Structuring the right compensation for sales persons
A majority of sales persons are paid in a combination of fixed and variable pay.
In businesses where the sales cycle is short and can wrap up within a few hours or days, a significant portion of sales person’s wages can be paid on actual sales outcomes within a bi-weekly pay cycle. The fixed pay component may be a small part and variable the dominant one in the pay plan
As sales cycles grow longer, require continuity of the sales person, or the sales person is required to participate in other organization building activities, fixed pay will grow and become a larger part of the overall compensation.
A thumb rule for structuring fixed compensation
Fixed pay can be structured based on the most probable business which a sales person is likely to bring in.
In a tech services company, a sales person wins $5 million in annual business on an average. The fixed compensation for the sales persons can be set assuming a $ 5 million win rate. If the total payout planned for $5 million in order wins is $300,000 and the industry norm is a 60% fixed, 40% variable in compensation for sales persons (and this will vary by industry and complexity of sales), then 60% or $180,000 will be paid in the form of a predictable fixed compensation.
Those who achieve more or less than the median of $ 5 million will see upsides or shortfalls in income through a variable compensation.
Most (not all) sales roles will have an element of variable compensation linked to performance.
The greater the variability of performance among the individuals in a sales team, the higher the probability of a variable pay plan and the amount it is likely to pay out as a proportion of overall salary.
Reciprocally, the lower the likely variability in performance, the lower the chances of their being a variable pay plan or if there is one, it’s payout may be small within overall compensation
A tech products company has become an aspirational brand and has consumers flocking to its retail stores. Once they get there the odds of making a sale are high. A potential customer could be funneled to any sales person with similar likelihood of sale closure.
Since all sales persons have similar probability of winning the business, the variability in compensation too can be kept low – with a low variable component.
There is a 1.5x difference in the sales output of the best and bottom performer of a seller of complex technology solutions. However, those at the top, middle and bottom change year to year, making it hard to make a case that the top performer in one year will consistently be at the top and hence should be paid a differential fixed compensation compared to peers.
This is where a case can be made for introducing variable compensation into the pay plan. Keep the fixed compensation of all the sales persons within a narrow range. Those who produce substantially higher in any year get an upside through the variable compensation.
Structuring variable compensation
Variable compensation is best linked to output which requires differential individual effort or initiative.
Based upon the nature of the business and specific goals, it can be paid on one time achievement, linked to ongoing sales performance, or a combination.
a) Milestone pay - One-time reward to meet a specific milestone or goal.
i. Winning a new client. Very relevant to new companies aiming to build a client base.
ii. Hitting 100% quota –Where hitting the 100% quota takes a stretch and only a small group makes it in any year. Equivalent of a Summa cum laude in a college. Works best in companies where quota setting is a mature process and sales persons have a similar opportunity to hit the 100% quota.
iii. Getting to a number of years of service – a retention incentive in times of high attrition. Also, very relevant for companies which have complex offerings or sales processes and want to retain those who have been trained in them.
iv. Seeing a long cycle time sale through – a retention bonus paid when the continuity of the sales person is important through a very long sales cycle
v. On winning a deal over a certain $ value which is aspirational for the employer
b) Time sensitive incentives
Used to incent a time sensitive goal. Car dealer has extra inventory on its lots and wants to clear it. Offers 2x commission for a month to its sales persons to incent them to sell more.
c) Commissions and incentives linked to ongoing sales performance
i. Commissions or piece rate incentives – A certain $ value or % paid for each sale. Can work well for companies still building a presence in the market & all sales persons have a similar opportunity to make a sale and earn the commission. Can also be used for those selling into new territories or even new business with existing clients.
ii. Quota based incentives – When the field becomes uneven with some territories or accounts having greater potential than others, quotas, and incentives linked to them work better. There has to be confidence though that the quota’s set will require similar effort and offer equal opportunity for all to achieve. Quota based incentives are best used where there exists maturity in goal setting.
iii. Threshold incentives – Organizations may have an aspirational level of performance expectation from their sales persons and a very small % of individuals are likely to reach this level of performance. They are the outstanding performers of the year. To reward them, differential incentives kick in at the aspirational threshold e.g., 1.5x commission for every $ sold after meeting 110% of quota or after selling $10 million in a year. In effect, the employer is sharing a larger proportion of the earnings from a sale with those who cross a threshold in sales performance.
iv. Incentives for complex sales – Complex sales are likely to require involvement of many participants. A group incentive can incent all of them towards the goal of winning together. When designing this, it is best to define the payout applicable to each of the members or groups upfront.
Where sales persons have a fixed + variable pay plan, quota-based incentives and even commissions may kick in only after meeting a certain level of sales. The premise is that a fixed compensation is being paid to achieve this level and only after meeting that, the additional earnings from variable compensation will kick in.
Pay plans for sales persons need to account for the cycle time and complexity of the sales process, and the likely variability in the output among the sales persons.
Fixed pay can range from very little in short cycle simple sales to a lot as the sales cycle becomes longer, or more complex
If all sales persons perform at a similar level, and one can take on the tasks of the other with minimal disruption, the performance variability is low, and sold the variable pay.
However, where individual initiative and capability can lead to differential results and performance, a variable pay plan can reward it.
Variable pay can be linked to a one-time achievement like winning a new client, or hitting 100% of quota. It can also be linked to ongoing performance, like the $ value of sales achieved or % of quota met.
Fixed pay needs to be sufficient to ensure that the sales persons are engaged with the organization, involved in its activities, and focused on selling for it. Variable pay is the carrot to sell, and sell more.