The question of whether or not to have a threshold is largely philosophical, though one could make a case that there is some relation to pay mix, in that a higher base salary would pair with a (relatively) high threshold  and a lower base salary would pair with a lower (or no) threshold.  For plans without a threshold, it is likely that  a substantial portion of the incentive that is paid from the first dollar is actually a “phantom base salary,” acting much like fixed compensation, and therefore not truly variable (or motivational).

It makes good sense to consider no-threshold plans for…

• Roles with low base pay as a percent of total compensation at target
• New business roles without any existing book of business to manage
• Roles in which compensation is calculated by transaction or deal (not aggregate results)
• Roles in which it is important for the sales person to have a clear understanding of the comp value of any proposed deal.

Is makes good sense to consider a plan with a threshold for…

• Account manager / territory manager roles with an existing book to manage
• Established/mature markets where growth is a priority
• Roles with good historical performance data enabling management to confidently set the threshold so that 90% of sales people are likely to exceed it
• Roles measured on aggregate performance measures (e.g., total sales, or total margin value) vs. deal/transaction-level measures.

Tips for picking the right threshold if you’re going to use one

If a plan does include a threshold, we generally recommend that the threshold be set so that no more than 10% of reps are performing below threshold.  Some organizations tie the level of the threshold to a base salary, or the fully loaded cost of an employee to the organization (which is often a multiple of the salary in the range of 2-2.5x times to account for benefits, overhead, etc.), expecting the sales person to “fully recover” their cost before additional (incentive/variable) compensation is earned.  However, this approach leaves little flexibility for times when the company needs to deploy a resource to sell a new product or service, or to build a new customer market.

While calculating the marginal cost of the next sale, or the next sales person, can yield good insights, it’s better to think about the overall cost of compensation as a system (total employee cost divided by total productivity) than at the person by person level.  This will enable you to set a threshold (or not) based on the minimum productivity that is acceptable given the different key accountabilities, and goal-setting confidence, for the different selling roles.

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.

Recoverable draw

A recoverable draw is an advance against future earnings. So if a person were paid a $10,000 draw for each of the first three quarters of work (typically in addition to a base salary), and if they earned under the standard compensation plan $5,000 in that same period, they would go into their fourth quarter owing the company $25,000 (3 x $10,000 – $5,000).  And since the sales cycle is 9-12 months, we might expect more substantial sales in the fourth quarter – perhaps earning $12,000. So the sales person would finish the fourth quarter owing the company $13,000 ($25,000 – $12,000).

Non-recoverable draw

A non-recoverable draw is an advance against earnings in a specific time period which will not be owed back at the end of that period if earnings on the standard plan are less than the non-recoverable draw amount. So consider a new sales person who is paid paid a $10,000 non-recoverable draw per quarter for the first three months, with earnings under the standard plan of $0 for the first quarter, $1,000 for the second quarter, and $4,000 for the third quarter, The sales person would receive payments of $10,000 each of the first three quarters since earnings are less than the draw. The fourth quarter would then start with no arrears position for the sales person, and the earnings of $12,000 in that fourth quarter would be paid to the sales person.

A declining guarantee

A guarantee is an amount that will be paid regardless of performance, and it is often structured to decline over time. For our example sales person, the guarantee might be structured as $12,000 for the first quarter, $10,000 for the second quarter, $8,000 for the third quarter, and then $0 going forward. In this case, the sales person would be paid the $10,000 for the first quarter (no earnings under the standard plan) + $11,000 for the second quarter ($10,000 guarantee + $1,000 earned) + $12,000 for the third quarter ($8,000 guarantee + $4,000 earned) for a total of $33,000.

The problem with this example is, of course, that we are assuming the same performance with different incentive plans. Many companies find that the declining guarantee makes for the fastest start since the sales person is protected in the early period, but there is no reason to hold back sales or not get as fast a start as possible since they all result in earnings.

Key sales objectives

For long sales cycle jobs, it is also reasonable to expect certain activities, training, and progress in creating account strategies and moving opportunities along in the pipeline in order to earn the full guarantee amount. So instead of a no-strings guarantee, the declining payment stream shown above might be made contingent on developing and executing a territory or account development strategy.

How many months, what % target?

So to be specific about your second question, a good approach is to offer a guarantee which, when combined with the earnings under the standard plan in the early quarters, will yield 2/3 to 3/4 of the target amount. You want the sales person to invest with you in this time period – you are paying something even though sales aren’t coming in, and they are earning less than their market value as they make progress towards closed sales. If the sales cycle is 9-12 months, there may need to be some accommodation for up to a year, but diminishing in value over time.

For an additional discussion of these ideas see another post about onboarding for a shorter sales cycle all-commission role, but many of the principles and examples will apply here in an obvious way.

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.

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.

Question

In professional services, do you compensate differently in sales plans for “new” business vs. maintaining an account to incent the best “prospectors” to develop new business?

Answer

I’d say that the best course would depend on both the company strategy and the way the selling roles are defined. If the strategy is focused on penetration of existing accounts, then the most valuable sales might be those in current accounts (this tends to be true with mature companies who have some kind of relationship already with most of their key prospects).

But for the majority of our clients, new business is very important. You’ll have to be clear about what counts as “new” – a new “logo” (new company name…), a new buying entity (maybe a new division/location in an established customer could be counted as new), a new service offering (generally one that does not replace an older legacy service they have been buying). Generally “new” business (however you define it) takes more time and effort to win than renewal or penetration business, and for that reason you’ll need to reward for it at a higher level in order to keep sales people focused on it.

Another approach successfully employed by companies with enough sales people to do this is to separate “Account Management” from “New Business Sales” so that different people/teams are responsible for those different selling activities. This may not be practical in a small sales force – but once a company achieves enough scale to operate this way it allows the focus of those who love the new business hunt to be where they do their best work, and those who love the longer-term relationships and more nurturing selling role can focus on managing and growing existing accounts. If you do end up splitting the role into Account Managers and New Business Hunters (sometimes called Sale Executives), you will probably want to have different pay plans for those two roles (e.g., quota bonus with a threshold and significant acceleration for over-quota performance for Account Managers; first dollar commission with lower quotas and less acceleration for New Business Sales).

Question

I need benchmark data on what percentage of annual gross revenue should come from new business and should be allocated to sales force compensation. For example, if in insurance or other annuities there is a commission on first year premiums only and not on renewal business or a reduced rate on renewals. I assume that the 1st year budget for acquisition is higher than maintaining existing customers, but I am curious is that is really the case or if there are any good benchmarks to use as a reference.

Answer

I believe your question is about sales roles with a new business focus when the acquired business generally turns into a long-term annuity type relationship. Examples from my experience include insurance policies, ASP software offerings, software leasing, online test delivery contracts, EDI services, data and voice communication subscriptions. In all these cases, the company most values the acquisition of new business, and counts on the quality of the service delivered to retain it.

In these business models, new business sold earlier in the year contributes more to in-year revenue than that sold later in the year as the revenue is generally recognized monthly. For this reason, much of the incentive design effort may be aimed at rewarding those who acquire significant new business early in the year by measuring “in-year new revenue.” Retention is sometimes the job of the new business sales person, but is often assigned to a different Account Manager or Client Services role. If the same person is doing both new business and account management, the total revenue from new business may be very small compared to the total revenue from the existing assigned book (5% – 20% of the total). Often the new business is commissioned (based on new in-year revenue or total contract value), and the retained business is handled more as a quota bonus, with the weight on each component proportional to the expected time allocation.

But to get to your specific question, the budgeted sales comp % revenue is likely all over the place, depending on industry and company stage of growth. In very high margin businesses (software, data services), you are likely to see a higher comp % revenue. Similarly, large deal sellers (deals in the millions, tens of millions and more) would see a smaller percent of revenue as their comp; and small deal sellers (I’ve seen deal sizes in the thousands of dollars) would earn a larger percent of revenue. And in earlier stage companies you are also likely to see higher comp % revenue. The right comp % revenue is really based on the market value of the job (numerator) and the selling model, which generates a reasonable sales productivity expectation per person (denominator).

If the role to which you refer is more of an account manager who lands the business only to manage the account and grow the relationship over time, then the ideal measure is recognized margin (the margin value of the revenue recognized). If margin is controversial or hard to measure or calculate on an account by account basis, then revenue may be the better measure (and it is certainly the more common measure for this reason). In this case, the person may be paid based on attainment of a quota customized for their book, or based on growth in the value of the assigned book over prior years (through more volume to existing accounts or addition of new accounts).

1. They may take more time and effort on the part of the sales person, so should pay more as a percent of sales to make them worth that time investment
2. They may pull sales people out of a comfort zone, and so should be more attractive to help them focus on new behaviors
3. They may be more difficult from a goal/quota setting point of view, with little/no history to use as a basis, and so goals/productivity expectations may have serious accuracy challenges compared to the base business.

Here are the typical comp mechanics to recognize these challenges:

Characteristic of the sale: Takes more effort

Comp mechanics: Pay a slightly higher rate – 15% to 50% more than base business is about right, depending on the degree of difficulty

If the “more effort” is only a startup challenge, make it clear that in the future it will revert to a lower rate – so they have every incentive to get these sales going quickly (for new products); if it will always take more effort, the rate should probably not revert (new customers)

Characteristic of the sale: New / out of comfort zone

Comp mechanics: Pay a higher rate on the new stuff and a lower rate on the old stuff – to provide “carrots” and “sticks” – so ignoring the new stuff would mean less earnings than last year for the same results as last year; and meeting expectations on both old and new would result in slightly higher earnings

Again, make it clear that rates will not stay this high on the new stuff forever, so it will be in the sales person’s best interest to get a fast start

Characteristic of the sale: Difficult to set goals

Comp mechanics: Pay on the new stuff (products/customers) from first dollar, without a lot of dramatic acceleration or bonuses around quota/productivity expectation. If you know your goals are rough, don’t make attainment of them a high-stakes event for the company or the sales person. In fact, a straight commission (at an attractive rate) without any acceleration is a reasonable arrangement in the first year.