Presumably the high revenue new equipment sales are generating a reasonable margin, though perhaps at a lower percent. If the relative value of these two offerings is accurately reflected in the margin value generated (dollars/euros…), then Margin Value may be the single measure that combines them both and balances effort and rewards appropriately.

However, there are many reasons businesses give for not using Margin Value as a sales compensation measure, including a reluctance to share margin information broadly and an inability to accurately measure margin at a sales person or order/contract level. In this case it may make sense to split the plan into two separate components with target incentive value assigned for New Equipment and Used Equipment separately, along with goals or quotas for each category. In addition it may be important to link the two measures so that a sales person cannot “win” by doing well on one and not the other. For example, there could be a requirement that in order to earn accelerated over-goal compensation rates on one of the measures, at least 90% of the annual goal has to be achieved on the other measure.

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Three effective ways to approach this:

1. Make revenue the primary measure using a goal-based incentive (see this post for a clear explanation of how a bonus or goal-based incentive work), and add a profitability multiplier. For example, offer the opportunity to earn as much as an additional 20% (1.2 multiplier) at year-end if a stretch profitability goal is achieved, lose as much as 20% of total earnings (0.8 multiplier) if they are below an unacceptable level of profitability, or have no effect on their own earnings in-between (1.0 multiplier). This would be most appropriate if revenue is the most important focus for sales, with profitability in the also-important category. It would also be appropriate if profitability is difficult to measure at the individual level, but very accurate by business unit or in aggregate.
2. Measure sales people only on gross margin or gross profit dollars, and drop revenue as a sales compensation plan measure. This would be appropriate if margin can be accurately tracked and reported by individual sales person. Here again, a goal-based incentive is probably the best choice.
3. Use a matrix with revenue goal attainment on one axis and profitability goal attainment on the other. In the middle of the matrix (at goal on both), pay 100% of the target incentive. As both revenue and profitability increase, pay over-target earnings. Pay very little for below-goal performance on both. And pay in-between if they’re over on one measure and under-goal on the other. It’s a little tricky to design the matrix, but once you’ve got it, it’s very easy to understand and administer.

Goal: Operating Income = -$200,000

To build the payout table, we’ll need threshold and excellence performance levels, a target payout, and a leverage factor.

Threshold = -$400,000

The Threshold is the level of performance below which no payout is earned. Usually the goal is aligned with the annual operating plan. No payout at all below goal means goal setting precision must be very high. A modest payout as goal is approached is often a better design.

Excellence = $0 (breakeven)

In this case where a loss is expected, it may be the case that breakeven would be a fabulous result for the coming year. If so, a handsome reward could be delivered at that point.

Target Incentive = $10,000

Someone reading this is thinking that it’s hard to pay an incentive to reward someone to deliver a loss. And clearly this is not a sustainable business model for the long run. But in come-back situations, or years of investment, it may be a great idea to have those who influence the outcome with compensation at risk, along with upside, for delivering against the annual operating plan.

Remember that we’re talking about sales compensation here, so the assumption is that the incentive pay is true at-risk pay, not over-and-above pay. The person with this incentive opportunity has put some portion of their market value at risk with the expectation that they do influence the outcome materially, and that when they do a great job they could earn back all that they have put at risk, and then some.

So what does the payout table look like? Here’s a sample:

The first approach identifies Sales Managers as members of the company’s management team and should be on the same management incentive plan as other managers in their pay grade. This usually means that some portion (typically 70%) is based on one or two financial measures at the region/area/sales channel level with the remainder based personal objectives (which are also used to determine merit pay increases). At times one of the measures are as high as the total company level; however, these are less effective since measurement at that level is so far from the line of sight of the managers that there is the perception that there is little, if any, alignment to everyday sales management activity.

The second approach sees Sales Managers as team leaders and therefore they should have their incentive pay directly linked to the performance of their team of sales representatives. In this approach, one or two of the key components of the sales representatives’ plan become the measures for the managers. Focus is on outcomes (e.g., new revenue, revenue growth, profit) not on sales activities (e.g., sales calls, closed leads). Activity measurement is best for the annual performance appraisal for the managers’ merit pay increase. The performance measurement for this approach is typically quarterly when the sales representatives are on monthly plans or aligned when both are on quarterly plans (with in some cases of an annual component in some cases for one of the measures).

The third approach is a mixture of the two, for example, 70% weight on team performance and 30% on financials. This sends the message that the primary responsibility is meeting the sales goals that support the Company’s financial metrics. The company stresses the importance of the sales representatives meeting or exceeding goals while also recognizing Sales Managers’ status are members of the management team. In this case as well, other performance measures are used for merit pay increases.

We’ll leave a lot of that to your other advisors and focus here on the compensation piece with the basic steps you need to complete to arrive at the right comp plan for your new hire:

1. Your first step is to determine a reasonable level of total compensation for a sales person in your business — in the U. S., that’s what their W-2 says at the end of the year. This is undoubtedly tied, in the thoughts of company management at least, to how much the person will sell in that first year — the cost needs to be associated with a reasonable return. You’ll get better at that as time goes by, but you’ll have to start with some kind of working assumption based on others in your industry, leadership’s experience in selling your products or services, even to a certain degree the perspective of your top candidates for the role and/or a recruiter who may be helping you to fill it.
2. Next you need to decide how the risk will be shared — how much of that target total compensation will be in a fixed base salary and how much in the incentive at target. For early stage companies, the fixed portion may be relatively low, even non-existent. 30% to 50% of the target total compensation is a good starting place. However, if you are trying to attract a well-established resource to bring their network, skills and experience to your company, you may have to offer a higher base since their choices include many with less risk.
3. Since you know the target total cash and the base, you can subtract to determine the incentive at target. Your next step is to be very clear about WHAT you expect your new sales person to PRODUCE per year. This is usually measured in revenue dollars, but may be measured in units sold or even gross margin dollars in some industries. Whatever the measure(s), you need to design a plan that delivers the target incentive amount for getting to the productivity goal. This is most typically communicated as a commission (to calculate the rate, divide the target incentive by the productivity expectation). There’s more to consider in designing the payout table than this article can address, such as threshold levels of performance (below which no incentive is earne), acceleration and deceleration in payout rates at over-goal levels of achievement, etc. You will also need to be clear about payout timing (monthly, quarterly, etc.), and measurement periods (independent or year-to-date). But many early stage companies do fine with a straight commission paid monthly – a single rate based on the incentive at target divided by the productivity expectation (e.g., x% of revenue, y% of margin, $z/unit).
4. Your last design step is to check the plan’s appropriateness across a broad range of possible levels of productivity, and be sure you’re comfortable with both the cost to the company as it relates to results and the income level for the sales person. You will very likely make some kind of adjustment after this review, which should probably involve someone from your Finance group or the company’s owner.
5. Once you feel you have the right design, your next step is to carefully document the plan in a Plan Document to be signed by both the sales person’s manager and the sales person. Here, you should probably ask for a review by your legal counsel.
6. And finally, determine how you will administer the plan – where the data will reside, what reports will be run, who will do the initial calculation, who will review and approve it, and how the information will be communicated to your payroll processors.

Then after you’ve been living with the plan for a few months or quarters, have a look again to see if it’s meeting your needs. Always include a clause in the plan document claiming the right to adjust as needed, then don’t adjust during the plan year unless you’ve got a BIG problem. But do consider adjustments each new plan year. As your business grows and changes, the perfect sales comp plan will also change.

We have a freemium model [offering a valuable service for free, typically online, with options to upgrade to a paid "premium" level of service] where all of our current customers buy online with a credit card. Zero sales interaction. No contract, no lock-in. The customers pay for the resources they’ve allocated to their application monthly in arrears.

But there are a lot of prospects and customers who would benefit from interaction with a sales person.

What we’ve started to do: We recently hired a sales guy. He’s being alerted to existing customers who do something that demonstrates deepening interest or commitment (i.e move from a shared to dedicated database). The sales guy e-mails the customer to see what they’re doing and how we can help. Once the customer replies and we connect with them, we help them be more successful on the app — which often times leads them to spend more. The goal is to get wider and deeper in the organization, piggybacking on the existing user’s early success.

But how do you comp that? There’s no close date. There’s no ACV [Annual Contract Value].

Answer:

At a high level, my suggestion is that this can’t be a high-risk/high-upside role since it will be hard to attribute definite income statement effects to the successful sales person’s effort. But some variable pay (20% – 25% of total comp at target) with a measure like average spend per customer (for customers > $xx in ACV), or average number of users/customer (again for “substantial” customers, or customers at least 6 months old or, …).

Try to find a measure that would improve if the type of customer that has long-term potential is finding more value in your offering, but be careful not to let successfully bringing in a lot of new early-stage customers drive the measure down. That’s the reason for measuring only those who have been with you for some length of time, or have some threshold level of established usage. Then the evidence of “sales” success would be making that sort of measure improve by a few percentage points – no incentive pay if it doesn’t improve, target payout at the targeted (and achievable) level of improvement, and meaningful upside if improvement exceeds expectations.

Would love to hear other ideas – please comment below if you can add to the discussion.

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.

Large sales organizations need structure. Local businesses need to focus their sales team on local priorities. How can these apparently conflicting needs be balanced? No talking on this one, but some good ideas!

To view at your own pace, click the Play button (>), then click Pause (||) and advance the slides using the controls on the bottom left.

By Beth Carroll and Donya Rose

The economy appears to have taken a positive turn and many companies are starting to think about growth:  hiring more sales reps, launching a new product, or breaking into a new market segment.  One of the first questions that is raised when a company returns to growth mode, especially if there has been significant retrenching, is, “What should we do with our sales compensation plans?” Odds are high that the right focus for the recession is not going to be the best focus for the company’s growth phase. It may be time to take a hard look at your sales incentive plans.  There are some key indicators you can check to determine if it’s time to make a change, and if it is, if you can afford to wait until January 1 (or the start of your next fiscal year) to implement the new plans.

1. You scaled back (or perhaps eliminated) incentive compensation during the recession, and now you see that your people are not engaged fully to capitalize on sales opportunities.You need to act as quickly as possible to regain momentum and re-energize your sales staff. While this is not a situation that should be left in place until the start of the next fiscal year, a full redesign of the plans may not be the only alternative. First, consider SPIFFs, contests and recognition programs. Are there things that can be done that will quickly drive new sales and create increased enthusiasm in a cost-effective manner? Second, consider adding a small “bounty” type incentive that provides additional income tied directly to the performance you need most right now (e.g., new customer acquisition), but that limits your exposure if sales opportunity radically exceeds or falls short of your expectations. Third, if you can, consider a stub-year plan that will shift people in the direction you will want to go at the start of the next fiscal year. If you filled in an incentive gap by increasing base salaries, you can start to move them back down again. If your employees have been earning 60% of what they earned in better years, you can start to bring that number back up again by developing a more modest incentive program with less leverage than was appropriate in more stable market conditions. In addition, you should consider the culture that has been enforced (or created) by your sales compensation program. Should you add a team-based element to keep the focus on working togethe
2. You scaled back your expectations in terms of goals or volume production, and now you are starting to see payouts that are far higher than you expected. This is also a situation that has the potential for serious negative consequences on two fronts. First, your company’s financial performance could be adversely affected by overpayment in the incentive program. Second, your employees’ sense of their own value in the market place could be inflated beyond reasonable expectations. It is remarkable how quickly salespeople come to expect a higher level of earnings on an on-going basis once they have experienced it for a few months or quarters. It can be very hard for them to accept the adjustment that will inevitably be required. Quick action is needed to recalibrate expectations, supported by thorough modeling to make sure that pay levels return to appropriate levels without damage to morale, and while still providing significant upside earnings potential for true top performance.
3. You are finding it difficult to hire top talent, and the reason cited is the lack of a competitive compensation package. You can take a two-pronged approach on this and develop a plan for new hires that would be a lead-in to next year’s plan for the existing staff. Because many companies provide a guarantee for new hires, such an arrangement is possible for a few months before any significant discrepancies in the two versions of the incentive plan are felt. However, you will want to make the transition strategy clear for the incumbents so they know that at a specific future date they will be moved onto the new incentive plan as well. Many salespeople have become leery of 100% variable plans, as they’ve seen what can happen when they fail to cover their draw month after month. Even top salespeople in industries that are highly risk-tolerant may be more interested in finding programs with at least a modest base salary. A 40/60 to 60/40 pay mix is reasonably aggressive, and yet either option allows some degree of control from an employer/employee perspective while providing salespeople with a greater sense of security. Of course, the less variability in the plan, the less leverage on the upside, as this is a necessary trade-off. But it is one that can be designed to provide very attractive earnings opportunities to true top performers.

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Business need: Profitable business

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Business need: Growth in sales of new/strategic products/services, or targeted customer types (e.g., new customers or customers in specific industries)

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Business need: Sales over goal/quota

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Business need: Consistent sales performance

Finally, with all these measurement possibilities and linkages on display, we feel compelled to caution you that, when it comes to sales compensation plan design,

Simpler Is Better. Be careful. No Gratuitous Complexity.

Only include these types of components in support of strategic imperatives for the business. And remember that you only really get to "say" about three things with your compensation plan and be "heard." Just because you can, that doesn’t mean you should.