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The Question:
When is it helpful to set quotas and measure sales people for performance over a half-year, quarter or month rather than the more usual one year period?
Most sales quotas in most businesses are on one-year quotas. And most compensation plans that offer added incentives to reach and exceed quota tend to pay top performers more towards the end of the plan year. This is a natural outcome of a corporate planning process with an annual measurement period for company results, executive incentive plans, and most broad-based employee variable pay plans, as well as the annual performance management cycle found in most companies. However, more companies are asking themselves if annual quotas for sales people are the best answer, and some are making the change to semi-annual or quarterly quotas with good results.
In this position paper, we provide guidance to help companies considering such a change in the following sections:
- The business case for measurement periods under a year
- Challenges of measurement periods under a year
- Keys to successful implementation of shortened measurement periods
The business case for measurement periods under a year
Companies considering shortened measurement periods generally do so because:
- Economic uncertainty reduces quota accuracy when quotas are set too far in advance. The recent recession, and the possible upcoming recovery have made the predictable steady growth experienced as “normal” only a few years ago a remote memory. The compensation plans in most larger companies depend on quotas, and so the quality of the compensation plan is fully dependent on the ability to set fair, attainable quotas that provide adequate challenge.
- Shorter measurement periods create more and smaller “hockey sticks,” smoothing out the deal flow more evenly over the year. With an annual quota, many sales people will push hard to reach and achieve it towards year end. If, for example, quotas are half-yearly, then that push happens twice a year, with a shorter peak each time, helping to smooth out the company’s shipments, service delivery, deal approvals, etc.
- Everyone is “in the game” for more of the year. If quotas are aggressive and sales people find themselves behind early in the year with no real hope of achieving or exceeding the annual quota, they may find themselves with no real incentive to push hard for results, preferring to win those big deals in the following year to help relieve a more achievable quota. If quotas are half-yearly, then the start of the second half offers a fresh start for the sales person who once again has a real chance to meet and exceed the second half quota.
- Early wins don’t result in “coasting” for the rest of the year. With an annual quota, sales people who do very well early in the year may not be as eager for the next sale as soon as they see their quota is in sight for the year. With quarter quotas, for example, the sales person who does well in one quarter will see clearly the necessity of meeting or exceeding their quota again in the next quarter.
The net effect of all of these benefits is that, done correctly, smaller measurement periods can contribute to improved quota accuracy, consistent deal flow throughout the year, a more motivated and productive sales force, and a better value for the sales compensation dollar.
Challenges of measurement periods under a year
Despite the advantages listed above, relatively few larger companies use measurement periods under a year. This is because there are some real risks and challenges to moving to a shorter measurement period:
- Company financial planning is done in an indivisible annual unit. This usually is an issue for company leadership, who simply cannot imagine allowing a sales person to enjoy a leveraged payout before the annual plan for the year is achieved. Typical comments include, “I don’t get any bonus any time during the year, and am totally dependent on overall company results. Why should a sales person who might end the year under quota have an over-target payout at the end of the first half? It just doesn’t seem right.”
- In a leveraged comp plan, shorter measurement periods may result in more sales comp cost for the same performance. If the comp plan offers an accelerated payout rate for over-quota sales, then a half-year plan could pay more than an annual plan to a person who ends the first half (on a half-yearly plan) at 110% of quota, and the second half at 90% of quota for a total annual performance of 100% of the annual quota.
- It is possible that sales people could game the plan with a high-low-high-low strategy. The prior challenge listed was focused on the cost of the combination of an over-performing measurement period followed by an under-performing measurement period, which might be expected to happen from time to time due to natural fluxuations in business. Of perhaps more concern is the possibility that sales people could realize that an “oscillating system” would be a great strategy to maximize their total earnings – over-performing in the first and third quarters, and under-performing in the second and fourth, for example.
- The quota setting process is too distracting and time consuming to do more often. In companies where it takes a lot of people a long time to go through the annual quota setting process, it may not be practical to consider more frequent iterations. This may be due to a complex coverage model in which several different types of sales roles are credited for each deal, weak or non-existent systems to support the quota setting process, dependence on historical actual sales data as a foundation for the new quotas with that data available weeks after the close of the prior measurement period, or time consuming political maneuvering to agree on quotas. Regardless of the cause, many companies cannot imagine going through their quota setting process more often than annually.
- The sales cycle is longer than the shortened measurement period would be. Shortened measurement periods work best when the sales cycle is short as well. So a three month sales cycle and quarterly measurement periods can work well. And a five month sales cycle and half-yearly measurement periods can be a great idea. However, a nine month sales cycle with half-yearly measurement periods presents problems. This is because the quota for the upcoming measurement period is likely to anticipate the future success for deals already in progress but not yet closed, giving the sales person the sense that there’s “no way to win” under their compensation plan. Ideally, the measurement period is long than the typical sales cycle length (if only slightly).
- Shorter measurement periods means more quotas, which may mean less accuracy. Quota accuracy matters – it’s the key to motivated sales people, predictable productivity, and in-control compensation costs. And the more finely the quotas are subdivided, the less the accuracy, all other things being equal. So an overall quota that is divided into five separate product quotas will result in product quotas that are less accurate than the overall quota. And an annual quota that is divided into quarterly quotas will result in less accurate quotas for each quarter than the annual quota. This is mitigated for multiple measurement periods in a year in cases in which the company is willing to update quotas as the year progresses so that the latest information is used to finalize the quotas for the next measurement period as the year goes by. However, some companies that use multiple measurement periods within a year announce the quotas for all measurement periods at the start of the year, which will almost certainly result in less accurate quotas for the smaller measurement periods.
Keys to successful implementation of shortened measurement periods
Your company could derive great business value from shortened measurement periods if…
- Your business is difficult to predict several quarters in advance, and you’ll know a lot more about what a solid sales performance should be in (for example) the second half as you near the end of the first half.
- Your sales cycle is shorter than the shortened measurement period you are contemplating.
- You could benefit from a more consistent sales effort throughout the year as the year-end sales push causes problems with discounting, delivery, inventory, or capacity.
- You have an efficient streamlined quota setting process so that running through it several times per year could be a great planning exercise, not a burdensome resource drain.
- You are willing to adjust your leverage down to anticipate some reduction in quota accuracy and manage your compensation costs to reasonable levels.
- You are willing to put your sales leaders on shortened measurement periods as well so that they will have an incentive to close every quarter/half-year as well as possible and thereby mitigate the risk of high-low-high-low gaming by individual contributors (which is all but impossible to pull off at a leader level).
Donya Rose, CSCP, is Managing Principal of The Cygnal Group. She is a recognized expert in sales compensation plan design, regularly speaking at conferences and writing published articles. She serves clients from F500 to growth-stage businesses, and advises WorldatWork on sales compensation hot topics and best practices.