Creating a sales compensation plan that falls short can lead to higher turnover on the sales team, plus the associated costs. Avoid these problems by creating an attractive sales compensation plan to hire top sales talent. The right plan also encourages the right behaviors, increases rep retention, minimizes risks and increases revenue.
But, how can a business owner create an attractive sales compensation plan to entice top sales reps to accept a position on the sales team?
In this guide, we'll discuss:
- What a sales compensation plan is,
- Sales compensation terms,
- The importance of a sales compensation plan,
- Types of sales compensation plans
- Tips to improve your sales compensation plan.
Let’s start with the basics and discuss what sales compensation is.
What is Sales Compensation?
Sales compensation is the pay that a company’s salesperson receives. Although compensation differs between companies, it typically consists of elements such as a base salary, commission, and incentives designed to drive specific performance of a sales organization.
Before going deeper into the topic of sales compensation, we need to explain and define some main terms.
Sales Compensation Terms to Know
Sales compensation plans are unique to the specific organization, but you may come across the following terms and concepts as you start the development process.
A sales quota is a target set by the company or sales manager for sales reps to hit in a designated period — either individually or as a team. Typical time constraints for quotas are monthly, quarterly, and annually. This ensures targets are met throughout the year. Plus, short-term and longer-term results are both rewarded.
It isn’t unusual for multiple quotas to apply to the same rep at the same time. Examples of these might include things like topline revenue, account growth, margins, retention, sales by product, geography and activity.
On-target earnings (OTE) provide salespeople with a realistic projection of what their total compensation for a position will be when they hit their goals and quotas. OTE typically includes the base salary and the anticipated commission resulting from closed deals.
A sales accelerator kicks in when a rep on the sales team hits a specific amount over their quota. This is enticing to most reps, giving them a sizable boost to their commission check when they have a highly successful month or quarter. So, it’s important to be careful when setting accelerators, in terms of your resources and budget.
An example of a sales accelerator is when a salesperson hits 110% of their quota by the end of the month. If you wanted to highly incentivize them, you’d pay 130% of their commission to exceed their targets. This type of bonus can be based on monthly, quarterly, or annual sales targets.
Sales decelerators have the opposite impact of accelerators. They penalize underperforming reps by reducing their commission. A decelerator may activate when a salesperson hits between 50–95 percent of their quota. For example, if a rep only hits 70% of their quota, they may get no commission or a reduced multiplier such as 0.5 instead of 1.0 may be used to calculate it.
A clawback occurs when a customer churns before hitting a specific benchmark such as discontinuing the use of your product or service within a given time period. It results in the sales rep not receiving their commission. This is common practice for subscription companies to maintain high customer retention.
Clawbacks are designed to encourage salespeople to focus their time and efforts on the best prospects that will most benefit from the product or service. This is also often included in compensation plans for customer success teams to reward them for their retention efforts.
Sales Performance Incentive Fund or Sales Contests
Sales performance incentive funds (SPIFs) or sales contests are used to incentivize high performance among salespeople.
These tactics are often used to change or encourage specific behavior(s). Rewards may be monetary or non-monetary. Examples of these bonuses include things like a $500 cash prize to the first rep who closes 10 deals of a certain product or a nice dinner for every team that increases their retention rate by a designated amount.
SPIFs and contests should run for short time periods of one to four weeks. If they run longer, these tactics become less effective because reps lose the sense of urgency created by these programs.
It’s also important to remember to limit how many contests run throughout the year. And be sure not to run ones encouraging conflicting behaviors at the same time. This can be counter-productive and reduce overall results.
What is a Sales Compensation Plan?
A sales compensation plan is the strategy that drives the sales team’s performance to increase revenue. It includes detailed information about the salesperson’s pay structure such as their base salary, commission, incentives, and benefits.
The purpose of a sales compensation plan is to encourage specific sales rep behaviors and clearly communicate expectations and criteria for compensation of sales team members. This plan is designed to incentivize employees to reach their objectives and organizational goals.
Each organization has a sales compensation plan unique to the business. It is based on team structure, resources, and goals. Some companies offer a higher base salary, where another may include a higher percentage of commission. This varies according to the business’ internal structure, budget, employee requirements, and team goals.
A compensation plan should include a detailed pay structure for each sales position within the organization. It should be tailored to the specific sales role, experience or seniority, length of sales cycle and type of customer engagement.
Other factors to consider when preparing a sales compensation plan include company culture, how competitors pay and the local cost of living.
Why is the Sales Compensation Plan so Important?
Selecting the sales compensation plan structure for the organization is an important decision. The chosen plan needs to inspire your sales reps to adopt the desired behaviors to achieve specific business goals while remaining profitable.
Compensation plays an essential role in attracting and retaining top talent, especially when it comes to building a sales team. That’s why getting sales compensation right can give a business a competitive advantage when recruiting. But sales compensation is specific to the organization and needs to be a good fit based on industry and company size in addition to the other factors mentioned previously.
Now, let's review the different types of compensation plans.
6 Different Types of Sales Compensation Plans
Sales compensation plans are not one-size-fits-all. They are tailored to suit the specific needs of your organization and sales team. The most common types of payment included in comp plans are hourly wages or salary, commission and bonuses. The percentages and inclusion of each vary based on many factors such as business type, industry, budget and goals.
It is essential to carefully consider the structure of your sales compensation plan since it will greatly influence and impact your ability to attract and retain top sales talent. This helps minimize recruitment and repeat onboarding costs, securing revenue as profits or to reinvest in the business.
The following examples include six of the most common types of sales compensation plans. Each example has a different structure. Use them as a starting point for customizing a plan for a specific sales team and business based on needs, resources, and goals.
1. Straight Salary
Straight salary sales compensation plans aren’t very common, but they are suitable for some organizations. This structure establishes a set amount salespeople will be paid regardless of how much they sell. As the name indicates, this approach to pay includes salary and no bonuses, no commissions, and few, if any, sales incentives.
This type of compensation plan is frequently used in industries prohibiting direct sales or when salespeople are measured as part of a small group or team with equal contributions. It is also employed when a sales team is relatively small or when sales is not the primary responsibility of the employee where most of their time is spent engaging in other tasks besides selling.
These plans don’t tend to motivate sales reps to go the extra mile because it lacks incentives to spur them on to the next sale once they hit quota for the current period. Plus, using this plan increases the risk of losing top performing reps who are inspired by commissions who may leave for better compensation.
2. Commission Only
A commission only sales compensation plan is based entirely on performance. Regardless of how much a sales rep sells, their pay is calculated as a percentage of their sales.
This type of plan is easier to administer than some of the other options because of its simplicity. Plus, they minimize financial risk by paying only for sales success when revenue increases and not needing to pay commissions when reps fail.
High-performing reps are often attracted by commission only plans, giving them the freedom to make as much money as they can, but can lead to burnout and high rep turnover.
When setting up a commission only plan, commission rates typically range from 5 to 45 percent.
3. Salary Plus Commission
A salary plus commission pay structure is the most common type of plan. It gives sales reps a fixed annual base salary plus commissions. This provides the security of a predictable income with the potential for increased pay based on performance.
This plan is suitable for most businesses, providing better clarity and predictability of expenses while attracting highly motivated, competitive salespeople. Plus, giving reps a base salary enables the business to require some non-selling tasks like assisting with new team member onboarding.
When commissions accompany a base salary, the ratio of salary to commissions varies from plan to plan. The standard resulting ratio is often 60 percent salary to 40 percent commissions, but some organizations prefer a 70:30 or 75:25 mix. Examples of factors to consider when determining the ratio to use include:
- Difficulty of the sale.
- Amount of autonomy or support needed.
- Experience necessary.
- Complexity of the sales cycle.
- Amount of influence the rep has over the purchase decision.
- Number of leads reps can work with simultaneously.
4. Territory Volume
A territory volume commission plan is typically used where sales teams work as a team to serve prospects and clients in well defined regions. Compensation is then calculated based on territory volume at the end of a compensation period. Then it is equally split between all the reps working that specific territory.
This type of plan works best in a team selling culture where the salespeople are all working to reach a common goal within a given territory. Leveraging an attractive commission rate with a rich territory helps attract quality reps to this type of plan.
5. Tiered Commission
A tiered commission plan combines a fixed salary with stepped commission structure. Salespeople under this plan receive increasing commission percentages based on which tier they reach for the period such as meeting quota or how much they exceed quota. But they receive a lower percent commission if they miss their target enabling the company to recover revenue to cover the sales rep’s base salary.
This type of commission structure is ideal for companies that need salespeople to consistently strive to exceed their goals while maintaining greater control of commission rates.
6. Profit Margin
Some companies prefer to pay reps based on profit rather than sales. This means that reps selling at a higher gross margin receive greater compensation.
The benefit of this plan is that it discourages discounting that erodes margins and decreases perceived product value. This plan prevents reps from becoming reliant on discounts to close deals that may negatively impact the business.
This commission plan also encourages salespeople to promote specific product lines and sell more of the most profitable ones.
Companies choosing to implement a profit margin compensation structure should remember that:
- Revenue must be a priority for this plan to work.
- Reps need to have control over pricing.
- An effective method of tracking gross margin must be put in place.
Tips to Improve your Sales Compensation Plan
A good sales compensation plan is a win-win-win: It’s easy to implement and benefits everyone. Here are five things to keep in mind when planning or updating yours.
Explore different types of Sales Compensation Plans
When selecting the best compensation plan it’s important to keep the company’s goals in mind. Refer back to the six types of plans we reviewed above.
Then, consider the following information:
- Value of overall budget.
- Number of sales reps.
- Types of compensation plans used by competitors.
- What salespeople will expect of the plan.
It is also important to determine the timing of commission payments. The four most common options include:
- When the customer signs a contract
- When the customer's first payment is received
- Every time a customer pays
- When deal goals are reached
It’s essential to set quotas that are attainable by 50-70 percent of the reps on the sales team. Otherwise, there is the risk of demotivating them or, worse yet, creating a high turnover rate. A properly set target will motivate reps to stretch but shouldn’t be unrealistic.
When establishing goals for salespeople, consider factors like average contract value, close rate, how long it takes to close a deal and whether there are sufficient resources to support these goals. Adjustments may need to be made for specific reps based on the potential of each rep’s specific territory.
Keep it Simple
Sales compensation plans need to be clear and easy to understand. If reps cannot decipher how the plan works, it won’t be effective and reps won’t be motivated by it.
But when it’s crystal clear to salespeople what they need to do to increase their income, they’ll be motivated to adopt the desired behaviors and strive to hit the targets set for them. Then they’ll be able to easily calculate how much they will be paid.
To keep the compensation plan simple, select only two or three activities to incentivize. This will drive the specific behaviors needed to reach company goals.
Involve the Right Team Members
Just as there is no one-size-fits-all sales compensation plan for organizations, there needs to be a different plan in place for different types of team members. Positions like sales support, sales management, vice presidents, field sales reps and inside sales reps all need to have their own unique plan. Plus, it’s important to consider experience levels as well. Doing so will result in compensation plans that are more appealing to each group.
Compensation = Performance
A well-formulated compensation plan should embody the company’s broader sales strategy, but SPIFs and sales contests should be leveraged as new products or priorities arise throughout the year. These temporary bonuses can be an effective way to drive specific sales behavior to meet a company goal. It can be based on individual or on team performance for the contest period.
Be sure to only hold one or two of these short-term events per quarter to focus rep behavior and ensure better results. And don’t change the sales comp plan partway through the year instead of SPIFs or contests. This complicates the situation and confuses reps while demotivating them.
Another option is to add an accelerator to an existing sales compensation plan to drive a specific behavior for a longer time period. This motivates salespeople to reach for the higher payoff for attaining sales above quota.
Determine On-target Earnings
It’s important to determine On-Target Earnings or OTE before deciding which type of sales compensation plan to use. OTE is the projected amount of pay a sales rep will receive annually including base salary plus incentives, commissions or variable pay.
Don’t Cap Compensation
Capping commissions limits the amount of compensation a salesperson can earn. So when a rep hits their commission cap, they are no longer financially compensated for closing additional business.
This demotivates sales reps from pushing to close more deals until the next pay period and limits the amount of revenue to the bottom line as well. It also makes the sales compensation plan unappealing to top-performing sales talent since they often prefer the opportunity to make as much as they can.
Sales compensation plans are integral to business success. Formulating the right plan helps attract top sales talent, increases rep retention, reduces risk and helps the company reach its goals. Get started today by using the tips to improve your sales compensation plan. Then adjust and revise it over time to keep it current and relevant.
Find out how you can increase accuracy, reduce costs and drive sales performance with your sales compensation plan and most importantly, manage the payout process with Varicent Incentive Compensation Management.