Linking Sales Compensation to Performance
Linking sales compensation to performance is a much discussed but not always well-executed concept. I will examine why it is important to be clear about compensation, the different types of compensation, tying incentives to the goals of the company, quantitative and qualitative measures for compensation, and a couple of frameworks that work.
In this article, you will learn 1) an introduction to sales compensation, 2) how you can link the sales compensation to performance, 3) some quantitative and qualitative measures, and 4) how management by objectives can help.
INTRODUCTION TO SALES COMPENSATION
1) The three most common types of compensation plans
There are three common types of compensation plans explained in details below.
- Rate: The rate plan is a rate-based mechanic that is also known as a commission. Commissions pay at a percentage of sales. The rate can vary depending on whether it is being paid on the percent of the total sale, the gross profits or even a set dollar amount per unit of sales. Example: I am selling widgets. One widget costs $10.00. My boss tells me my compensation is 10% for each widget I sell. Easy math, I get a $1 per widget. Now my boss tells me he makes $7 per widget he sells, and I will receive 10% of the gross profit. Now my compensation per widget is 70 cents per widget I sell. If my boss decides he wants to pay on a set dollar per widget, he may tell me that he is going to pay me 50 cents for every widget I sell. All are easy math, and the employee can figure out the compensation level versus his performance.
- Quota: The quota plan pays an amount of money for the employee who makes their target (quota) and then adds compensation for going over the quota. That “over the quota” amount can be scaled up as well. For example, my boss tells me to sell 100 widgets and for every 10 widgets above the 100 I will receive $10. However, if he would like to “scale up” the compensation then he might add $10 per 10 until I reach another 100 widgets and then it is $15 for each 10 units over the 200 mark. A little more complicated, but still easy for the sales employee to figure.
- Link-based compensation: The Link-based compensation plan is one where there is a link between two measures. First the employee has to meet the first measure and then there may be a multiplier that enhances the payout of all the employee has sold. There are several ways to do this. For example, I am to sell 100 of the blue widgets and as many of the red ones as I can. If I sell at least 100 blue widgets and 50 red widgets I may see an additional percent or dollar amount as an enhancement to my compensation.
2) When compensation is confusing
Compensation packages for sales professionals can be very confusing and sometimes de-motivating. As children, we hated delayed gratification, as adults we hate it even more. As a company, we will lose good people to other companies when our sales compensation plans are confusing.
If managers put together a complex incentive package, the salesforce has no idea if they are making their goals or not. Making their goals translates into their incentive and if those are pushed too far out the employee does not feel a connection between what he is doing today and what he might be paid at the end of the year.
3) When compensation is too far in the future
The sales person asks, “how am I doing?” Will my efforts be enough? Keying in on these feelings, many companies change their compensation plans yearly. Again, the employee feels a level of frustration on how they will be paid in the future. If they did well that year, they might feel the company changed the formula to make it harder for them to make their goal the next year. As humans, we go with the negative first, even if there is no merit in that thinking.
Excellent sales professionals want to know how they are performing. Even though they are receiving a base pay, that tells the top performers nothing about how they are actually performing. Some companies will argue that the sales cycle is long and therefore paying out on a yearly basis makes better sense. It might, for the company, but delaying gratification, no matter how large the payout, may create burnout for the sales force. The gratification is too far in the for the incentive to mean anything tangible.
4) When it takes a cycle or two to make the sale
Correcting the problem involves having a set process for figuring compensation that everyone understands. Make sure you set rewards based on the performance measures that are most critical to your company. When the sales objective takes two or three cycles, but it is critical to the company, have a partial compensation measure for that salesperson. Otherwise, long-term sales relationships may be overlooked for short-term sales opportunities and, therefore, faster rewards.
5) Some statistics
Benchmarking for success or how are we doing as a company? The best-in-class companies set the pace. According to Peter Ostrow, in 2012, Best-in-Class companies had 83% of their sales representatives achieving their annual quota. This is in comparison to the 53% of other firms that did not have sales representatives making their stated goals. How does your organization measure up to the 83%? What about the first year sales force? In Best-in-Class companies, 61% of the first year sales reps achieved annual quota in the last measured year versus 40% among all others. But how does that affect the bottom line? Well, 14.9% averaged year-over-year increases in corporate revenue, all others averaged 3.6%.
HOW TO LINK SALES COMPENSATION TO PERFORMANCE
Devon McDonald’s article discusses the importance of identifying where your company is and then structuring a compensation plan around those goals. The first step is where are you and your company? Start-up? New and low sales? More established company? For new companies, it is all about making the sales. For a new company, or one just in the start-up phase, heavy compensation for sales is a motivator. The danger with starting with heavy compensation is after the company starts reaching sales goals, the company has to decide if they are going to continue to pay higher compensation. If the answer is no, then what will happen to the motivation of the sales force? This is when company equity could be a motivator to the sales force and replace some of the higher compensation.
Step 1. Understanding the goals of the company
If the company is established does the sales force understand the needs and goals of the company? One way to determine the sales needs is to start with the number in sales you want to make during the year and then work backward to determine how much needs to be sold to meet that goal. Then break that number down and assign compensation to meet that outcome for the company. Keep the compensation plan simple and straight forward. Never cap your compensation plan. Capping the compensation plan means as soon as sales meet their goal they can relax. Tie the compensation plan to both individual goals and team goals.
Step 2. Defining timing
Define timing for tracking and payout for sales professionals. Sales professionals want to know how they will be measured and tracked and how this will relate to their individual earnings. Mark Donnolo advises setting the levels and the timing. Be clear about what you are measuring, is it for an individual or the region? After selecting the measure, make sure you pay on a set schedule, monthly or quarterly. Another aspect of setting the timing is to make sure you are in synch with the long sales process. If your company is one that has a longer sales cycle, then payouts need work within that sales cycle.
- When to reward: Reward when goals are met. The more frequently your company can pay out the better. However, that compensation may be different for different levels in your sales force. Met goals on a long cycle can be recognized with incentives other than the end payout. If your company cannot pay out in the cycle, then find other ways to acknowledge and reward top salespeople.
- Threshold is met: Initially companies need to communicate the threshold to their sales force. This is where the sales professional starts to earn incentives for results over and above their salary. Sales professionals need to understand that the threshold is tied to the operating costs of the company and is necessary to fund the basic salaries. Over and above the threshold is where the sales professional can affect his income. Once the threshold is met, then the sales professional aims at hitting the plan.
- Target is met: Hitting above the quota, hitting the plan, or making the incentive is going above the threshold of operating costs and making the extra money for the sales force and the company. Once the target is met then the real sales earnings start.
- Excellence is met: Being excellent is being in the top 5%-10% of the sales force for the company. Excellence needs to be defined in your organization. Remember, excellence includes not only sales goals but other measures as well. Time with customers, getting new accounts, maximizing sales with an established account, selling more of new product and other measures.
- Sliding scales: Sliding scales can be used when the sales rep is expected to make high volume transactions. However, it does not work as well when the sales are a smaller number that include larger sales.
Step 3. Defining Incentive Mechanics
Identifying the roles and compensation for the sales professionals in your company is also a place to increase motivation. If the lead generator is newly out of college, then the expectations for pay may be weekly or monthly. If the sales professional is a vice-president for sales, their compensation may be monthly or quarterly, in addition to when the company pays regular salaries.
- Defining base salary: You need to determine, in your business, how difficult it is for your sales team to make the sales goals. Are the leads plentiful or do sales people have to really dig for them? If the leads are plentiful, then the level of compensation should reflect that and the same if they sales rep really has to work to find the lead and make the sale. You also have to determine how much you are going to manage the sales rep or do they have a high level of autonomy? When the sales rep is experienced in your company then they clearly need less supervision, however, even if they are experienced sales person coming from another company, some coaching will be necessary to integrate them into the culture and incentives of their new company.
- Defining Commissions: When defining commissions for the sales team, it is important to determine some variables up-front so that incentives serve their true purpose. First, the company needs to know how complex is the sales cycle for their product? How much influence do the sales reps have on the on the buying process? The last question is how does your business operate… is it based on inbound sales, outbound sales or farming? Inbound sales are those sales that come to the company, outbound is the hunting function of the sales reps and farming is growing the existing business through more sales or products. Each of the methods has a bearing on the levels of compensation that are necessary to incentivize.
Another question to ask yourself in setting up a compensation plan is whether you want to set a floor and a ceiling. Yes, you want a floor. A floor is where each sales person starts. They are expected to sell at that level to start and can go nowhere but up. If they fall below the floor, then immediate coaching is necessary. However, no sales person should stay at the floor for more than a cycle – using this is their training period. Should you set a ceiling, no! You want sales reps to sell until the cycle is over and start again. Why set a cut-off for your business? Is this all you want to make this cycle?
- Defining Bonus – over performance element of sale compensation: Bonuses reward excellence. Set too high no one will attempt to reach the goal, set too low, they will not serve the purpose of being a reward to the sales force, i.e., everyone makes the bonus. Remember, the bonus does not always have to be monetarily. If you are compensating your sales force well with salary and other incentives and set the bonus level high, then extraordinary bonuses could be used. Some companies reward with stock or equity in the company. Other companies give vacations or gifts.
QUANTITATIVE AND QUALITATIVE MEASURES
Generally, the measures for sales performance can be splitted into two major categories: quantitative and qualitative. Here are some more insights about both categories.
Quantitative measures – it’s all about the numbers
The quantitative measures are the ones you are most familiar with, and we have been discussing. These are the sales numbers, the quotas, the threshold, the targets. They are black and white numbers.
i) How much did I/we sell?
“How much did I make?” is a quantitative measure. Make this formula easy for the sales professional to understand. The more difficult the metrics, the more room there is for error and de-motivation. Sales professionals know how much they sold, they need to easily be able to figure what their commission is for that sale.
ii) Did I/we capture a new customer base?
Did I capture a new customer base? How many new customers did I find this cycle? This is a real number as well. If you ask your sales force to generate their own leads, then they can expect to see current and future sales from that new customer. As a company, you have to decide if you also reward the sales rep for finding a new customer base over and above sales associated with that customer.
iii) Will our new customer base yield us more dollars?
Will these new customers yield us the type of sales we need? These are the numbers we are accustomed to and we base compensation off of for the sales force. Hard and fast numbers are what we are all used to from a sales perspective and a business owner or manager.
iv) What are the company metrics for me?
Again we revisit the idea of the tangibles for sales people. Making this clear for sales professionals is not always a strong suit for companies. Each person needs to have it in black and white what their sales metrics are and how they will be measured. Complicated formulas generated by others without any input from the sales reps can end up being very de-motivating.
Qualitative Measures – subjective measures
The qualitative measures are the subjective measures and are often overlooked in the haste to generate new sales. So what are the qualitative measures?
i) Customer Service – retaining the base dollars
Did we retain our customers by providing excellent service to them or were we more worried about making the next sale? It is much easier to keep the customer you have (and profitable) than having to look for a new one. After the sales professional has made the sale the customer will want to deal with that person if there are problems, not someone else in the firm. Repeat sales depend on good customer service. However, it is difficult to split time between making sales (where you generate income) and servicing an existing customer (already made the income).
ii) Team player in a field of one?
Did you set us your sales force to work in a team environment? If so, does help someone else mean losing income? If so, you destroyed the team. Make sure there are incentives for being a team player then do not interfere with but add to overall compensation. While some companies believe putting salespeople against each other is good for the company, it can result in stolen sales or customer dissatisfaction. Contests are good, but again, ask sales what they want rather than imposing something “stupid” on them.
iii) Rewards in the long sales cycle
We talked about breaking down incentives to cover a long sales cycle. Make sure the sales reps understand when they are paid and what they are being paid for each check. Payout what you can rather than waiting longer. We want to increase motivation. This is a great time to increase communication and see what will work by asking the sales reps for their input.
iv) Linking qualitative performance and key sales objectives (KSO) to milestones
Create milestones for the team, link those sales to key sales objectives (KSO). Colletti and Colletti-Fiss give six ideas to consider. The first is to state a clear path for the KSO incentive and the limit the number of KSO measures, adhere to best practice selective criteria, set appropriate incentive weights, specify a realistic performance period, and simplify KSO administration. Carefully set these reward sales for non-sales milestones. You might not want to reward non-sales activities for sales personnel but carefully crafted these KSOs will generate sales in the long run and loyalty in the short run.
Make sure you do not over do it with too many measures. The majority of organizations (75%) use three or fewer performance measures. Companies want to see total revenues as their first measure and gross margin sales as their next. Keep your sales force engaged. We often wonder where good sales people come from and where do our good ones go? Incentive plans have a lot to do with sales reps jumping ship. Make sure you are communicating with your sales reps on how they are doing and how they will be paid. When interviewing for new talent remember, if they were top performers at another company, that does not mean they will be a top performer for you. Quite the opposite is true. Talent is not talent. Individuals thrive in certain circumstances so find out if you are a good fit for them, rather than are they a good fit for you.
MANAGEMENT BY OBJECTIVES (MBO) – BASED PAY AND BALANCED SCORE CARD (BSC)
MBO – Based Pay
MBO based pay is using other measures to compensate the sales force. MBO rewards employees for meeting objectives. MBOs can be used when it is difficult to collect the needed data on individual sales and provide appropriate compensation for those individuals. MBOs can be used after the sale. Previously we talked about how to keep sales reps motivated when they feel they are missing current sales by handling already established customers. MBOs can bridge that gap for your company helping the sales rep to reap rewards, and your company retain established customers.
Data-Driven Sales objectives
Michael Martin and Kyle Heller discuss using MBO-incentive plans when there are certain factors that affect the typical ways to pay. If a company is selling to a big-box retailer or engages in team selling, it might be more difficult to break down the individual’s contribution to the total dollar’s sold. Some companies do not collect sufficient data to measure individual sales performance, or the cycle does not neatly fit within the sales year. The team or the individuals are therefore rewarded on a set of objectives that are tied to sales, but can be rewarded without having to meet a set quota.
Linking the data to everyone
In a team selling environment, creating solid MBOs can move a team forward. The MBOs give a clear path, drive results, and involve the entire team in sales efforts. Since the data is tied to everyone, someone who is not performing will be noticed right away.
Balanced Score Card (BSC) based pay
The Balanced Score Card (BSC) is used in the banking industry. There can be an add-on bonus for those positions not tied directly to sales but as support for the team when they make their goal. The system focuses the seller on what is driving the organization, the outputs they have to have, and what is most important in their jobs. Again, compensation must be immediate rather than a long cycle.
Using strategic planning to drive the metrics
Part of the strategic planning is to develop a checklist that defines what is important to the organization. Then that checklist can be attached to real jobs and real outcomes. These checklists define that job position’s metrics and how that person will be measured and thereby compensated.
Focus the seller on organizational objectives
This process helps to focus the seller on what is important to the organization, not just what is easy to sell. When a company has too many metrics to measure sales, and some of those are quicker and easier than the rest, sales reps will concentrate on those. The faster easier payout may not be what is best for the organization.
In summary, a good compensation plan linked to sales must be clearly communicated to the sales force. Measures need to be established, so individuals know how they are being evaluated. Pay incentives must be as immediate as possible accounting for long cycles. Other incentives are acceptable, even desirable, as long as adequate compensation is delivered first. Never set a ceiling on incentives or bonuses.