How to Develop a Sales Compensation Plan in 8 Steps
This article is part of a larger series on Sales Management.
Sales compensation plans provide the framework for how you will pay sales reps. A well-thought-out system ensures your team knows what to do to succeed and motivates them to hit peak performance. From determining baselines and establishing goals and quotas to implementing your plan, follow our step-by-step process showing how to develop a sales compensation plan for your business.
1. Select a Method for Sales Compensation
There are various approaches you can take as you develop a sales compensation plan in terms of methodology. Every organization will be different depending on sales culture, industry norms in terms of what typical compensation rates or methods are in that vertical, and maturity of the business. The chart below shows different methods you can use, along with the pros and cons of each:
Annual, monthly, semi-monthly, or bi-weekly amount of income to be paid to a rep regardless of production
The rep's income is based on a set percentage of sales or revenue generated by the sales rep during a set time period
Salary + Commission
Combination of base or set income amount plus percentage of revenue generated by the sales rep
Salary + Bonuses
Combination of set income and cash rewards for hitting milestones such as a stretch goal, closing a certain size deal, or exceeding a goal by a certain amount
Salary + Commission + Bonus
Combination of set income, percentage of the revenue generated by the sales rep, and cash rewards for hitting milestones
While we put this as the first step, you can also choose to wait until after steps two and three when you understand the financial implications more. Moreover, if you are a fairly new business without consistent financial information, you will likely want to do all of your estimates prior to selecting a method.
Whether you plan on using one of the performance-based methods or a salary, check out our guide on sales performance management for how to get the most out of your team. You’ll get insights on what performance management looks like for different organizations and tips to better motivate your sales employees.
2. Determine Your Break-even Point
Determine the amount of revenue you need to generate to cover base expenses. This is foundational to setting your overall sales revenue goal and individual quotas, which we will do in the next steps. Since salaries are a fixed expense, those will be easy to include in your analysis. If you want to experiment with commission or bonuses, however, those will be variable expenses based on the revenue generated and milestones met.
Break-Even Sales Compensation Calculator
3. Establish Sales Goals
Once you know your break-even point, it’s time to set a sales goal, or total revenue goal. Your overall sales goal is the break-even point plus desired profitability. For instance, using the example from the previous section, if you want the business to make $100,000 in profit beyond expenses, add $100,000 to the $229,900 (if salary only) or $160,147 (if Salary + Commission).
Alternatively, you can also base your goal on a profit margin percentage, such as wanting to make a 40% profit. In this case, multiply the break-even point by the percentage, as in the examples below:
- Salary Only: $229,900 x 1.40 = $321,860 sales goal
- Salary + Commission: $160,147 x 1.40 = $224,205 sales goal
4. Assign Sales Quotas
If strictly production-based, setting sales quotas is as simple as taking your sales goal and dividing it by the number of sales reps. For instance, if you took the sales goal of $321,860 and divided it by three sales reps, you would then set individual sales quotas for each rep at $107,286 in revenue. We advise, however, that you take the experience and individual skill sets of each rep into consideration when setting quotas.
You may find it easier to do deal-based quotas where you set a minimum number of new clients or customers each rep needs to bring in. Lastly, if you know your sales pipeline conversion rates, you can do activity-based quotas, where you set a minimum number of calls placed, emails sent, appointments set, or leads generated for a time period such as weekly, monthly, or quarterly.
For example, let’s say you know that you need four new deals per month to hit your revenue goals. Based on conversion metrics, it typically takes 200 cold calls to new leads for every deal closed. Therefore, you would set your minimum monthly quota at 800 cold calls per month in order to hit your four deal sales goal.
This is where customer relationship management (CRM) software can support and streamline your efforts. CRMs like HubSpot allow you to track individual or team sales activity, which in turn makes it easier to keep your team on track as far as activity quotas and revenue goals.
5. Set Compensation Rates
The objective here is to determine salaries, commission rates, and/or sales bonus structures to incorporate into your sales compensation plan. This particular step also has some flexibility in terms of when to complete it. For instance, certain industries—such as real estate or insurance—have industry standards as far as standard commission rates. In this case, you will have established this in step one.
You also could have established these numbers during your break-even analysis. During that step, you can play around with the numbers to see how it affects your break-even point and determine whether the sales quotas set can provide fair compensation to your sales reps and be realistically attainable.
You may find during your financial analysis that if you hit a certain revenue point, you and your business can elevate to another level. In that case, you may decide to add a bonus to your sales compensation plans that give X number of dollars to a rep (or the whole team) if they surpass that revenue point.
One way to set your rates is by combining realistic expectations with a solid income level to attract sales rep candidates. For example, let’s say that you know you want to use a Salary + Commission model due to the balance it offers. You feel that an $80,000 total salary is fair for the type of sales work this job will entail.
Additionally, you believe based on historical figures that the average rep can produce $300,000 per year in revenue and that $30,000 is a respectable base salary to offer. Therefore, you would set your commission rates at 16.6% (50,000/300,000). Any sales rep who produces above-average numbers will receive above-average commission compensation.
6. Develop a Payout Schedule
After setting base salaries, commission rates, and bonus structures, you are ready to determine a payout schedule. This is more so for administrative purposes and managing expectations for reps regarding when they will be paid. Decide when you want to pay the commission or bonuses. Below are a few ways to consider for your payout schedule:
- When the deal is closed: Commission or bonus is paid at the next payroll period after finalization of a new deal or when client/customer is onboarded. While this approach is great for sales reps, it’s risky to your business if clients default on payments.
- When the customer pays: Commission or bonus is paid at the next payroll period after the customer or client makes their first or ongoing payments.
- At the end of a time period: Commission or bonus is paid at the next payroll period after the month, quarter, or year is complete and/or the threshold has been reached (for bonuses). This approach is more favorable to the business but could frustrate sales reps if they have to wait to receive their compensation.
Pro tip: Use accounting tools like QuickBooks Online to run your payroll and ensure your sales compensation plans are managed properly. The payroll processing features of this platform let you manage employees, contractors, benefits, and payroll taxes. Additionally, QuickBooks Online integrates with many popular customer relationship management (CRM) systems such as Insightly, Zoho CRM, and Salesforce.
7. Communicate Your Plan
As part of sales management, you need to document and be able to explain your plan for recruitment, liability, and motivation purposes. We recommend outlining the plan in the employment contract of new hires and employee handbooks for on-demand reference. When implementing a new structure, plan to have both group and individual meetings with reps to explain the new system, answer any questions they have, and respond to their concerns.
Pro tip: Track performance and commission accumulations with your CRM. Popular platforms like Performio let you view commissions payable on a dashboard, track individual performance, and easily view forecasts for sales commission costs as deals go through the sales process. It’s for these reasons Performio is ranked the best commission tracking CRM system for 2022.
8. Execute & Evaluate Your Plan
One of the most important aspects of how to develop a sales compensation plan for your business is following through with paying the appropriate salaries and/or performance-based compensation. Envisioning, developing, and executing motivational techniques is all part of sales leadership and should be addressed in your plan.
As you run your business and manage your sales team, continuously evaluate whether the salary structure you created is appealing to your reps, fair to your business, and makes sense financially. If something is off, you may need to rethink the structure of your plan and go through these steps again to find something that works better.
For instance, let’s say you’re managing a sales compensation plan and find that sales reps keep leaving because they don’t feel motivated enough. You find out that the cause of the lack of motivation is that the commission rates are not high enough to make it worthwhile for reps to give their full effort. This would be a good scenario to reconsider the structure and make changes like increasing commission rates, shifting to a bonus structure.
If a redesign of your plan is necessary, tread the waters carefully in how the system is changed. It becomes a sensitive issue when changes are made to someone’s income or compensation structure that could result in cultural, turnover, or legal liability issues.
For instance, let’s say you decide to move from a Salary + Commission sales compensation plan structure to a Salary + Bonus one. That significant change will need to be handled with care, including giving plenty of notice of the change, constructing bonuses in a way that reps would make as much or more money based on current metrics, and potentially easing into the transition by providing a cash compensation early to account for any potential income gap.
Sales Compensation Plan Statistics
Check out these stats below to see how other businesses are developing their sales compensation plans and some of the biggest challenges in this arena:
- On-target earnings (OTE) of the average sales rep is about $115,000
- 62.6% of companies say the biggest challenge in developing a compensation program is setting goals and quotas
- 63% of businesses changed their compensation plan in 2021 due to the pandemic
- Software as a service (SaaS) sales reps earn 10% of the annual contract value in commissions
- More than three out of four companies using automation tools enjoy more than 95% compensation payment accuracy
- 35.6% of companies put new sales reps on a fixed salary
- 82.3% of organizations tie payouts to individual performance
By learning how to develop a sales compensation plan that gets maximum production out of sales reps and keeps them satisfied in their roles, you are ultimately growing your business. Designing and implementing an effective plan requires analysis of your financial data, using effective management practices, having an understanding of how to recruit sales reps, and investing in the right software tools to make your compensation plan easy to execute.