Creating a Sales Compensation Plan

When it comes to how businesses pay their salespeople, there's no one-size-fits-all approach. That's especially true for many companies with diverse products and services that include a mix of products and services. Some pay commission based on sales, while others only pay on margin; still others blend both with incentives and special bonus plans.

No matter which approach you use, success depends on awareness. Your sales management team must understand your company's overall goals and structure compensation to align with them. In short, sales compensation should be not just a tactical focus for your organization, but a strategic one, as well.

Sizing It Up
Compensation plans shouldn't be developed in a vacuum. You and your sales leaders need a solid grasp of your overall industry and your organization's place in it. You'll need to factor in variables such as new product launches and major promotions, as well as consider your personnel structure.

You should also address these questions: Is your company a startup or an established business? What are sales goals? How long are your delivery cycles? What are your objectives to secure new clients, increase average order sizes and grow margins? Do you want to open a vertical market or new products? Each answer will help you design a compensation plan tailored to your company's specific needs.

Finally, take a hard look at your sales organization. For instance, do you need to attract new representatives to make C-level sales calls? Do you want to retain employees to build a long-term, client-based sales team, or is rapid turnover acceptable?

Understanding Cost of Sales
Of course, you can reduce selling costs and enhance profits by capping sales compensation, but in the long run you get what you pay for. If you hire good salespeople and compensate them poorly, expect high turnover, which comes with costs of its own. A sales plan that compensates strong performance will allow you to attract the best salespeople -- and retain them, as well.

Calculating the cost of sales (CoS) is an important part of planning a compensation package. For a quick CoS ratio, simply take an individual's salary plus commissions earned at 100 percent of quota and potential bonus opportunities, then divide by that person's revenues to obtain the percentage. A more sophisticated approach adds in marketing expenses, corporate overhead, direct expenses paid to the salesperson and expenses related to sales support costs.

Examining the Options
Compensation plans vary widely, but all should include "accelerators" -- that is, increased commission rates for employees who achieve target levels.

• Profit-Based: Commission rates change as margin levels increase. These plans are generally based on invoice, product or monthly averages of margin generation.
• Revenue/Quota: Compensation is based on sheer volume achieved over the previous sales period or on a percentage of a quota achievement.
• Balanced: Compensation is based on margin, revenue and a third component, such as quota attainment.
• Team: Bonuses go to all team members when quarter-to-date (QTD) sales goals are achieved.

There are many variations and we recommend multiple combinations based on the objectives of the organization.

Tailoring Tips
Here are a few final considerations to keep in mind as you customize your compensation plan:

• In new organizations focused on expanding within existing markets, the compensation plan will differ dramatically from that of an established company in the same industry. A mature, market-dominant company that receives a large percentage of its revenues from a small, loyal customer base can offer lower commissions and, perhaps, lower overall salaries. But a newcomer to an existing market probably needs to offer higher compensation to attract top-performing salespeople who can build a strong customer base.
  
  
• New organizations in new markets need compensation plans reflecting the volatile environment, usually with higher-than-average base pay.
  
  
• Companies in transition or undergoing a turnaround typically experience a higher CoS ratio; they may be best served by flexible plans incorporating morale- and team-building components.
  
  
• Organizations positioned for high growth should develop plans covering brief, six-month periods. This will let management test theories and change direction while allowing the sales team to adjust accordingly.

No question about it: Creating an effective sales compensation plan is hard work, but the effort typically pays off in both improved sales performance and achievement of your corporate goals.

Posted by Ken Thoreson on October 07, 2014