Designing sales compensation plans for your startup
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Sales incentives are one of the most complex areas of sales compensation, and they generally have a significant impact on company results. Designing successful sales compensation plans for your startup requires a fine balance of business strategy, competitive pay levels, and affordability.
Once your startup has established a design team for the plan (see Successful sales compensation plans: Setting the foundation), you can begin the design process.
Designing the sales compensation plans
Designing sales compensation plans involves a number of decisions that will define how plans will be managed and how a salesperson will be paid. This will include exploring the five factors outlined below.
Once designed, both your sales and finance teams should test a plan extensively to identify problems or gaps, based on circumstances that may arise for your business.
1. Eligibility: Who will participate in the sales compensation plan?
Your first step in developing a sales compensation plan is to determine who will participate in the sales plan. Start with those who have direct impact on a sale, such as salespeople, sales executives, or, for more complex products and services, possibly a technical pre-sales consultant or engineer.
If an executive participates in the sales compensation plan, ensure that no conflict of interest exists for making compensation plan decisions, and that the plan is aligned with any other executive bonus plan in which they may participate.
For a startup, it’s best to keep the plan as simple and clear as possible, and not include too many peripheral support roles.
2. Total target compensation
Total target compensation is defined as the total amount that someone would earn if they met their annual quota.
It is important to establish a competitive value for the job in relation to the market for similar skills in your region and industry. This can be determined using informal networks or more formal channels such as purchasing published compensation survey data. Ensure it is the total target compensation value that you review, because the mix of salary and incentive will vary based on a number of factors.
Using total target compensation as the benchmark (as opposed to actual incentive payments) is considered the best practice, as there can be many uncontrollable or irrelevant factors that affect the actual incentive pay in a given year.
3. Compensation mix, or leverage
Matching the right compensation mix or leverage for your plan (the ratio of base salary to incentive compensation) to the role is critical. The mix will affect the type of salesperson you’ll attract and the type of behaviour you’ll see.
Example: If a salesperson’s total target compensation was $150,000 with a 50/50 mix, then their base salary would be $75,000 (50%) and their target or planned incentive pay would be $75,000 (50%) if they achieved their quota. Actual amounts earned, however, would fluctuate (often dramatically) based on what is achieved.
Two key factors influence the compensation mix of a job:
a) The degree of time spent devoted to driving sales versus other responsibilities such as management, administration or ongoing customer service and support. The higher the focus on selling, the higher the percentage of incentive.
b) The length and complexity of the sales cycle. Generally, the longer the sales cycle, the higher the percentage of base salary to provide continuity of income and to recognize the effort required for each sale
4. Performance measures
Typically, performance measures in sales compensation plans will include one or more of the following:
- Revenue—note, it can be difficult to set quotas without historical data
- Profitability—like revenue, profitability can also be difficult to forecast, but considers both the revenue and expense for each sale. For example, if the salesperson can change the price of the product or service within set guidelines, this will affect profitability due to lower or higher revenue. Similarly, if the salesperson adds functionality or more service options to the product or sale, this will affect the cost or the expense of the sale and lower the profitability
- Strategic objectives—this involves specific milestones that are typically qualitative and well defined
In a startup, the criteria on which the quotas are based are typically reviewed monthly or quarterly so that adjustments can be made as experience builds.
5. Incentive formulas and features in sales compensation plans
There are many possibilities to consider when determining incentive formulas and features. The incentive formula may be very simple (e.g., a quota-based plan). Or there can be many variables that make up a salesperson’s incentive formula.
The key to the calculation is to tie the market value, or total target compensation, of the salesperson to the performance measure. This will allow you to calculate the incentive payout at any level of achievement. This can vary by job or job level, but it is wise to keep the formula as simple as possible.
The incentive formula can also feature accelerators or caps. An accelerator is an increased rate of incentive once the salesperson reaches their target or quota. For example, a commission rate may be 5% until a quota is achieved and then increase to 7% for sales beyond that target. The incentive formula may also have a pre-determined cap that limits the amount of incentive that is paid.
For an example of incentive formulas and features, see Sales compensation plan: Sample template of a sales contract.
Testing and modelling sales compensation plans
The cost modelling process is critical to determine any “loopholes” in the design of the sales payout formulas in any sales compensation plan. It is typically the finance team that will examine “what-if” scenarios and financial ratios (e.g., product profit margins, costs of sales) to determine the potential effect on affordability.
Modelling is also used to finalize performance measures and weightings by ensuring that the performance measures used for each salesperson are weighted to drive the right behaviours. For example, if a salesperson has a significant amount of weighting tied to products that are being discontinued, they will continue to focus on those products because of the payoff.
Further reading
For more information on sales compensation plans, see:
- Successful sales compensation plans: Setting the foundation
- Implementing and evaluating sales compensation plans