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How to Set Up a Sales Compensation Plan

Advice for small businesses on how to create the best compensation plan for your sales team, by determining sales goals, performance measures, payout formulas, and the sales cycle of your business.
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One of the biggest management challenges for a growing business is compensating salespeople effectively. You know you need an incentive compensation plan that encourages your sales force to land new accounts and continue to upsell existing customers, but where do you begin figuring out the best way to compensate them? It often boils down to finding the right balance between base pay and commission. But other questions also may come in to play: Will a commissions-only model work for you? How do you set parameters for performance? How do you measure that performance?

If these issues seem daunting at first, don't worry. You're not alone. Sales incentive programs can have an enormous impact on the bottom line and on future growth of the business.  Executing a well-designed sales compensation plan can help companies create a sales culture of high performance where individual goals are aligned with those of the larger organization.  Furthermore, building a reputation for recognizing and rewarding good performance accurately also helps companies attract and retain top sales talent.

"It's probably one of the fundamental keys for success for a business, provided they have a sales force -- which would apply to vast majority of businesses," says Jim Stoeckmann, senior practice leader for sales compensation for WorldatWork, a not-for-profit professional association focusing on compensation, benefits, and work-life issues. "Going to market is really a fundamental part of planning your business. The compensation plan is how you operationalize the sales force, get them aligned with the business goals, and get them motivated and driven to implement your go-to-market strategy."

The following pages will detail what to include in a sales compensation plan, how to select a pay formula for your sales force, and how to implement your sales compensation plan to further business goals.

Dig Deeper: Keeping Your Sales Strategy Relevant During Tough Times

How to Set Up a Sales Compensation Plan:  The Elements of the Plan

A sales compensation plan is a way to put your marketing strategy into operation. Given the impact that sales compensation plans can have on growth, almost every company with a sales force should take a more strategic approach to designing their incentives plan. Fully understanding both the key drivers of successful sales incentive programs and the ways to optimize them can be complex, and plan specifics can vary widely. Nevertheless, there are a few key factors that you should consider when designing and administering an effective sales incentive program.

Writing the Sales Compensation Plan
Virtually all sales compensation plans are written and documented. The sales compensation plan should be available and distributed to the sales force. The front line manager should use it as a tool to communicate the sales strategy and goals and motivate the sales staff to sell. Here are some of the essential elements to include:

  • Strategy. The business' sales strategy, what the business case is, and what the business is trying to achieve.
  • Performance measures. Spell out benchmarks and performance measures to help guide the sales force in terms of their focus.
  • Payout formula. This is perhaps the most essential component that spells out to your staff what is in it for them. The payout formula lays out how they will be paid in terms of straight compensation or commission for sales.
  • Governance. Detail how you will resolve questions or conflicts over sales compensation that are not covered in the plan and may arise.

The compensation plan won't be able to cover everything. Issues are going to be raised, whether it's what constitutes a new account or what happens when several different people claim credit for a sale. "There are going to be things that come up during the course of the year that are not covered or are a matter of interpretation," Stoeckmann says. "You need to spell out the way those are going to be resolved. It may be a committee or a chain of command." When a sales person brings a question to the sales manager, nine times out of 10 they will be able to resolve the situation, but when they're not there needs to be some means of resolving the issue. A committee might have representatives from sales, human resource, and finance to arbitrate.

Develop Meaningful Sales Goals and Performance Objectives

While most sales managers want to design sales compensation plans that 'pay for performance,' those managers often have inconsistent and conflicting views about just what 'successful selling performance' means. "Meeting quarterly sales quotas can be one measure of performance," says Scott Shimamoto, the principle in charge of incentive compensation for ZS Associates, a global management consulting firm specializing in sales and marketing consulting, capability-building, and outsourcing. "But what if those quotas are met by selling products at a deep discount?  Should those sales count as much as those that protect the company's margins?" Meeting the existing needs of current customers is also important, Shimamoto points out. But you may question whether product sales to an established account deserve to be rewarded with the same vigor as product sold in a new market.

That quandary is something you need to consider when designing your sales compensation plan. It may very well depend on your business objectives. Your business may want the sales force to focus on a new product. In that case, the sale of a legacy product should not be rewarded at the same level as the sale of the new product. Similarly, your business may want to focus on landing new accounts. In that case, you may choose to not compensate increased sales to existing customers at the same rate of commission.

Shimamoto says that tying individual performance parameters to a company's broader growth objectives is crucial for the success of any sales incentive program. "You must clearly identify sales-related actions and behaviors that support larger business objectives," he says. "Then you can design the sales incentive program so that the sales force is motivated and rewarded for behavior and actions that comply with the corporate strategy."  Taking the guesswork out of the definition of 'successful selling performance' reduces ambiguity and angst, and provides clear marching orders to your sales troops.

Sales Compensation Formulas
After identifying your sales goals and spelling out the vision of success for your sales staff, you need to figure out how your business will compensate the sales force. Some companies pay their sales people with straight salaries; others put their sales people on 100 percent commission. Those are the extremes. A straight base salary guarantees that valued sales staff members are compensated even during an economic downturn, when a lack of sales is attributable to factors outside the salesperson's -- or the company's -- control. On the other hand, variable pay, such as commission, incentivizes salespeople to work harder to land new accounts and drum up new business -- they will see the results of their hard work in their paychecks.

The vast majority of businesses opt for a middle ground. In 2008, WorldatWork surveyed its members in conjunction with the National Association of Sales Professionals (NASP) and found that a mix between base salary and variable pay were the most prevalent forms of sales compensation. Eighteen percent of respondents used a mix of 80 percent salary and 20 percent commission. Sixteen percent used a 70 percent salary, 30 percent commission ration. And 14 percent reported a mix of 60 percent salary and 40 percent commission.

How you decide to structure your pay formula should depend on a variety of factors, including the following:

  • The role of the sales person. The degree to which a sales person influences a customer's decision to buy a product or service should be at the top of your list in deciding whether to award commission or some type of compensation tied to the sale. In some industries, products sell themselves; in other industries, customers need to be courted and sold on a product or service. "If a sales person plays a critical role, you should recognize that in a fairly rich pay mix that drives their behaviors to be optimized in terms of sales," Stoeckmann says. Conversely, if you have a more collaborative sales process, involving the sales person, a business development person, an application engineer, etc., then you may want to lower the commission ratios. "If you have a number of people involved in the sales process, there should be less aggressive sales compensation," Stoeckmann says.
  • The kind of selling. If you're driving new account sales, you may also consider being more aggressive in your pay mix and basing more on commission. "If you're trying to encourage a sales person to go after brand new accounts, you want them beating the bush," Stoeckmann says. "You want them to generate leads and follow up on them." At the same time, you may want to use a more conservative pay mix for growing sales to existing accounts. In addition, if your business has put a lot of focus on selling new products, you may also want to award higher commission for selling those new products than you do for selling older products.
  • The sales cycle in your business. The type of business you're in and its sales cycle also should be factored into determining the pay mix. Companies that sell airplanes, such as Boeing or Airbus, have a long selling cycle during which business is booked as much as a decade in advance, Stoeckmann says. That may necessitate less focus on commission and more on steady pay. Conversely, if your business is selling paper, you may be making sales and landing new accounts multiple times in a given year. "Factors to consider would be whether you are selling systems versus commodities, long versus short selling, and complicated high-tech versus lower tech sales," Stoeckmann says.

While a high risk/reward incentive program may be necessary to attract your ideal sales person, you need to think through the possible (and sometimes unintended) consequences. "One factor often overlooked in determining the appropriate amount of at-risk pay is its impact on a customer's experience," Shimamoto says. "Customers who enter a car dealership or a clothing store can have very different experiences, based on a salesperson's incentive plan.  A salesperson with too little incentive may not get up from behind the counter or make a compelling sales call.  Conversely, a salesperson with a disproportionately high at-risk earnings opportunity may be too aggressive about closing the sale – a tactic that often backfires and turns off your customers."

Understanding the impact of at-risk earnings on their business can help companies better determine the level of risk/reward that motivates the sales force, while allowing them to guard the company's long-term interests and reputation.

Dig Deeper: What's Considered a Fair Sales Quota?

How to Set Up a Sales Compensation Plan: Implementing Your Plan

After devising a sales compensation plan, the more difficult task is putting it into practice. The factors involved in implementing your sales compensation plan include people, timing, analysis of results, and your ability as an organization to make changes if sales goals are not being met. The following are suggestions on how to make your sales compensation plan help you meet business goals.

  • Timing. Target the time frame when you want to put this plan into practice. The ideal time is at the beginning of the first quarter of a New Year. In order to be ready to meet this target, you need to start planning in advance. Stoeckmann suggests that businesses start the process by August to be ready to take action Jan. 1. "If you find yourself in the first quarter or later and have a sales force not focused on the goal, you're in trouble," Stoeckmann says.
  • Pull the right team together. A typical sales team should consist of a sales manager, someone from the field, a representative of human resources, another representative from finance, and someone from sales administration or operations. "You want to have the sales leadership set the perimeters up front," Stoeckmann says.
  • Analyze the current plan. Let the team evaluate the current sales compensation plan to see if it is working. Have everyone at that table to do some analysis, Stoeckmann suggests. The sales managers should give feedback about how the plan is perceived by the sales force. Human resources should look at what other companies are doing. Finance can give feedback on the cost of sales and whether sales representatives are paying their way. The sales operations staff can report on whether the business is rewarding the right people. "Are your top revenue generators getting the top pay?" Stoeckmann asks. "You want to make sure that you're differentiating performance on behalf of the sales force so that high performers are earning the high pay."
  • Determine whether you need to make changes. After the results of the analysis are clear, the team should give thought to whether the sales compensation plan needs to be updated – in terms of goals, quotas, or pay ratios. Updating the sales compensation plan in mid-stream is common in business today. "We've seen a fairly consistent trend that on average nearly two-thirds of organizations are changing their sales compensation plans each year," Stoeckman says, citing WorldatWork's latest survey. That change may come even more frequently when business cycles change. Business goals when the economy is moving into an upturn are different than when the economy is going through tough times.

Dig Deeper: How to Keep Your Sales Reps Motivated

How to Set Up a Sales Compensation Plan: Measuring Successful Selling Performance

One critical element of a sales compensation scheme is to measure success of your sales force and whether they are meeting business targets. In order to do so, you need to set effective sales goals and performance objectives and keep a running tally of who is meeting those objectives.  Sales goals should be clearly defined and achievable, but they also need to be challenging enough to motivate sales reps to work hard to achieve them. To determine effective sales goals you'll have to answer some questions. What are the metrics that best reflect sales performance at our company? What are the various dynamics that impact a sales rep's ability to achieve these goals?

"Small businesses can benefit from simple incentive planning that can include comparing each sales rep's goals with their historical performance and reviewing the territories that are being asked to generate the highest and lowest levels of growth," says Shimamoto. "And while it's always good to keep your goal setting calculations simple, they cannot be simplistic.  For example, a goal that requires each rep to grow sales 10 percent annually may be easy for the reps to understand but it may not be a fair goal if the reps work in very different selling environments."

Finally, a company should also set performance goals on the more qualitative elements of selling: teamwork, customer relationships, flexibility, and initiative. A star seller, for example, who also is a lone wolf, may be asked to enroll in a training program to help improve his ability to work on teams. Or an experienced salesperson may be asked to mentor someone on her team or join a new product development strategy committee.

Communication to the sales staff about performance metrics is also key. Shimamoto suggests publishing performance scorecards on a regular basis. Realizing the value of accurate and timely reporting has led to more and more companies adopting Web-based solutions that calculate performance and communicate sales incentive earnings via user-friendly reports. Sales incentive management programs are available on a software-as-a-service basis from such providers as Salesforce.com, Xactly, Incentive, Callidus Software, and Makana Solutions, among other providers.

"Designed and delivered well, sales compensation scorecards can be an eagerly awaited event each month," Shimamoto says. "They can keep the sales force on track and provide just the right amount of motivation to close the next deal or break into a new account."

Dig Deeper: A Sample Commission Form for Your Sales Staff

RELATED LINKS
Motivating Employees
How-to Guides on motivating employees.

The Commission Conundrum
Column that explores the use of a commission-only sales staff.

Managing One-to-One
Article about tailoring offerings to individual employees.

No More Spreadsheets
A run-down of online sales incentives management service providers.

RECOMMENDED RESOURCES
The Complete Guide to Sales Force Incentive Compensation -- How to Design and Implement Plans That Work
A book published by a division of the American Management Association and written by Andris A. Zoltners, Prabhakant Sinha, and Sally E. Lorimer.

Sales Compensation Best Practices: Designing New Sales Plans
Downloadable white paper from online sales incentive compensation services company Incentive.

WorldatWork: The Total Rewards Association
Non-profit organization dedicated to sharing information about compensation, benefits, and work-life balance.




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