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:

Double quota/double credit

Description: Each participant in a sale receives full quota and full credit for the sale (or “their” piece, e.g. Product Specialists take only their product slice)

Advantages:

• Strong encouragement for participation of multiple sellers in an opportunity
• Clear message regarding expectations communicated via quotas

Disadvantages:

• Difficult to model selling costs in relation to sales productivity
• Special care must be taken to ensure the team size is appropriate for the opportunity

Appropriate use:

• When it is possible to anticipate the requirement for participation of each team member in a certain class of selling opportunities
• When teaming is essential to the execution of the sales process

Credit splits

Description: Credit for all sales is divided among participating team members, with total credit adding to 100% of actual sale value

Advantages:

• Easy to model and anticipate selling costs in relation to results
• Opportunities will tend to be handled by the smallest effective team

Disadvantages:

• Disincentive to team with others due to anticipated reduction in sales credit
• Expectations regarding degree of teaming are not communicated via quotas

Appropriate use:

• When it is important to be able to assign a team to an opportunity “on the fly”
• When it is difficult to anticipate the teaming required, and therefore to set quota

There are ample variations on both of these types of incentive, including

• “Layered quota / layered credit” in which more than two people are involved in a sale (e.g., Account Manager, Product Specialist, and Channel Manager)
• Split credit with more than 100% of total sales being distributed (e.g., allow up to 200% credit, but with no more than 100% going to any one person/role)

Most complex sale requiring involvement of multiple sales people in most deals benefit from some form of shared sales credit. The appropriate form will depend on the intended coverage model and key accountabilities of each sales role. While the CFO will be concerned about “double paying” when several people receive sales credit and compensation for one sale, these concerns are generally allayed through rigorous modeling of the total cost of the selling function as it relates to overall sales productivity.

Advantages of relative ranking payout systems include:

• The dispersion in variable pay is known in advance, designed, intentional, and totally controlled.
• The total cost of variable pay for the organization can be budgeted with confidence – regardless of overall results, the total payout is unchanged.

Disadvantages, however, are significant:

• The payout doesn’t vary with overall business results – total pay delivered in a “bad” year is the same as that delivered in a “blowout” year.
• The sales people end up competing with their peers in a very real sense – “The only way for me to ‘win’ is for you to ‘lose.’” This is the reality of a relative ranking plan, and can undermine a sense of collaboration and shared success.

Relative ranking plans work best for sales forces in which collaboration is not a key requirement for success, the sales force is large enough that sufficient dispersion in pay can be created in the designed payout distribution, the sales role has limited influence on overall results (customers are buying from the company more than from each sales person, and the sales person has more influence over awareness than over the final buying decision – think of pharmaceutical sales reps).

For most sales roles, the more direct tie between performance and payout, independent of the performance of peers, provides the better combination of motivation for the sales people and alignment between sales results and the cost of compensation.

While there is no easy answer to this question, here are three good ideas worthy of consideration:

• Lower the stakes on quota attainment – If your quotas are less accurate than usual, then plan features focused on quota attainment may need to be rethought. Some companies offer binary quota achievement bonuses ($5,000 paid when the quota is achieved), or dramatic acceleration starting when the quota is achieved. These types of plan features put a lot of emphasis on the exact value of the quota. If quotas are inexact, some acceleration might be offered at (for example) 90% of quota, continuing to 110% of quota and then further accelerating. The total payout at target could be exactly the same, but the stakes on an exactly correct quota would be reduced.
  • Risks: Moving to and beyond the exact quota will be less important to sales people.
  • Advantages: Everyone can focus on approaching and exceeding the generally expected level of productivity without a lot of arguments or attention to the exact quotas.
• Shorter measurement periods – Most sales compensation plans are based on an annual goal, with monthly or quarterly payouts for progress towards those goals. If a sales person falls behind early in the year, then they can find themselves “out of the money” for most of the year. Breaking the year into halves or quarters, with separate goals for each, can give sales people an opportunity to get back into the game after a disappointing quarter or half.
  • Risks: Sales people who have not made their total year number may still earn upside in an over-performing measurement period (quarter/half). Mitigate this by offering somewhat less acceleration for over-quota performance. Similarly, the chances of significant under-performance go up when the measurement period is shortened (less time to “catch up” from a disaster), so it may make sense to lower thresholds somewhat if you have them.
  • Advantages: More sales people are working for more of the year with the support of the motivational value of their comp plans.
• Shorter measurement periods, with quotas updated just before the start – In a year when it is very difficult to know what to expect of each sales person by Q4, it may make sense to measure them quarterly or semi-annually and announce the goal for the coming quarter just before the new measurement period begins. This treats each measurement period as if it were a sort of “mini-year,” with an opportunity to adjust as needed based on new insights into business conditions.
  • Risks: This can be a lot of work, almost like doing your annual planning exercise two or four times per year. It also risks offering upside to people who don’t make “their” contribution to the annual plan, and raises the possibility that the sum of all sales goals does not add to the annual plan. As in the prior option, reduce acceleration over quota and lower thresholds when measurement periods are shortened.
  • Advantages: Goals can be made as fair and achievable as possible – not too low and not too high. Everyone is definitely “in the game” at the start of every measurement period, so motivation is maximized.

As such changes are considered, affordability is the right focus for the modeling effort. Make sure the cost of compensation is appropriate and affordable along every section of your payout curve, taking into consideration all the people who will be paid for each sale (the field sales person, their boss, maybe an inside sales person, etc.).

If your plan year is already under way, these ideas may be worth considering as the year progresses if the quotas turn out to be problematic. If they were set too low, it may be difficult to make any changes mid-year. If, however, they were set too high, announcing a mid-year “year end” and restarting with a shortened year, attainable goals, and appropriate compensation mechanics could breathe new life into a haggard sales force.

Question

My company is in the throes of revising the comp plan for next year and one of the most hotly debated items revolves around compensating a salesperson on all business generated from dollar one for the life of the account. Currently our firm doesn’t discriminate between “new” dollars and what I’m calling “annuity” dollars- they pay the same rate over the account life whether it’s 1 year or 10. We don’t have a lot of support staff so most, if not all the account maintenance falls on the salesperson’s shoulders. Most of the heavy lifting is done during the prospecting stage & within the first 1-2 years of the relationship then the historical pattern is the revenue drops (variety of reasons outside of the salespersons control and some within).

Answer

There are several ways to put together plan mechanics in such a situation, and I have listed a few below, with some commentary.

1. First dollar payment, and “a dollar is a dollar.” This is what I believe you have now. This will focus sales people with substantial annuity business first on maintaining the base, then once that is secure, on growing new business. It generally is straightforward to track sales credit and calculate compensation – both very desirable. The cost of comp in relation to sales volume is very predictable, as is the income level of the sales person. The challenges raised by this arrangement are:

1. a. It does not recognize the increased degree of difficulty in landing truly new business – so that the time spent on new business development may not be worth the risk of not closing to a sales person who can farm established accounts.

1. b. It can result in a “phantom base” where the sales person has a large portion of their apparently variable pay that will almost certainly not vary year to year – so they have little real risk or upside in their compensation plan to help support the drive to grow.

1. c. Depending on how the compensation plans work, it may mean that each deal is paid over the life of the contract based on the comp plan in place at the time it was signed. If this is the case, the compensation administrator may be simultaneously administering several comp plans (this year’s, last year’s, etc.). This would tend to limit the company’s willingness to adjust the plans to focus sales effort on this year’s priorities.

1. d. Sales people with “rights” to an annuity stream are less likely to accept restructuring of territories to expand the sales force, reassignment of accounts, etc. This can limit a growing company’s ability to scale quickly and maximize market penetration.

2. Added payout value for new business. This is similar to #1, except that the payout on the “existing” business (“existing” vs. “new” needs careful definition) is reduced to fund a higher payout amount on the “new.” Generally the intention will be to keep total compensation the same, but to shift the emphasis to the new business a bit. This can be as simple as an increased commission rate for all new business during its first twelve months, funded by a reduction in the commission rate for existing business. This solves a above, b somewhat, and does very little to address c and d.

3. Split the compensation into a quota-based incentive for the existing business and a true commission on the new business. For the quota-based incentive on existing business, there may be a threshold below which no payout is earned (e.g., 80% of the quota), and dramatic acceleration for any over-quota attainment (e.g., double the target incentive at 120% of quota). For the new business, the payout should be from first dollar and perhaps it should accelerate over quota. In this case, business should count as “new” for the first twelve months, not just for the rest of the plan year. This approach solves issues a, b, c and d listed above; but it also undermines simplicity, makes it hard to know the comp value of existing business on a per-deal basis, and raises the stakes on setting reasonable and accurate quotas for both existing and new business.

There is not a perfect answer to this situation that will satisfy all stakeholders and be bullet-proof. But there are better and worse approaches, depending on your sales roles and your business model.

The logic for raising thresholds in this economy would be to protect profit. The logic for lowering them is that we are not nearly as confident in our quota setting accuracy in this economy – so while we “knew” that 70% of quota was unacceptable performance last year, this year we’re not so sure where the unacceptable attainment will fall. (And, by the way, that is the point at which the threshold is often set – the level of performance below which the sales person is clearly not performing acceptably, and likely to be on formal notice.)

A percentage of the first order/circulation

Use when:

• The sales person influences the size of the first order, and a larger first order is both strongly desirable and indicative of the long-term value of the new customer relationship
• There is a fulfillment/retention channel separate from the new customer sales channel that is responsible for ensuring re-ordering and growth of the account. This could be a call center or a self-service online capability, for example. In this case, the sales person’s job is to get that first order, acquire new accounts – and another part of the organization takes it from there.

A percentage of each order/circulation

Use when:

• The sales person is responsible for the first sale, the ongoing relationship, the growth of the account, or
• A team of sales people are working to take in as much transactional (not relationship-based) business as possible, and different people may sell to a given account at different times – for example, a call center with calls routed based on language or simply availability.

A fixed sum for the first order/circulation

Use when:

• The first order generally results is a satisfied customer and repeat business
• The first order may be sold at a significant discount
• The sales person has little influence over the size of the order
• Any first order, regardless of size, takes about the same amount of work.

A fixed sum for each order/circulation

Use when:

• The sales person has ongoing responsibility for processing orders/ transactions as quickly and efficiently as possible
• All orders have about the same value (profit) to the company
• The sales person has little influence over the size of an order.

By far, the most common sales incentive design is based on a percentage of each order. However, depending on the way you have designed your selling model, there may be good reason to measure and reward in one of the other three ways you mention.

While this is not always appropriate, it should be considered when:

1. The plans are goal-based and goal setting is “loose” so that some people achieve, for example, 200% of the goal. In this case, the high level of achievement could be due to a bad goal.
2. The sales people sell very large deals, which could tend to make performance “lumpy.” Oftentimes these deals are closed with help from senior leadership in the company, and often also at a lower marginal profit. While it may be harder to close a $4M deal than a $2M, it’s probably not twice as hard (and it may not be worth twice as much to the company).
3. The company has a history of capped plans. Deceleration is always much preferable to caps.

The other philosophical principle here is that you want to put as much money as you can right above goal so that the reward for getting to and beyond goal is the opportunity to live on a wonderfully accelerated slope. In fact, it’s great to put so much money there that the company would not choose to afford it indefinitely. So when you do decelerate, the rate is still quite attractive. This will serve to pull your OK performers up and over goal without causing an unaffordable high cost of comp.

The other thing to consider is the economics of the draw. Is there a valid business reason for delivering pay this way vs using a modest salary? Typically there is “recurring revenue” that is generating a relatively fixed amount of compensation that is actually acting as a base salary. I’ve found over 10 years of designing sales comp plans that 9/10 times using a 100% variable approach with a draw actually REDUCES the effectiveness of a sales incentive plan and makes it hard to attract talent vs using a modest salary + truly variable incentive. However, in some industries, this approach is the norm.