will play another crucial role.
Easier said than done.
Designing and creating such a Compensation Plan from scratch is actually really tricky and can be tough to get right.
People in general are eager to find loopholes in any system and to exploit them. A good intentioned Compensation Plan in the hands of a few wrong people can easily be turned against you or your company if there are only a few minor tweaks that can potentially be used in another way.
The variables going into the practical use of such a Compensation Plan can be manifold and it will be hard to design it in a way that works from day one.
Thus expect to observe the practical use and the performances delivered, and to make changes over time if necessary.
Nevertheless, here are some basics that should be considered for any compensation plan.
Why is a Compensation Plan important in sales
The Comp Plan drives performance and focus of your salespeople in their daily activities.
Usually, it is also a direct part of their monthly earnings.
Here it varies from one business to the other. Some businesses pay commission only for their salespeople. Other businesses pay a large fixed salary and only a small commission on top.
The right amount of commission that can be earned will depend on the product you intend to sell and the industry you are operating in.
Beyond that, the Compensation Plan can also include further incentives or benefits, such as a company car or a better office.
The Comp Plan thus intends to create positive behaviour and provides clear expectations for your salespeople. It aligns the goals of your business and of you as the Entrepreneur or Sales Manager with the goals of your sales team.
In practice, the detailed structure of the Compensation Plan can vary by the exact role of the salesperson and other factors such as the length of the sales cycle. From the business perspective you should also consider a few more points along the way:
How much can you afford to pay your salespeople while still earning enough to keep your business profitable?
How much could those same people earn if they started working for a competitor?
What are your long-term goals and how exactly will you intend to reach them?
How will the compensation plan affect your company culture?
These will be the most common decisions to make and things to take into consideration when creating your Compensation Plan. Make your decisions wisely, as it can and will have an impact on all those areas sooner or later.
What will you compensate your salespeople for?
The commission can go from 1% to 45% or more depending on the product or the industry.
It is often largely determined by the amount of effort a salesperson has to make in order to close a deal.
If you have dozens of customer inquiries coming in day by day and all your reps have to do is pick up the phone, then the commission can only be a few percentages.
After all, the customers are rushing to your door, not your salesperson’s door.
The work to be done is actually rather technical and operational. Your business, your products, your marketing or whoever does the heavy lifting for the sale.
There is no need to reward the salesperson in any special way for customers that want your business without any of the salesperson’s help.
The more your sales reps have to be involved in a sale to close a customer, the higher the reward usually has to be.
If they are required only to do the operational part of the sale, the commission can be minimal.
If they are required to close the sale, the commission should be a little more.
If they are required to generate the lead, track down all the customer information, sell the product and close the sale, the rewards should be accordingly.
Analyze your sales process and see what exactly it is your people have to do on a daily basis. Look closely at how much effort is required, how much risks have to be taken and if they have to go the extra mile to achieve a sale for your business.
The structure of a Sales Compensation Plan
In most companies every employee will have to meet some kind of quota.
For example, in the insurance industry a clerk in the claims department will be expected to look at 6 customer claims per hour.
This is the minimum amount of effort on the job that is expected, and usually calculated in terms of how difficult the task at hand is, how long the task takes and how valuable it is in the overall business itself. The employee’s salary usually is in relation to the quota and the task that has to be dealt with.
Simply put, the more valuable the task is for the company - the more you can expect to get paid. The less worth you bring into the business, or the more replaceable you are, the less your salary will be.
Salespeople are measured in the same manner by their sales quota.
This is usually the minimum amount of product one sales rep has to sell, in order to justify the salary, costs for the office, equipment, travel expenses and so forth provided by the business. Often the Sales Quota also has a profit already calculated in it, meaning when quota is met usually the business is satisfied.
In Sales, there can be more forms of goals and targets than just this simple quota.
For example there could be some Sales Accelerators in place.
What this means is that basically if you reach a certain amount, you will be rewarded with an extra bonus.
If the quota for a sales rep is to make 1 million in revenue per year the Sales Accelerator could be an extra 20.000$ bonus if revenues exceed 1.4 million USD.
Or it could also be a number based on the revenue generated so far.
Let's say the sales rep earns 1% commission and is expected to bring 1 million in revenue.
The sales accelerator could kick in at a revenue of 1.4 million and lift the commission to 1.5%.
Then it can also depend if the first million also will be affected by this raise, or if anything above the first million is paid in the additional 0.5% commission. What will be the right solutions for your business and sales team is up to you.
If we have a Sales Accelerator, of course then there exists also the opposite known as a Sales Decelerator.
As you can imagine, it does exactly the opposite. Instead of rewarding the good performing reps, it is penalizing the bad performing sales reps. Those who do not even meet their minimum expected quota, can have cuts in their salary. However, keep in mind that in some countries it might be against the law to pay someone less than you initially stated in their contract.
This means for a Sales Decelerator to legally work and be enforceable, you have to make sure to pay people already commission as part of their salary for the quota. Cutting the base salary of an employee might set you up for trouble, whereas cutting the commission of an underperforming rep is usually no problem. Seek some legal advice for your situation before putting a sales decelerator in place.
Another common method used in Sales Compensation Plans are so-called Clawbacks.
The idea behind a clawback is to ensure that the salespeople are working on long-lasting and mutually beneficial customer relationships. Now there are several ways to achieve that.
For example in some companies the sales rep gets paid the commission only after the customer has used and paid for the products for several months. This is especially common for selling subscription products with a monthly payment plan. While this is not a clawback directly, it merely postpones earning the commission for the products your team sells.
In other industries it can get more directly, for example if a customer cancels the order or products after a while, the sales rep has to pay back the earned commission. This is already a really tricky part of the Compensation Plan, but it can get even worse. In the financial industry for instance, some companies even let your commissions run in the negative if customers cancel.
That means if you lose some customers to a competitor (which can happen to the best of salespeople), your commission balance will be in the red numbers. That means you have to sell even more only to get to zero - or you might face a substantial cut in your salary the next payday.
These clawbacks can last for years! Meaning even if 3 years later the customer cancels, it will affect your commission today.
As a sales rep, you should really be aware of clawbacks. Sales Managers and CEOS alike often avoid talking about them or do not mention them at all, instead you will find them in some fine print on your contract hidden somewhere.
However they can seriously affect your earning potential. As a Entrepreneur or Manager you should communicate clawbacks openly and make sure they are fair and trigger the desired behaviour you want to see in your salespeople.
Last but not least, the Compensation Plan can also include occasional Incentives. These could be separately set contests or competitions for your salespeople. As an example:
The top-selling reps in the company for the first quarter receive an additional 3.000$ cash bonus at the end of March.
A similar competition could be launched in the next quarter or in any quarter of the year. It could also be a competition for a month, or for the next 6 weeks.
With such incentives you can boost morale in times where you know the business is usually turning lower than during the other months. Or it could be used to get some people out of a sales slump.
Be aware however, that incentives tend to reward your best people usually. Meaning those with already big commission checks will get an even bigger commission check and so forth, unless there are special criteria.
With more detailed guidelines, you can directly boost those parts of the team you would like to push further. The incentive could only be valid for those who are in your company for less than a year, if you want to push the new hires. Or it could be valid for all those who missed their quotas last year to get the weaker parts of the sales team motivated.
There are literally no limits to how you can design your incentive for your sales team. Just make sure you reward those behaviours you want to reward, and to push the part of the team you would like to push further.
Sales Draws - Recoverable / Non-Recoverable Draws for Commissions
These Compensation Plans seem to pay the salesperson a fixed salary, often even a very high fixed salary with no questions asked.
Careful however, because especially in sales nothing is ever free.
The salesperson receives a monthly check with let’s say 5.000$ which would make a really attractive salary. Well, not exactly.
To earn the amount of 5.000$ a month in the form of your own money, you have to sell products worth at least 5.000$ worth of commission every month. If you do not deliver this amount, you have legally not earned the money.
With a Recoverable Draw the company is basically giving their salespeople a monthly loan whereby the money is not theirs, unless they sell the required amount of products to earn the commission necessary to cover the full salary.
It is a Commission-Only Compensation Plan, only hidden and covered by the impression of having a fixed, monthly salary. Well, not really a salary. The salesperson is actually taking on debt every month, unless enough commission is earned.
The Recoverable Draw in Sales Compensation Plans can be very tricky for the salesperson. Having a few bad months can result in being in debt for working in such a company!
The business has no risk of any kind of course and can only benefit in the short run. That is, until the bad reputation caused by these practices start to spread.
Nonrecoverable Draws on the contrary can be used as a form of entrance to get started for new sales reps. As the business cannot take it back and also does not expect to take it back, it can help to show people what they could earn on a monthly basis when enough commission is reached.
A new sales rep starts working for you. In the first 3 months he or she has to learn a lot.
A lot of time will be used up for learning the ins & outs of your products and the business itself.
Even if you expect people not to hit their quota in these first months, a Nonrecoverable Draw can get them used to what the salary will be like if the quota is met every month.
After the training is over, the salesperson is then expected to bring in enough sales on their own efforts and the Draw gets removed.
The Draw can also be decreased over time, such as lowering it 20% every 3 months for example.
Building a Sales Compensation Plan for your Business
Putting all these elements together, you can get a really good idea of what a Sales Compensation Plan should look like.
The crucial element is that the Compensation Plan should directly influence the daily behaviour and silently guide your team towards the direction you as the entrepreneur want them to go. After all, to grow your business your sales efforts and their results will directly influence how much your business grows.
Therefore as an entrepreneur you should have a very good idea of how your Compensation Plan is structured, what exactly it rewards, for whom, and why.
The first question you have to ask is:
How much will you pay salespeople in fixed salary?
Commission-Only Compensation Plans
The fixed part of the salary will be the starting point for calculating anything further.
Some businesses even tend to have their sales reps work on Commission Only basis, without any fixed salary.
This means that there is no base salary at all, and that to earn merely a dollar per month your salespeople have to sell something. It totally outsources the risk from the business to your salespeople personally. If your salespeople are successful, your business thrives. If they totally go belly up, you lose nothing.
Keep in mind however, that sales can be cyclical and often depend on outside circumstances outside of the salesperson’s control even with their best efforts. Meaning there will be good times, and there will be bad times. Sincere and hard working salespeople should not be punished for something they cannot control.
Even if you pay generous commissions and the salesperson has months with an income of 10.000$ a month and more, what about a month when things turn southways and the commission for an entire month of work only makes up 325$?
In some months the sales rep can live large, while in others he or she will struggle to pay the rent or any other costs of living. This creates enormous pressure on the sales rep and in turn can again trigger undesired behaviour.
It will also deter any smart and talented individual in the long run, since there is absolutely no stability for their income.
Providing for a family, having a place to live and many other aspects require at least a certain amount of stability in income. Commission-only Compensation Plans therefore tend to drive away valuable, hard working salespeople. They know their efforts will be better rewarded elsewhere.
Commission-only should exclusively be used if you do not intend to attract highly talented people and also do not intend to keep them for a long time. Coincidentally, some good salespeople might stay with you for some time. But this will be more of an exception.
Commission-only can also quickly burn your reputation for hiring new people as well as the impression you make on your customers. Several Multi-Level-Marketing companies use this approach for years, with the result of quickly burning through a lot of people and leaving a devastating reputation behind. A lot of people in sales will do what is best for them, which can result in chaos if all they get paid for is a high number of sales regardless of how they achieved them.
Salary-Only Compensation Plans
The opposite would be to pay Salary Only for your salespeople.
It is best suited if your reps have mainly duties that are not sales-related, such as training new team members.
Sure, the salary-only approach will provide a stable income for everyone on your team. Whatever your people sell or do not sell, they take home the same income.
Your sales team thus faces no risk whatsoever, but also cannot be motivated or pushed by any form of compensation.
After all, why should they?
If the income is decent anyway, why bother if you meet the sales goals for this year?
If you enjoy a good standard of living and have everything covered, why should you call that customer back after 5pm?
If you enjoy a happy life and have most of what you wish for, why would you put the extra effort into your work?
Even if your salespeople meet their quota, they now can sit back and relax for the rest of the month or the rest of the quarter.
All the goals are met, there is nothing that would reward any further effort from this point on.
Sure this releases all sorts of pressure from your salespeople. And it makes calculating your costs fairly easy and predictable. But it totally abolishes the thrill many salespeople seek to earn a higher income than usual and the excitement of closing new customers or landing new deals.
If your competition employs high-commission earning sharks in the same market, it could really become a disadvantage for your business and might cost you more than a few sales.
Base Salary Plus Commission Compensation Plans
Between the two extremes lies this most common form of a Compensation Plan.
The salespeople get a fixed salary, and have the potential to earn a higher (sometimes even much higher) income if they get their commission on top and make enough sales.
It usually gives the Sales Manager enough leverage to motivate people to go above and beyond, while it also makes sure that everybody is supplied with a decent income to provide for their private life even in the bad months.
The exact division of commission and base salary will depend on your industry. Common ratios could be 70% base salary and 30% commission; 60% or 40% or similar.
A healthy combination of a fixed salary to cover all necessary living expenses, with an additional option to really earn good money with commission will be the right approach for most businesses.
Keep in mind factors such as the living costs in your area or the personal lifestyle of the salespeople on your team.
The commission can kick in from the first sale they make, or the salesperson has to meet a certain amount of revenue before the commission is earned and boosts their income.
The exact ways to do this as outlined in this article are manifold and you can see how many factors quickly come into play.
As an entrepreneur you should never underestimate or neglect the importance of creating a right compensation plan and the impact it can have.