I recently wrote an article that talked about the alignment of incentives and outcomes. That sentiment is never truer than in how we compensate salespeople--who, we know, are typically coin operated. The whole idea is to give salespeople the incentive to make more money by selling more.
The problem, however, is that you can find yourself in a place where your incentives aren't aligned with the results you want, especially when your commission structure is in conflict with your sales cycle.
Let me dig into that a bit.
It's typical that most salespeople get paid a mix of a base salary in addition to a variable component, like a bonus or a commission. As business owners, it's very attractive to make a high percentage of that pay mix variable. That way, if the person performs well, they get paid more and the company benefits as well. A high performer might make a ton of money, which is OK because they're bringing in so much business. On the flip side, if the salesperson isn't performing, they don't get paid much -- which means they may opt out of the company voluntarily. It feels self-regulating and actually assists in figuring out who is an A player.
A problem with weighting the pay mix too heavily towards variable can arise based on how long it takes to sell your product.
Let's consider two examples.
Company A makes a retail product that sells for $5,000 to $10,000 and a salesperson sells something every day--sometimes twice a day.
Company B, on the other hand, sells complicated business IT infrastructure software to Fortune 500 companies. The price tag for the software can run into the millions or tens of millions, but a salesperson can only count on a monster sale about once a year--maybe once every two years.
Since the salesperson in Company A is making 200 to 300 sales a year, it's OK to pay then a high percentage of pay in commission. You might even be able to pay them 100% commission and they'd be happy because they are constantly earning money from their sales. It's predictable and they can always do better tomorrow. Again, top salespeople might be killing it for you while lower performers might opt to work elsewhere. You would still want to calculate a target income based on a reasonable number of sales a year to set the commission rate.
But in Company B, since the sales cycle is so complex, long, and slow--where you need to engage multiple levels of the customer like legal, finance, marketing, and engineering--paying too much in variable compensation will likely cause problems with your sales team. They would starve during the time it takes to close the sale. That means you need to pay these folks a much higher base with a smaller variable sweetener. If their target pay is something like $150,000 a year, you might need to pay them a fixed salary of $130,000 and then something like a 0.5% commission on the value of the sale. That way they could land a $250,000 commission or more when they periodically close that giant sale. This works out well for both the salesperson and the company. It's a little harder to find the A players with this pay structure since there are so few sales and commission checks.
When you are thinking about sales compensation and commissions, take into account the length of the sale's cycle of your product and remember that short sales cycles can have more commission and long sales cycles need more base pay.