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 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.

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.

The problem occurs when stellar performance this year results in a very high quota next year (calculated as a percent increase over this year’s results), and so a significant risk that the new higher quota will not be attained next year. Sales person frustration will be compounded if, in addition, there is a relatively high threshold below which no payout is earned (e.g., 85% or 90% of quota), and total compensation at target does not increase with added quota. If all of this aligns, then the sales person who wants to maximize total earnings over the long run may do best to adopt a pattern of dramatic over-performance in one year followed by dramatic under-performance the next year. Most sales people in this situation, even if they realize that the high-low-high-low pattern is their best strategy do not intentionally execute it. But they are painfully aware that top performance will not go unpunished.

To avoid this situation, consider these suggestions for quota-based plans:

1. Set quotas based on territory potential, not just prior year actual sales.
2. Avoid setting low quotas for weak performers and high quotas for strong performers, unless you…
3. …Offer higher total compensation at target to those with the highest quotas, perhaps adjusting both the base and the variable pay at target for them.
4. Set any threshold at the level of quota attainment below which performance is truly unacceptable. And you know what’s unacceptable because you actually terminate or reassign people who perform at this level, and it’s probably not more than 5% of your sales people. (If you have more than 10% or 15% of your sales people below threshold, earning no variable pay, and you’re not putting them on a performance plan or moving them out of the role, then your thresholds are too high.)
5. Offer meaningful acceleration for over-achievement so that the added risk of next year’s higher quota (if that’s what will happen) is offset by the added compensation for this year’s over-achievement.

If you have other suggestions, please add them below in the comment box.

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

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

Why do attainable quotas matter?

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

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

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

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

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.)