Developing a sales compensation plan involves figuring out what type of sales compensation will best motivate your team, establishing goals, setting your commission rate, and being clear on how you measure compensation and when sales reps will be paid. Creating an effective sales compensation plan helps you drive sales and reward your top-performing team members.
Here are the seven steps you can use to develop a sales compensation plan for your team:
1. Decide on a Compensation Strategy
First, sales managers need to decide which strategy you will use to compensate your sales team, including whether you will pay a salary, commission, bonuses, or some combination. Since each has different benefits and drawbacks, the strategy you ultimately choose should depend on a balance between your overall goals for your business and how you want to motivate and reward your salespeople.
The list below isn’t meant to be exhaustive since there are as many variations on these as there are sales organizations. However, it will give you a framework you can use to both understand different types of compensation methods as well as which is the best fit.
Here are the four primary methods of compensating your salespeople:
A salary means that you set the total compensation for your salesperson in advance and they are paid on a scheduled basis, such as every other week. While a salary means that everyone knows exactly what an employee will earn, it does not reward him or her directly for their specific performance.
Most consistent overall compensation strategy and both the business and salesperson know what to expect
Does not reward salespeople directly for their performance
The best strategy to start out newer sales reps as they complete training and build a portfolio
Less motivating for salespeople to perform since their pay isn’t tied to performance
Encourages departments to work together to deliver the best product and services rather than just glorifying sales reps
This compensation strategy means that a salesperson earns a percentage of each sale they make as a commission. This model has the highest upside earning potential for a salesperson (other than when their earnings are capped), but also involves the greatest risk since 100% of their compensation is directly tied to their sales performance.
Least risk and most desirable for businesses from a pure cost standpoint since the business only pays based on salesperson performance
Many salespeople will feel undervalued if they are only paid based on the revenue they generate
High earning potential for top-performing salespeople
Hard to recruit top salespeople if they feel there's too much risk for earning potential
Salary + Commission
The most common form of sales compensation involves some combination of a base salary plus a commission. In many cases, the ratio of the two variables is adjusted over time, with the salary decreasing while the commission rate increases. This provides new salespeople with a “ramp-up” income as they build their portfolio and experience, and then transitions the primary source of their earnings to the commission they earn based on their direct performance.
The most balanced overall method of compensating salespeople for both their effort and performance
Can result in low-performers sticking around longer to collect a paycheck even if they aren’t earning commissions
More likely to keep talented salespeople through difficult seasons since they know they can count on a paycheck
Salary + Bonuses
A bonus is different from a commission because it’s paid out for hitting a goal, not as a percentage of each sale. Bonuses are extremely common in sales compensation plans and are always used as an extra incentive alongside one of the other methods. For example, you might offer a salaried salesperson a bonus based on their performance, or you might give an additional bonus for the salesperson who earned the highest commission or exceeded their sales quota.
2. Establish Sales Goals
Unless you are paying your salespeople strictly with a salary, you need to establish the specific goals you will use to measure commissions. Even with a salary-only plan, you still need to determine your target compensation for sales reps and do the math to make sure that what you are paying is rationalized against what you expect a given rep to produce.
A few of the specific goals you should consider include:
Target compensation is what you expect to pay a salesperson either in salary, commissions, or a combination of both. Decide on the target compensation for each salesperson so you can be sure your expectations are reasonable based on the size of the portfolio, as well as the individual responsibilities. Often, this amount is directly related to the expected revenue production.
For example, a ratio of 10:1.5 is often applied to compensation models, meaning that a sales rep who manages a $1 million portfolio would be expected to earn $150,000 in some combination of the sales compensation methods. However you choose to set your target compensation, it’s important to establish it upfront and use it as a guide while developing your sales compensation plan.
Company or Team Goals
Your sales compensation plan should be designed to directly support your company goals. That means you should take the time to set them based on the overall performance you hope to achieve. As you are creating a compensation plan that motivates your sales team, consider how it will support these goals by creating specific and measurable goals for your company.
For example, if you want your business to expand your customer base over the next 18 months, your sales compensation plan might be designed to reward salespeople who generate new customer accounts or expand their existing portfolio. In the same vein, if you want to add a new product line, you could incentivize your team to prioritize those sales by rewarding them with a bonus based on how many they sell.
Individual goals for salespeople are often referred to as a quota. This is a measure of revenue, new deals, or sales activities, and should be set so that individual goals are directly connected to the larger company goals. This is where you break down the team and company goals into the components that each salesperson is responsible for.
Usually, this is measured in terms of revenue performance across a portfolio. However, measuring sales activities can be an effective way to motivate your team, especially in new territories without an established track record of revenue generation. For example, you might create a quota of 15 appointments per week, or five new customer contracts per month. Both are designed to reflect the company goals, even if they aren’t specifically revenue related.
3. Determine How You Will Measure Compensation
There are two aspects involved in determining how you will measure revenue in order to calculate the compensation owed to a sales rep. In order to figure out what to pay your salespeople, you have to decide what revenue numbers you’ll use and where you’re going to get them.
Decide to Pay Out on Revenue or Profit
The first decision is whether you will calculate commissions based on gross revenue or net profit. While both are commonly used, the one that makes the most sense for your business depends on what you are selling and how much control your salesperson has over pricing negotiations. If your profit margin is consistent across products and services, it makes more sense to use the gross revenue since it’s to your advantage to incentivize larger deals.
On the other hand, if the margin for different products varies, using net profit as your measurement will incentivize your sales team to prioritize higher-margin items. The decision for your business should refer back to the goals you’ve set, and how you want to motivate and reward your salespeople for reaching them.
Establish Your Measurement Tool
The second consideration is to establish what you will use to provide your measurement of revenue, which is also often referred to as a “source of truth.” Generally, this is a sales crediting tool, a customer relationship management (CRM), or an accounting software app such as QuickBooks.
While there are pros and cons to each of these, the more important factor is to determine what you will be using to measure results upfront so that there is no confusion. Both you and your sales reps should be able to easily view and validate whatever source you choose to use as your revenue measurement.
4. Set Your Commission Rate
If your sales compensation strategy involves paying a commission, determine the rate you will use to calculate what you pay your salespeople for the revenue they generate. The rate you use will vary widely based on the type of products or services you sell, the costs involved, and the complexity of your sales cycle. It also depends on whether you are paying a commission on the revenue or profit of a sale, with rates being higher on the profit margin.
Commission rates can range from 7% of gross revenue for simple sales cycle products to 20% to 25% of the profit margin on more complex product sales. If you’ve previously set your target compensation for a salesperson, you can use that as a guide to determine the appropriate rate. Do this by evaluating the time involved in making a sale. Then, calculate what the target compensation is per hour:
Total Target Compensation / 2,080 hours worked full time
For example, if you’ve set a target compensation amount at $100,000 for a sales rep who manages a $700,000 portfolio, $40,000 of that might represent their base salary, with the rest being commission. If you divide the commission amount by 2,080, which represents the number of hours a full-time employee would work over the course of a year, that means their commission target is $29 per hour.
$60,000 / 2,080 = $29
Now that you have an hourly rate, determine the average amount of time required to make a sale using your current sales process. Add up the time spent meeting with clients, managing administrative tasks, communicating via email, preparing proposals, conducting research, and anything else that goes into making that sale. In our example, let’s say that number is 15 hours. In that case, the total commission on the sale would need to be $435 to cover the costs.
$29 x 15 = $435
The target commission for each sale is $435. Let’s imagine this sales rep closes a little over 11 of these sales each month, or about 138 of them a year, each with an average value of $5,072. Based on these numbers, his commission rate would be about 8.5% of the gross value of each sale.
$425 / $5,072 = 8.5%
As you can see, determining a target compensation amount is important in determining your commission rate and the balance between salary and commission. Each of these variables should be carefully considered to create a plan that motivates your sales team to reach their sales goals.
5. Establish a Payout Schedule
Determining when you pay your salespeople can have significant implications. If you are paying a salary, you’ll most likely pay your employees either twice a month or every other week. If you’re paying a commission or bonus, the question is whether you pay these when a contract is signed or as the revenue actually comes in. In addition, you have to determine whether there is any delay before making payments.
Let’s consider each of these aspects:
Paying Based on an Executed Contract
In some cases, it makes sense to pay a commission when a contract is signed, i.e., when your salesperson brings you a signed contract and is compensated based on the value of that deal. One of the drawbacks is that it incentivizes reps to simply close a deal, even if it’s not the best deal for the customer or your business. It also doesn’t consider whether the customer will actually pay, so it might be better to wait until the money is in the bank.
Paying When Revenue Comes In
Another option is to pay a commission when the revenue is actually recorded. Often a business will sign a contract, but may not actually make payment for weeks or sometimes months later. Sometimes, a contract reflects an ongoing subscription or service agreement that includes revenue that will come in over a period of time. Paying a commission as this revenue comes in means that the salesperson makes money as the business actually receives the income.
Other times, it makes sense to wait for a period of time before paying out a commission. This is especially true if your product is something that is frequently returned. It’s also true when dealing with highly complex products and services that involve long implementation cycles after a contract is signed or revenue is received. In these cases, you would establish upfront that commissions are paid 30, 60, or even 90 days after the triggering event (contract or payment).
6. Communicate Your Compensation Plan
Once you’ve decided on your strategy, established goals, determined how you’ll measure performance, set your commission rate, and how you’ll pay out commissions, communicate your compensation plan with your sales team. Since your plan will help motivate salespeople to reach their sales goals, it’s critical that you communicate clear expectations in a way that leaves no mystery or confusion about how the plan rewards your team for their work.
Here are a few things to consider as you communicate your plan:
Be Transparent & Clear About Your Plan
There shouldn’t be any secrets or ambiguity when it comes to sales compensation plans. You should articulate both the source of the data you’ll use and the rate you will use to calculate commissions. The last thing you want is for your team to feel like you’re hiding something or making it hard for them to know exactly where they stand.
In addition to being transparent, make sure that you are clear about expectations, and what you expect from your team. Not only does your team need to know how you’ll measure their performance, but it’s also helpful to know exactly what those performance expectations are and how they can meet them.
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Put It in Writing
The best way to be transparent and clear is to put your sales compensation in writing and make it available to your salespeople. This eliminates any confusion and allows everyone to see exactly what is expected and how they will be compensated. Making a record of your plan can help your team focus on closing deals instead of worrying about what, how, or when they’ll be paid, plus it gets new reps up to speed quickly.
7. Evaluate Performance & Effectiveness
After you’ve created a sales compensation plan, pay keen attention to how it affects performance. This helps you ensure that you are motivating your team to reach their goals and allows you to make changes as necessary. Software that specifically calculates sales commissions can also help you track how effective your plan is at driving the types of sales activity and revenue that meets your business objectives.
Make Adjustments When Necessary
Even though you put your plan in writing doesn’t mean it’s set in stone—it should be a dynamic, rather than a static, document. As your business and individual needs change over time, it makes sense to adjust your compensation plan.
In addition, you may find that as portfolios change, it may make sense to adjust the ratio of salary and commission. You may also discover that certain aspects of your plan aren’t driving the type of performance you expected and want to make changes accordingly.
One of the most important aspects here is to honor your current plan for any sales or activities that were executed while it is in place. Be upfront and clearly articulate what changes are being made, and provide the new plan in writing to your team. This will reduce the natural resistance that opposes change, and can help eliminate confusion about what your team can expect in the future.
Why Sales Compensation Plans Matter
Sales compensation plans matter because they provide both the business and the salesperson with a clear understanding of how sales performance will be rewarded. It helps everyone be on the same page with regard to how compensation will be structured and what metrics will be used to calculate how much a sales rep is paid. This matters in recruiting top salespeople and in rewarding and retaining your best employees.
Additional Information About the Types of Bonuses
While we already looked briefly at how bonuses fit into an overall compensation plan, here’s a little more information about a few of the most common ways bonuses can be used in a compensation plan to motivate and reward your sales team. However, a bonus will only work if it is perceived as achievable.
Here are a few different ways you can use bonuses in a compensation plan:
Hitting Individual Quotas
The most common type of bonus is paid for hitting a specific quota or achieving a specific metric. For example, when I was a digital sales rep, I was paid a base salary and received a bonus if I reached or surpassed my assigned quota.
In addition to individual quotas, bonuses are often tied to team or company quotas. In this case, when the team accomplishes its goal, everyone receives a bonus. Likewise, if the team over or underperforms, the bonus is adjusted accordingly. Team quotas are often combined with individual quotas to calculate an overall bonus structure that rewards salespeople for their direct performance as well as the effect it has on overall revenue goals.
One-time Bonuses (SPIF)
A SPIF (which doesn’t stand for anything though people often say it stands for sales performance incentive fund), or a one-time bonus, is commonly paid out as an incentive for achieving a specific sales activity. For example, a car dealership might offer a $200 cash bonus to the person who sells the most cars in a given week.
For example, when I worked with sales development reps (SDRs), one of their main goals was to make a large volume of cold calls and set product demos for sales executives. We would do things such as having an hour-long or daylong calling contest, and the SDR who secured the most demos would get $100.
Understanding how to develop a sales compensation plan can help you create a strategy that rewards your sales team for their performance as they deliver results. Following these seven steps creates a sales environment that makes the most sense for your business by establishing goals and creating the right incentives to motivate your salespeople to reach them.
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