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.

Some people hear the word “bonus” and mistakenly conclude that the payout outcome will be binary (all or nothing). While that’s possible, it’s rarely advisable. A typical sales compensation bonus plan will include payout rates to pay additional compensation for every increment of additional performance. The most straightforward approach here is to pay 1% of the target payout for every 1% of the quota achieved. So if the target payout is $40,000 and the quota is $1,000,000 then for every $10,000 in sales (1% of $1M), $400 is paid (1% of $40,000). It is also usually advisable to pay at a higher rate once the quota is achieved. So in our example, the payout for every additional 1% of quota over 100% (every $10,000 over $1M) might be 2% of the target incentive ($800).

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.

To be clear, this law would apply only to true commission plans, so sales incentives paid as a goal-based incentive would not be subject to it. For more on the difference between these two, see What is the difference between a commission and a bonus? (Note that a goal-based incentive is officially called a “bonus” by WorldatWork, the accepted keepers of the “Sales Compensation Body of Knowledge.”)

It is always a best practice to provide great plan documentation, and we generally recommend it take at least two forms, possibly three:

1. The rollout presentation. This is often a PowerPoint document which provides an overview of the plan design, explains what is new for the updated plans, and makes it clear what focus, behaviors and results are needed to earn well under the new plans.
2. The plan document. This explains the plan in further detail, ideally with good examples included. It is not general across all sales people, but specific to the person who receives it, and includes documentation of their own target compensation and sales goals. It also includes a section covering a range of contingencies (shared sales credit, crediting rules in case of transfers, provisions for leaves of absence and termination, management discretion clause, etc.). It needs to be technically correct in terms of the mechanics of the compensation plan, but also needs to be reviewed by legal counsel in all jurisdictions in which eligible employees live and work.
3. The earnings estimation calculator. This is either built in to  the compensation administration system as a feature, or provided as a stand-alone spreadsheet, often in Excel. It allows the incentive-eligible employee to enter sales goals and target compensation, and also possible sales results, and see the resulting compensation. (We love it when a comp plan is so simple that a calculator would be overkill, so occasionally we can recommend NOT providing a calculator. But for most businesses, a calculator can be a great tool to speed understanding of a new plan.)

These three communication tools are so vital to plan success that they are standard deliverables in all Cygnal Group Full Service plan design engagements.

New business sales jobs focus primarily on acquiring new accounts.  The incentive plan rewards for new revenue or profit margin brought to the company.  In contrast, account managers often are assigned a book of business that includes several new business sellers’ territories. Their focus is on retaining and growing established accounts (so new business sellers can continue to bring in new customers).

The territory manager we will discuss is a hybrid of the two with the expectation to not only acquire new customers but also retain these customers (and grow revenue or profit margin). The compensation plan that results is often is a hybrid of the hunter and farmer plans’ key components that may let the territory manager decide whether hunting or farming will maximize the incentive pay regardless of sales management’s preference for a more balanced approach.

An alternative approach that has been more successful in achieving sales management’s objective is to measure performance and pay incentive pay based on net new business revenue or profit margin.  This approach communicates to territory managers that any lost business must be offset by new customer acquisition or selling additional products or services to current customers.

The key is that the net new business goal is set based on historical territory performance plus the desired growth.  The goal will not usually be as great as for a direct seller since the lost business goal for account managers is an offset to the growth.  In addition, there is often real work involved in servicing and maintaining the established book at historical levels before any growth is achieved. However, the net new business goal should always be a positive number – new business exceed anticipated losses to keep the territory manager focused on growing the business by at least the overall percent the company is expecting revenue or profit margin to grow.

When goal setting is a challenge for this job and results may be volatile, and effective compensation arrangement may be a mix of bonus and commission.  For example a prorated bonus is paid for performance above threshold to excellence (e.g., 80% to 120%) then a commission is paid for above excellence performance (over 120% in this example).  This approach retains the needed linkage between pay and performance while ensuring that the additional incentive dollars are self-funded.

A well-written sales compensation plan document clearly defines when the commission* is officially “earned,” and this may or may not be at the same time that it is paid. Many companies will pay some or all of the commission for a sale following the booking of the order, but reserve the right to reverse sales credit and payment if the order is cancelled, the product is returned, or the sales value is not collected from the customer within a certain timeframe.

Typical “triggers” for payment include:

• Booking/Order: The customer has agreed to purchase a specific product or service at a specific time for a specific price with specific terms, all documented in writing (e.g., booking)
• Shipment/Work completed: The product is shipped from the warehouse, or the service is delivered and accepted by the customer
• Revenue: Revenue for the sale is recognized in the company’s account in system (which may be triggered by shipment or service delivery as well)
• Cash: Some or all of the payment for the sale is received.

In the case where some or all of the commission is withheld until the company receives payment from the customer, some states (Illinois and Maryland) are beginning to adopt what is called “substantial procurement” doctrine, recognizing the right of sales people to be paid commission for booking a sale, even if their plan document states that payment is not earned or made until cash is received.

Despite this clearly defined “trigger” for earning and payment in the plan document, former employees in Illinois and Maryland can now argue otherwise. Their argument is rooted in the significant investment of time and effort on their part culminating in the successful close of the sale. They argue that a booked order “substantially procured” the commission because they (1) were able to convince the customer to agree to the sale, (2) processed the order, and (3) knew the company was prepared to ship or deliver the product or service to the customer.

In today’s economy, with companies struggling to maintain their cash flow, sales reps are not typically in the business of securing payment, leaving this task to their friends in accounts receivable.

Bottom line: In at least two states in the US, your sales people have the right to their commission payment if they obtained the order, regardless of the wording of your sales compensation plan document. Thus far, the practical implications have extended only to terminated employees. Watch for similar actions in other states, and for sales people making the claim that payments may not be withheld until cash is received if their job is done once the order is obtained.

For more details see the article on the SHRM web site by Joan Deschenaux (SHRM Senior Legal Editor), visible only to SHRM members.

*To date, this issue has arisen only with true commission plans (communicating compensation as a percent of the value of what is sold). However, the principles apply and the issue may shortly arise with other forms of sales compensation including quota-based incentives or bonus-type plans.

First place to look is your plans document

If you don’t have one, then there’s probably no legally binding obligation so you’re free to think about what you should do (not what you must do). If you do have a plan document (which you should), you will need to follow your own commitments. If the plan documents it includes a “management discretion clause” or beginning and ending effective dates (which it should), then you are under no obligation for future years (in most jurisdictions); however, your choices here will be watched carefully by current staff – so be sure your choices are consistent with the type of selling your people are doing. And that’s where we’ll focus for the rest of this discussion, on…

What type of sales role do you have

• Independent operators who build their own books of business with a high rate of renewal or repeat business
• New business sales people who sell multi-year deals into an assigned territory
• Account managers who manage and grow an assigned book of named accounts

There are many other sales roles, but these are the three for which the question of the future commission buy-out would be most likely to arise. (And if you’ve got another type you’re wondering about, please post a comment below or send me an email, and we’ll add it in if we’ve overlooked something!) We’ll take each of these one at a time.

Independent operators who build their own books of business with a high rate of renewal or repeat business

This would be typical of someone selling a subscription service (software as a service or business class internet services), or an ongoing agreement (insurance), investment management, etc. In these businesses, sales people work hard to land new accounts and make a modest amount of money in their first year, but make the more meaningful income as they grow their “book” based on the annuity stream it provides in the out-years. If the product or service being sold is available from other very similar competitors, then these sales people may be able to go to another competing company and have much of their book of business transfer with them. They are often on 100% commission plans (no base, or perhaps a modest recoverable draw against commissions).

These people are truly running their own business inside of their employer’s business. There are often arrangements at retirement for the successful sales person to “sell” their book of business to a younger sales person because that annuity stream has substantial value; and their employer may accept, or even encourage, this practice because it enhances the chance that those valuable customers will remain with them after the retirement of the long-time sales person. In these cases, there is often a buy-out in some sense, but it’s not the employer who buys out the future commission stream – it’s a fellow sales person.

New business sales people who sell multi-year deals into an assigned territory

This type of role is often found in large systems sales (software with implementation services, utility infrastructure, large scale construction). Deals are large, often with very long (multi-year) sales cycles. And the company recognizes revenue from these sales over a long period of time, typically several year. Sales people who lead the selling effort for these deals are often paid over the deployment period as revenue is recognized (sometimes with an up-front “win bonus” or other mechanics – but payment triggers is a whole separate topic). These sales people typically have a more substantial base pay, enough to live on (perhaps not comfortably) in the “building” years before the first deal is closed. Their compensation on the large deals may eventually make up 40% – 60% of their total compensation, but far short of all of it.

If a sales person who has been successful selling several of these large deals leaves the company before full payment is made, a few different approaches could make sense:

• Continue to pay the commissions under the standard compensation plans, even after the sales person has retired. This would be appropriate if the deals include substantial anticipated revenue that is not a full commitment (e.g., up to 1000 hours of professional services at $200/hour). In this case, the reason for the delayed payment may be that it’s not absolutely clear what the full value of the contract will be by the time it’s over – so the most sensible approach is to just pay it out as it would otherwise have been paid.
• Pay commission only up to the time of retirement. This would be especially sensible if there is an ongoing responsibility for managing the customer relationship through the deployment, and this responsibility will need to be assigned to another sales person when sales person retires. That newly assigned sales person will need to be paid for their contributions, so they would likely pick up the commission stream from that point. (Alternatively, there could be some sharing of the future commission stream if a good handoff is important to incentivize.)
• Buy out the future commission stream at retirement. If the full value of the deal is known at signing, and the comp value is also known, it may just be simpler for all concerned to calculate the expected value of the future commissions, perhaps discounting the out-years a bit based on the time value of money, and end the tracking and accounting with a check at retirement.

Account managers who manage and grow an assigned book of named accounts

These sales people are responsible for important accounts, often the largest and most important accounts in the company. They may have been the original seller, or they may have “inherited” the accounts from others who came before them. Either way, their job is to maintain and grow these account on behalf of the company. Typically they are coordinating multiple resources inside the company to serve the needs of their assigned customers. They generally have a substantial base pay, and a stated target incentive amount, perhaps in a 60/40 to 70/30 mix (%base / % incentive at target), with the ability to earn about twice the incentive target in a great year with great results.

These people are team players who are doing an important job inside the company as part of a larger group. Their incentive pay is really for this year’s results given the book and opportunities that came their way. No buyout of future commission payment would really make sense for them. In fact, their compensation plan is likely to be a bonus type plan and not a commission plan anyway.

By Beth Carroll, The Cygnal Group

(Read Spotlight on a Sales Representative: A Sales Rep’s Perspective on How Sales Compensation Plans are Implemented and Communicated)

Communicating changing sales compensation plans is never easy. The salesforce will always start with the assumption that the new plan is going to take something away from them, and will be skeptical of anything the company tries to push as a “positive change.” It usually takes two payout cycles under a new plan for the reps to figure out what behaviors they need to change to maximize their pay under the plan, and this is the point at which your top performers will finally stop holding their breath about the new plan design (provided, of course, it is designed well and truly rewards top performance in a fair and equitable manner).

There are several strategies that can be used to help ease the change process for the salesforce.

• Include the reps in the assessment process by interviewing or surveying them before you begin the redesign effort. If you don’t have time to talk to every rep (and there are diminishing returns the more reps you talk to), be sure you select a few from each role who are new reps and a few who are tenured. You can typically avoid under performers UNLESS they were star performers under previous year plan designs. In this case, find out what has changed.

• Be sure you include sales management on the design team. However, do not under any circumstances include anyone as part of the design team who will be paid under or as a direct roll-up of plans being designed. It is impossible for anyone to be objective when it comes to his/her own pay.

• Once the plans are designed, hold a challenge team meeting with a few of the most vocal sales reps, team leaders and front-line managers who were not part of the design process. They should be told they are helping to craft the plan communications, which they are. However, they will also poke holes in the design (even if you tell them the design is set), and this may provide you with a chance to correct any problems you have missed. Also, your communication effort will be smoother because of this step.

• After the plans have been rolled out, you want to check in with your sales reps frequently to be sure they have understood the plans. Using an earnings calculator is a common way to help reps internalize the designs and plan their year to maximize their pay. This can be a simple Excel-based tool, or it can be an add-on module available from several of the EIM vendors.

When selecting the reps to participate in the process, you want top performers who are vocal and considered leaders by others. Often, you may find you have your most “difficult” sales professional included in this group, and there is usually a reason. A good sales rep never stops negotiating, and will therefore push at every opportunity to get the best deal he/she possibly can — especially from their compensation plan. The only time I truly worry about a plan design is when there are no complaints from the reps.

My employer thinks I made TOO much last year therefore he has a new pay package for me which caps my sales commission! I am paid a percentage of the profits from my sales…..how can I make too much?

Answer

Unfortunately, we don’t have a quick easy answer to make all employers rational sales comp designers. We have to just help the clients who want help, one at a time. That said, here are two principles that may be relevant:

1. No caps. We rarely recommend a sales comp plan be capped – no need to take your top performers’ motivation out. But we do recommend deceleration at high levels of attainment, per-deal caps, caps on the % of margin on a deal that may be paid to the rep, etc. – these keep pay rational even in case of windfalls and large deals that were sold with “help” from company leadership.
2. Over time, sales people generally should earn more money each year – with pay going up as the labor market rates go up (a few percentage points per year). In a well-run company, sales productivity should go up much faster than the labor market rates for the sales people due to the investments the company makes in broadening the product line, building the brand, selling tools and systems, etc. As a result, compensation plans that are communicated as commission (% of revenue or margin sold) generally have to be adjusted so that the payout rates decrease. That’s the only way the math works. For a more thorough explanation of this idea, which helpful illustrations, see the Talking Slide Show, The Cost of Sales Compensation vs. Productivity Over Time (under 2 minutes).

So… you are right that caps aren’t a great idea. But your employer may also be right that there should not be a linear relationship between your compensation and your productivity over the long run.

By Beth Carroll, The Cygnal Group

It’s fall again, the economy appears to have shifted toward the positive in many sectors, and companies are thinking about redesigning their sales compensation plans for 2011. In order to ensure the redesign process and resulting plans will provide a good return, businesses should address six key areas:

1. Planning
2. Involvement
3. Knowledge
4. Modeling
5. Communication
6. Administration.

Planning
Incentive design is a process, not an event. Whether this is your first design effort or you’ve done this more times than you can remember, you should not underestimate the time and effort the project will take, particularly given the recent economic upheavals. You also must allow time to carefully communicate any plan changes. Employees are nervous about adjustments to their compensation in the best of times, but they are especially skittish now. In a tumultuous year, even more time in the design process should be allotted to communication. Keep in mind if you are reading this in September, you may already be running a bit tight on time for a January effective date, although you can still accomplish what you need to if you move quickly but carefully.

Involvement
Too many people involved in a sales compensation design project can be unwieldy; too few can lead to a complete failure of the design if a critical viewpoint was not adequately represented.

Senior leaders must be visibly and vocally supportive, whether or not they are directly involved in the project. Sales leadership, finance, human resources, sales operations and IT must be represented on the design team at fairly high levels, as they are key constituents who have the best knowledge about the organization, the history, the systems, and what is and is not possible with incentives.

The design team should not include anyone whose compensation will be directly affected by the outcome of the process, but a representative sample of sales employees and managers should be interviewed to gain feedback and insights into sales jobs and processes, as well as what has and has not worked in prior compensation plans. Such inclusion will give them a sense of being heard, which can be critical in gaining acceptance once the plan is rolled out.

Knowledge
If there is controversy about the effectiveness of the current plan design, a survey of your salespeople may provide some needed insights to break a logjam. If there is concern regarding the amount being paid relative to market, a market pricing review can provide guidance about the need to raise or lower target pay levels. If management believes the goals that have been set should be attainable, a bell curve graph showing that 80 percent of employees were at 50 percent or less of goal might be what’s needed to show the disconnect between management’s belief and what is realistic. Spend time at the start of the project to build this fact base.

Modeling
Once you have developed your initial recommended plan design, you must model it under different performance scenarios. If you do not take the time to do this important step, you will find an unpleasant unintended consequence the following year; it’s only a matter of when.

What if you are at 80 percent of goal? What about 120 percent? Are the payouts still acceptable as a percentage of revenue or profit? What are the best measures of sales’ contribution to the company? What would you consider a successful outcome for an individual and the company, and based on the modeling, will this plan get you there? Are transition arrangements needed to move people in an orderly fashion into the new plans? All of these questions must be addressed for a successful outcome.

Communication
A simple incentive plan that is well-communicated and understood by the field can be far more effective than the most mathematically perfect design that no one understands. Senior leadership must take the lead in communicating the new plans. Managers should be told about their plans first, as their support is critical to the rest of the communication effort. Examples must be provided showing how different performance results will pay under the new plans.

Plan documents and quota-acknowledgement sheets should be provided in one-on-one meetings between the employee and his/her manager. This meeting should focus on employees’ goals and earnings expectations, their specific strengths and opportunities, and the best ways for them to win under the new plans. Excel-based earnings calculators can be powerful learning and motivational aids, but be careful employees are not so busy estimating their pay that they forget to actually do the work.

Administration
The last key area to address is administration of the plans. Payouts must be on time and accurate in order for salesforce members to trust the plan design and learn to modify their focus to improve their results. As part of the administration process, be sure that regular reports are provided to design team members, so they can assess the plan’s effectiveness as the year progresses, and to employees, so they understand the direct connection between their performance and their pay. It is also a good idea to include a “motivation” section that shows how much additional could have been earned if a hurdle or threshold had been cleared. Often, necessary design changes are only surfaced when it comes time to administer the plans, so test your administrative processes before you actually communicate the new plans to the field.

Conclusion
While there are many right answers for any sales compensation plan, there are perhaps even more wrong answers. A process that addresses each of these six areas will yield a right plan design that will create great value for the company, the salespeople and even your customers.

As far as how much to pay, it’s probably best to start with the total comp needed to attract the right kind of people into the role, and a reasonable number of appointments they should be able to set (that close) per month. If some portion is being paid as base salary, then take the remaining total comp at target per month and divide by the expected number of total appointments that close, and that’s the rate per appointment. Finally, check affordability – is each appointment worth that amount to the company? If not, the sales model doesn’t work and needs a re-think. If so, you’ve got your answer.

The rate per appointment varies wildly from one industry to the next, based on the maturity of the business, the strength of the brand, access to good target buyer lists, etc. But the fundamentals above will guide the comp designer to the right answer.

I have put in links to a couple of “Sales Comp Answers” below that are not specifically about this exact situation, but that do give more detail about the principles that will guide you here.