1. Relevant – the incentive program should be tied to meaningful business results. Define what matters to your business, what are your objectives for the year (improved customer service, increased revenue from new customers, better margins from existing customers, improved operating profit, etc.) and link your bonus to those objectives.

2. Controllable – to the extent possible, drive the measures as close to the individual’s line of sight as possible. If the overall objective is improved operating profit, think about how each person can impact that measure and tie a portion of the plan to the specific results they can deliver that help achieve this goal. For Accounting, that might be an A/R balance target of $0 > 90 days. For Sales, it might be improved top line growth which provides more revenue to work with to cover expenses. For HR it might be better recruiting performance with less turnover.

3. Measurable – if you can’t measure it, you can’t pay for it. Also, you need to be able to automate your measurements as much as possible or you will drive yourself crazy with the added administrative burden of calculating bonuses. For many roles, you will only need to calculate a bonus at most quarterly (for some annually is just fine). For Sales roles you will find yourself calculating pay more often, probably using more complex calculations, which is why sales compensation is a specialized compensation function and consulting discipline.

4. Objective – you need to avoid subjective payouts at all costs. These are demoralizing and risk legal challenges. Pool approaches, though common in small companies, are often based on a subjective allocation (“we’ll see how much extra we made and then share that with the staff”), but this does not provide anyone with a goal or ability to take control of their potential payout. Instead, any bonus under this type of approach ends up being just additional pay with zero motivational value.

Another caution for small companies is to not base their employee bonus on final operating profit (after management/ownership has taken out their disbursements) as this creates a conflict of interest and lack of control in the outcome for employees, as the more the owners take in disbursements the smaller the profit to use for employee bonuses. The employee bonus amount should be determined prior to owner disbursement and budgeted for as a fixed cost rather than just a “sharing of the profits” at the end of the year.

Generally small companies start from the wrong end of the equation when thinking about bonuses. They ask “what do we have left over” rather than thinking about “what do we need to pay to get good talent, and how can we divide that pay up between salary and bonus for the maximum motivation.” Obviously the economics need to work out either way, and the second approach requires more management involvement in controlling staffing costs, but the bonus targets should be built into the budget, allowing for upside if company and individual goals are exceeded.

The right system can have a dramatic effect on productivity and morale, because people will know what is expected of them and what they can do to change the outcome, plus it creates a map for the company showing how everyone fits together to achieve his/her own piece of the puzzle that will lead to the company’s overall success…provided the 4 watch-words above are adhered to in the design. A program that uses measures that are irrelevant to the business, uncontrollable by the employee, not measureable, and not objective would of course have a profoundly negative effect!

1. A limited number of specific objectives should be assigned to each person so that the plan is easy to understand and administer, and so that sales people have a clear understanding of what is expected, and what they will earn based on what they do. The objectives are weighted so that 100% of the target payout amount is divided among them.
2. The objectives need to be stated in a way that provides for different levels of payout since pay at risk and upside both matter to creating good motivation. There should be some level of performance below which no incentive is earned (threshold performance), some level at which the target incentive is earned (at-goal performance), and a higher level at which some upside is offered (excellence performance). This will provide a basis for keeping sales people “in the game” over an expected range of performance, and will encourage over-goal performance.
3. At the end of the performance period, evaluation of sales person performance should be straight-forward and objective so that any three people who understand the business and the objectives would easily agree as to whether the sales person had: (1) failed to meet the threshold, (2) exceeded the threshold but had not met the goal, (3) had met the goal but not the excellence level of performance, or (4) had met or exceeded excellence.

Then when it is time to assess performance and deliver the payment, an assessment table and calculation method like that shown below works well:

Well-crafted objectives like those shown above provide clear guidance and link pay to performance over a range of possibilities.

This is a topic on which sales leaders and finance people have strong opinions. While I’ll discuss some of the nuances around the topic below, my bottom line is that most people should achieve or exceed quota.

To be more specific, more than half of the people should hit or exceed their goal. This would be clear evidence of a “achievable quotas.” While it may be difficult to tell at the start of the measurement period whether or not assigned quotas are truly achievable, it is not at all difficult to tell by the end of the measurement period — if most people achieved the quotas, then they were achievable; if not, then they weren’t.

Why do attainable quotas matter?

1. Motivation. Most people, and even more sales people, want to be “successful.” The quota is the performance standard. People who don’t get there are underperforming, and people who get to quota are performing well, and people who exceed their quota are over performing. The opportunity to be successful, and to be seen as successful, and to enjoy the fruits of success (good variable pay) — these are powerful motivators. Quotas which are out of reach for most people create at least as much frustration as motivation.
2. Management credibility. Attainable quotas are a sign that the company and sales leaders understand their market, their value proposition, and their selling model. Territories are balanced, sales resources are appropriately deployed, and a reliable selling system is in place so that the relationship between sales capacity and sales results is a stable. Sales people like to be part of such a system, customers like to be served by such a system, investors like to invest in such a system. Attainable quotas are a clear sign that this sort of value-creating selling process is in place.
3. Delivering market-competitive pay. Most companies intend to pay their sales people at a level which is competitive for the market. If the combination of base pay plus the incentive that target (at quota) is set so that it will deliver market-competitive pay, then if most of the sales organization does not achieve their quotas you will have most of the sales organization not earning market-competitive pay. Some companies mitigate this risk communicating above-market pay in anticipation of under-performance versus quotas, hoping to actually deliver market-competitive pay median performer. However, you can imagine how assumption-filled the analysis is which connects expected total compensation to market values.
4. Budgeting and performance prediction. For the purpose of predicting the performance of the sales organization and the cost of their compensation, the most straight-forward approach would be based on assuming that average quota attainment is 100% of quota average target incentive earned is a bit more (usually 5% to 12% depending on the amount of acceleration in the comp plan). Trying to predict total sales productivity and the cost of compensation in a business in which quotas are generally not attained can become an exercise guessing, gamesmanship, and frustration for all involved.

This is all about quota — what about the rest of the performance distribution?

If the objective is to maximize the motivational value of the comp plans, the ideal performance distribution is:

• Not more than 5% of the sales people “out of the money” (earning no variable pay), and the these people should generally not be “keepers”
• About 40% of the sales people earning some variable pay, but less than the target amount
• About 45% of the sales people earning more than the target amount, but less than the fully leveraged upside (fully leveraged upside is generally 2 to 3 times the target incentive)
• About 10% of the sales people earning the fully leveraged upside or more.

Question

Our sales people sell long-term deals, most of which span several years. When should they be paid for these – upon signing, as invoiced, when revenue is recognized, at completion, or a combination of these?

Answer

We have seen several different compensation arrangements for long-term deals, which are often found in subscription businesses (e.g., SaaS, phone/internet service, online test delivery), and complex multi-year implementations requiring installation/configuration (e.g., enterprise software, utility infrastructure). Some businesses pay the sales people who sell these long-term deals all at once, and others stage the payment over time. The most common arrangements we have seen are listed below, along with some idea of when they are most valuable:

Pay upon contract execution

This is most common when the sales person is a pure “hunter” and there are project management or account management people in place to take the hand off after the contract is signed. The sales person has “done their job” when the contract is signed. And the value of the contract to the company is very likely to be exactly as expected at the time of signing.

Pay as invoiced

In this case, the customer may pay a portion of the agreed price at signing, then pay over the course of the contract, perhaps as milestones are attained, or perhaps on a regularly monthly schedule. Often the sales person will receive payment after each invoice is created. In many types of business this will also align with revenue recognition (when goods are shipped), but may not (especially in the case of software sales or professional services for installation). This type of payment policy will keep the sales person focused on ensuring the contract is executed as planned, and invoices are generated. It will also allow the company to better align the cost of the sales compensation with the income received. And in cases in which the contract is for a rate (e.g., for bandwidth used, hours of professional services, or tests delivered), it will ensure that the sales people is paid fairly for actual realized sales.

Pay when cash is received

If collection is often an issue, or if sales compensation cost must be funded directly out of cash receipts, a cash-based payment policy may be used. This will have the effect of focusing the sales person on seeing the transaction all the way through to collection. This is most commonly used in cash-flow-constrained early-stage businesses. Most more mature businesses find that well-written contracts and careful negotiation of terms, combined with customer-pleasing delivery and a capable accounts receivable function ensure the cash comes in; and they would rather have their sales people focused on selling than on collections.

Pay when revenue is recognized

Especially in the sales of licensed software, software as a service, and professional services associated with software implementations, revenue recognition rules come into play. It is possible for contract to be signed, and even for substantial cash to be received, and yet for the company to not be able to recognize significant revenue until a later quarter or year. When revenue recognition that is potentially out of alignment with order acceptance, invoice generation, and cash receipt is an important business goal, sales people may be paid based on recognized revenue.

Pay portions of the compensation on a deal based on a combination of the above “triggers”

In some cases, several of the objectives cited above may be in play. For example, there are new business “hunter” sales roles for which the “handoff” to the project management team happens over a six month period while implementation is under way. In such a case, 50% 0f the payment for the deal may be made following contract signing, and 50% following completion of implementation.

Key principles

1. Finish paying the sales person at the point at which you would like them to disengage and focus on the next deal for the typical deal.
2. It’s reasonable and appropriate to include charge-back provisions so that sales credit and payment will be reversed if deals fail to materialize as anticipated. This should only be used as a fail-safe when such reversals are rare (well under10% of deals).
3. The payout arrangement has to work for the sales person and the company – so if the company is cash-strapped, payment aligned with cash collection may need to be considered.
4. Beware annuity “tails” – they create plan administration complexity, encumber the company years from now based on a plan designed today, and, over time, may create a situation in which current year pay is not tied to current year success for sales people.

Most of the time, the amount of the commission at goal (or “quota”) is higher if the quota is higher – so if one sales person has a $1M quota and another has a $1.5M quota, then one has a target commission that is 150% that of the other. Whereas in a “bonus” world, the target incentive is fixed for the role (e.g., $40k per year) and is paid for hitting quota, which may vary from one person to the next. Of course there are myriad nuances and variations, including the possibility of “personal commission rates” which communicate a “bonus” as if it were a “commission,” etc.

In deciding whether your compensation plan should be quota-based or commission-based, the key question is one of your business’ philosophical starting place about variable pay for sales people.

1. Do you start with a fixed amount you know you can afford to pay to get your offering sold (e.g., 5% of revenue), and design the plan to manage to that value?
2. Do you start with the idea that the sales job has a market value, and that those who meet the goals assigned based on the sales organization and roles you have put together should earn that market value?

If your starting place is #1, a commission is likely a better fit for your business. If your starting place is #2, a bonus type incentive could be a better approach. Commissions are more typical and appropriate in earlier stage businesses, new business roles, product launches, and certain industries; and bonuses are more typical and appropriate in more mature businesses, complex selling organizations, and account management roles.

Of course, both the cost of the sales compensation compared to the sales team’s productivity and the compensation delivered to the sales people as it relates to their job prospects outside the company must both work in order to have a successful business model.

1. A performance standard (some say quota, others say productivity expectation or goal) and
2. A good tracking and reporting system (have to keep up with it if we’re going to pay on it).

And I honestly think you could get a lot of traction just by doing those two things well. Add in the reward and you’ve definitely covered a lot of the triggers that help maintain focus and motivation.

A reward system can go awry if the rewards (and risks) are so great that people get a little too “creative” in meeting or exceeding their goals, or if they are so small as to seem to undervalue the contribution they are meant to reward. The first case (inappropriately large incentives) is much of the root cause of the current backlash against incentive pay, in my view.

• Make your own raise – sell more
• We like to keep our fixed cost (base) low and don’t mind if people are paid well as long as they have produced (higher risk, upside).

I would say that you should manage your base (+/- 20% of a range midpoint) if you can clearly articulate what you are paying for in the base, and what you are paying for in the variable pay. A good starting place would be…

Base pay is for

Experience

Potential (expected long-term value to the company)

Leadership

Skills.

Variable pay is for contributions to company success this year, ideally directly affecting the income statement.

If you don’t have a solid performance management system, you may find that latitude in base pay levels will result in not-best-practice practices. Some I have seen include…

• Base pay raises to underperformers to “keep them whole,” sometimes (and you can’t make this stuff up) accompanied by low/no raises to top performers because they already got their money via the variable pay plan
• Everyone at the top of the range – so no differentiation in base
• New hires coming in at a higher base, because that’s what it takes to get them in the door, so that green and less skilled sales people have the highest base pay levels.

All of this is to say that there are potential pitfalls of managing base within a range, and if you aren’t ready to support it with solid performance management, put that foundation in first. But once you do have that in place, you will find that managing base pay within ranges has these advantages:

• You have a way to differentiate pay for people who are highly valuable that does not rely on this year’s sales results
• You can manage your base pay ranges so that they increase over time, along with the variable piece (if you don’t do this, you will end up with a pay mix that is inappropriately incentive-rich because variable will grow while base stays the same)
• If you do decide to change your pay mix to be less incentive-rich (which would be the typical change as a company matures over the years), you will be able to directly control the base pay levels and ranges so that you can do this gradually over time.

Question

Do companies achieve secondary goals like introducing new products or improving the product mix or the average unit price through comp plans? Is it advisable to pursue more than the number one goal of rewarding sales?

Answer

Most sales compensation plans include more than one objective. In a selling environment with any complexity at all, one objective rarely covers all of “the most important things.” Some sales are more valuable than others. These more valuable sales may be literally more profitable (better margin products), or strategically important (solidifies a longer-term relationship with the company), etc.

While I am a passionate advocate for simplicity in sales plan design, most of the plans I have helped to create include more than one component. Examples are:

• Revenue on legacy products, revenue on new products
• Existing customer sales, new customer sales
• First year contract value, out-year contract value
• Sales value (e.g., dollars), margin value (e.g., dollars)
• Individual sales, total team sales
• Bookings, recognized revenue.

Two measures in a comp plan doesn’t worry me – it probably means the comp plan accurately reflects the sales priorities. Three measures may be warranted as well. Four measures can sometimes be justified, but usually is not a good idea. Five measures is more than I can recommend.

You can “say” all you want to in a comp plan, but only about three things can be “heard.” So three measures is a good maximum, and fewer is better as long as you don’t over-simplify the business priorities.

Question

I’m looking for ideas in revamping our sales comp to include metrics and pay for items other than just meeting a traditional sales quota. Perhaps a bonus for a close rate of XYZ, for example. Any ideas are welcome!

Answer

Our counsel is generally to pay for results, financially measurable results (as opposed to activities). Sales compensation, to be really motivating, generally involves significant cash and upside — and you want to be sure that those payouts are rewarding sales people for results that more than cover the money to be paid.

With that said, other great measures besides just sales/bookings/revenue generally have to do with the quality of the sales dollar. Some sales dollars may be more valuable to your company than others — like sales of more profitable products or services, or sales of strategically important new products, or sales into an important targeted industry segment. Also, sales over goal are generally more lucrative for the sales person than those below goal. And consistent sales performance is often valued over sporadic sales performance. These are just a few of many alternatives to just paying on sales. But picking the right one is all about aligning the rewards with what is most important to the success of the business.

Any tips for putting together an incentive plan for “inside sales” employees? We are trying to get our employees into a “value-added selling” frame of mind (instead of price-point) and want to provide an incentive.

Answer

What type of inside sales are they doing? Do they qualify for the 7i exemption or are they non exempt employee? These questions must be answered because, if they are non-exempt, any incentive earned must be included in their hourly rate. If they are exempt, it would make it much easier to implement an incentive with less administrative costs. Assuming you conclude they are either exempt, or that the administrative burden if they aren’t is “worth it,” then here are a few tips for designing their incentive plans.

Tips for Inside Sales Plans

1. Incentives are a great way to support an initiative to change behavior, but the rest of the initiative needs to be in place as well. This may include training, systems enhancements, coaching and mentoring, etc.
2. If you really want to use incentives to motivate and excite, they need “carrots and sticks” to be part of them. Over time you will want to migrate base salaries down as a percent of target total compensation so that the target incentive must be earned in order for the employees to maintain market-competitive pay.
3. The amount of pay at risk depends a great deal on the nature of their inside sales roles. Although it can be more complex than this, one simple division is between jobs that are primarily “inbound” and those that involve more aggressive “outbound” calling. If an inside seller mostly reacts to requests from customers and is primarily doing an order management function (perhaps with some ability to cross-sell or up-sell), then a relatively smaller percent of pay at risk (in the incentive) is appropriate. For outbound inside sales people who more strongly influence a prospect’s decision to buy through their own creativity and initiative, more pay at risk (and more associated upside) would be a good idea.
4. Beyond this, the basic principles of role-based incentive design apply, including the following.

Basic principles for role-based plan design success

1. Pick measures that are linked directly to income generation for the company (e.g., revenue, units sold, margin) rather than activity level (e.g., number of calls)
2. Pick as few measures as possible to cover the primary accountabilities of the role. One or two would be a good number for a newly-instituted plan. Three might be OK. More than three would have to be well-justified as it dilutes both the message communicated by the incentive plan and the payout value of accomplishing any of them.
3. Design the plans with sales leadership’s involvement so that they introduce them with a message like, “Here are our new incentive plans. We are thrilled to share them with you because we believe they will significantly increase both your income and that of the company. Let me show you how . . .”
4. Provide great materials to communicate the plans — since the reason you’re doing it is to motivate and excite your inside sales people.
5. As soon as you have an idea of what the final design may be, start planning for accurate and timely administration of the plans and great reporting. You risk losing much of the motivational value if employees don’t see a frequent and easily understood connection between their results and their earnings.