How to Make Sales Compensation Plans Fair and Effective

Transparency and fairness are key to a successful compensation plan.
Senior Staff Reporter
November 30, 2021
Updated: December 1, 2021
Senior Staff Reporter
November 30, 2021
Updated: December 1, 2021

There’s a common belief that salespeople are purely motivated by money. But if that’s true, asks PatientPop VP of Inside Sales Kevin Dorsey, then why do so many sales reps fall short of their quotas?

He believes most salespeople are motivated by the same things as everyone else: security, creativity and autonomy. And that perspective shapes how he approaches building his team’s compensation plan. To him, it’s about setting targets and quotas that the average rep can reach to earn their commission, along with incentives to encourage the high performers.

Tips for Designing a Sales Compensation Plan

  • Start with understanding your company’s strategy for the year. This ensures incentives are aligned with your goals.
  • Keep the plan simple. You shouldn’t incentivize more than two or three behaviors. 
  • Even stretch goals should be attainable. If quotas are too high, reps will game the system or give up.  
  • Use commission accelerators and sales performance incentive funds when you ask reps to go above and beyond. 
  • Clawback provisions can ensure reps bring on the right customers. But they need to be time-limited and clearly defined.
  • Don’t include cliffs. Many reps start treating the cliff as their quotas. 
  • Don’t increase quotas without offering additional support.

As long as sales is a commissions-driven role, the compensation plan is still the primary driver of a rep’s behavior. It serves as both a blueprint for how the company expects to grow its revenue and what salespeople need to do to make earnings for the year. However, it’d be a mistake to assume that, to get reps to work harder, they just need a bigger carrot.

If compensation structures aren’t aligned with sales strategy, reps can game the system by stuffing deals with unnecessary add-ons, making promises your product can’t deliver on. Or, if the plan feels unfair, reps will become demotivated and eventually leave the company.

Making a compensation plan work is all about balancing what’s best for the company with what a sales rep can control, Dorsey said.

 

Sales Compensation

In sales, there’s often a direct line between how a sales rep operates and their compensation plan. The plan is typically released before the start of the year and includes the rep’s annual quota target, weekly or monthly performance metrics, and how their salary will be calculated.

Since sales reps are directly responsible for generating revenue, most compensation plans tie a rep’s earnings to their quota through commission. The plan will often include an on-target earning, which represents a rep’s full pay if they reach their goals. If they underperform, the rep will make less than that number. If they overperform, companies can bake in higher commission rates or incentives that allow the rep to make more money than their on-target earning specifies.

The best plans take into account historical sales performances and expected win rates to calculate exactly how many calls, meetings and demos it takes to reach the annual quota. A rep should be able to read it and know exactly what they need to do each month, said Laurie Page, VP of sales strategy at the sales consulting firm The Bridge Group.

“I’ve literally spoken with sales reps who have said, ‘I don’t know what I’ll get paid at the end of the month or the end of the quarter,’” Page said. “That’s never a good thing.”

The compensation plan should also align with the company’s goals. If the company wants to prioritize new businesses, they can offer a higher commission rate for deals that bring in a new company. Likewise, if a company wants to expand its reach within its existing companies, it can incentivize those deals.    

Most plans will also include potential bonus pay called sales performance incentive funds. These can take the form of a bonus, a paid vacation or extra commission reps can receive for achieving a specific sales goal. Throughout the year, sales leaders will often hold contests offering sales performance incentive funds to encourage activities — like selling a new product or feature — that boost revenue or reach a new company goal.

 

Kyle Racki, co-founder and CEO of the sales company Proposify, details how to compensate tech sales reps. | Video: Proposify

Sales Compensation Plan Examples

There are several different ways to structure a compensation plan, but the right one for you will depend on your sales strategy and team. Below are some of the most common compensation plan examples.

 

Salary

This compensation model involves paying sales reps the same way other teams are paid — through an annual salary. Instead of rewarding reps with a commission for reaching certain targets, their metrics are presented as a set of standard expectations for the pay. Sales leaders can also offer a bonus to encourage reps to exceed their goals.

The salary model is rare in sales as leaders question the ability to motivate reps without commission. Still, Dorsey argues that it’s an effective strategy for sales reps who are driven by security, and it can be used to hold your team to a higher standard.

   

Commission Only

The commission model gives sales reps complete control over how much money they make. With no base salary or cap, a rep’s salary is only limited to how much they can sell in a given month. The model can be effective for reps driven by money, but it can put a lot of pressure on reps to close a specific amount of deals each month. Without providing the proper support, you could risk reps rushing deals to close to earn commission.  

 

Base Salary Plus Commission

This is one of the more common compensation strategies in sales today. In this model, reps are paid a base salary that is supplemented with their commission earnings. Compensation plans will typically include an on-target earning that represents their full income if they reach their quota. 

This strategy has a couple advantages. It gives reps a measure of security because a portion of their salary is guaranteed each month, and it allows leaders to incentivize over-performance with commission boosters. But there’s also the risk that underperforming reps are allowed to stick around because they’re being paid less, Dorsey said. 

 

Tiered Commission

Similar to the commission model, sales reps are paid a portion of money for each deal they close. The difference is that reps in the tiered model are paid an escalating commission rate as they close deals that meet specified benchmarks. So a sales rep might earn, say, 5 percent commission on the first $50,000 in revenue they earn, then 7 percent on deals until they reach their quota and, finally, 9 percent on deals that exceed their quota.

This model is a useful way to incentivize middle performers to keep working toward a higher target, while giving high performers a boost for exceeding their quota, according to a guide from sales software company Xactly.

 

Gross Margin

The gross margin compensation structure pays reps a commission based on the profit margin of the deal. So the higher the company’s profit on a sale, the more money a rep will earn. The strategy aims to incentivize reps to sell larger deals and disincentivizes discounts that can lower the revenue a company generates on a deal.

    

Territory Volume

If you have a sales team that sells to businesses on the West coast, another for accounts in the Midwest and a third on the East coast, then a territory volume compensation plan might work best for your team. In this strategy, each regional team is paid a commission based on the total revenue they generated in their territory, which is then divided evenly among each rep. This model works best if you have well-defined and balanced sales opportunities in each territory.  

More on Sales CompensationAre Your Quotas Too High?

 

Start With Thinking About What You Want to Accomplish

When it comes to building a compensation plan, Weisen Li, VP of revenue operations at the email marketing software company ActiveCampaign, recommends a sales leader starts with understanding the company’s strategy for the year.

Understanding what the goal is — whether it’s to bring in new logos or increase annual revenue through partnerships — will help determine what’s expected of each sales rep. Without taking that step, the company runs the risk of incentivizing the wrong behavior or setting targets that go beyond a rep’s responsibilities.

“In my opinion, when people say compensation plans are a mess, it’s usually a downstream manifestation of upstream sales problems,” said Li. “The process starts all the way back with the company’s strategy point of view, but I’ve observed that a lot of sales leaders don’t think that far back when it comes to commissions.”

Li makes sure she develops a clear definition of each position’s role and responsibilities before she builds her plan. Counterintuitively, this is especially important at fast-growing startups where responsibilities can shift day to day.

Shaping compensation around clear responsibilities helps ensure that each person has incentives tied to outcomes they can control. For an account executive, that could be a commission tied to bringing in new customers, whereas a sales development representative should earn commission for setting up meetings.

 

Keep the Plan as Simple as Possible

One of the most common mistakes Page sees companies make is designing compensation plans that are too complex. Often, that’s the result of incorporating different commission payouts for bringing on new business, new logos, reaching a specific gross margin and for customer retention.

That makes it impossible for the salesperson to figure out how much they’re going to get paid. A good rule of thumb is that, if you can’t explain how the compensation plan works, then it isn’t going to motivate your reps.

“If you need a Ph.D. to calculate your commission plan as a sales rep, it’s just not gonna work,” Page said.

At most, she recommends sales leaders incentivize two or three activities. If the company wants to expand new logos and increase sales of a particular product, then structure the contract to prioritize those types of deals.

When Page unveils her comp plan to her team, she’ll often give them a tool to calculate how much money they can earn to get them excited.

 

Set Fair (but Challenging) Quotas

There’s nothing more demoralizing than an impossible-to-reach quota. And yet, Dorsey frequently sees companies creating on-target earnings and quotas that are impossible for all but one or two reps to hit.

The issue stems from focusing too much on the revenue target and not on what it takes to achieve that number, Dorsey said. While an effective quota should be a stretch to motivate reps, it shouldn’t be outside the reach of an average salesperson on the team.

Finding that number requires looking at the average contract value and close rate, and then working backward to understand what it takes to close a deal. If the rep’s goal is $100,000 in revenue each month, and the average deal size is $10,000, that means the rep will need to close 10 deals, Dorsey said.

But are 10 deals possible?

To figure that out, Dorsey tries crunching the numbers. If the average close rate is 30 percent, the rep will need to run 33 demos to close 10 deals. And if only 70 percent of customers actually show up to the meetings they’re scheduled for, a rep will have to schedule 45 demos in a month to hit the target.

From there, he’ll determine whether the SDR team can give the rep enough pipeline to hit those numbers. If they can’t, he knows he either needs to provide more resources to help the rep or lower the quota.

Ultimately, it’s all about tying a rep’s compensation to a quota they can attain, Dorsey said.   

“We expect you to be average. If you’re going to be below average, you’re going to make less. Above average, you’re going to make more,” Dorsey said. “There’s a lot of comp plans that expect you to be above average.”

Li, however, believes that there is value in setting a quota that pushes reps to stretch toward their goals. Her rule of thumb is to set a quota that about 80 percent of the reps meet.

She’ll calculate that number by looking at the deals her top-tier reps, her average reps and the bottom quadrant of reps close. The number can help to incentivize or weed out low-performing reps but is not so high that salespeople become disheartened.

Just make sure the quota is relative to the rep’s territory, Li said. If one rep is selling software in Silicon Valley and another is selling it to Alaska, their quotas need to represent the demand in their territories.

 

Always Pay for Overperformance

While a compensation plan should represent the company’s overarching sales strategy, there are often new products and priorities that crop up over the course of a year.

That’s where sales performance incentive funds come in. These temporary bonus payouts can be one of the most effective ways to accelerate sales behavior around a specific goal. It can be designed as a team-wide competition or structured around additional sales targets. 

“Where companies get in trouble is when they don’t make it extra — they change the comp plan so that reps now have to go do these more difficult things to make their OTE.”

Dorsey has paid bonuses to reps for bringing on customers who paid for the length of their contract upfront, or for selling a particular product to three customers in a month. The key is that it should reward a salesperson for going beyond their daily responsibilities, Dorsey said.

“Where companies get in trouble is when they don’t make it extra — they change the comp plan so that reps now have to go do these more difficult things to make their OTE,” Dorsey said.

SPIFs can also bring out the competitive side of salespeople. As a former sales leader, Page used to poll her team around what rewards they’d want for a quarter and then design competition around that. The bonuses can also be structured to bring the team together by setting a teamwide goal to earn an outing or reward.

Just don’t incentivize too many behaviors, Page said. The more focused a salesperson can be around one or two bonus payouts in a quarter, the better the results will be.

“If I’m paying a sales rep for logo expansion and I’m SPIFing them for 17 other things, it’s like, ‘Now what do you want me to do?’” Page said.

Commission accelerators can also be an effective tool to get the most out of sales reps, Page said. An accelerator pays a rep a higher commission rate for any deals a rep closes beyond their quota.

While there is some risk that the company could end up paying every rep for overperforming, fair quotas and accelerator caps can help to keep payouts within budget.

 

Clawbacks Can Hold Reps Accountable

No matter how well designed the compensation plan’s strategy is, there is still the risk that salespeople bring on ill-fitting customers or pack deals with unwanted features.

Both lead to high rates of churn, causing the company to lose money, even though the rep is meeting their goals. Having a clearly defined clawback policy can be a useful tool to hold reps responsible for the customers they’re bringing on.

A clawback is a provision that requires a rep to pay back all or a portion of their commission if they don’t meet a specified requirement. At ActiveCampaign, for example, that provision is tied to short-term customer churn. Sales reps are paid commission on the year-long value of the contract. If a customer doesn’t fully onboard and churns in the first couple of months, a rep will have to pay back that commission.

To ensure incentives align across the entire customer journey, customer success managers and account executives are paired with each other and the two are rewarded jointly for retaining and upselling customers.

“Sales has a lot of ability to influence whether a person churns within a short period of time.”

This structure helps ActiveCampaign align its sales strategy with its customer success goals and reduce churn, Li said. The clawback provides a check on sales reps to make sure they’re not selling customers on packed deals that they will cancel within a month.

Still, it’s important the clawback provision is within a reasonable timeframe that a rep can influence during a deal, Li said. Churn isn’t always reflective of a bad deal, and a salesperson shouldn’t be punished for that.

“Sales has a lot of ability to influence whether a person churns within a short period of time. That period of time, though, is different, depending on the size of the customer and the region,” Li said. “So you have to make sure, like whatever period that you clawback is one where it’s within a rep’s reasonable ability to influence.”

 

In Consideration of a Sales Salary

For as long as sales has existed, commission has been considered the only way to motivate salespeople by many.

The most common format for a compensation plan is a 50-50 commission structure, in which 50 percent of a rep’s earnings are their base salary and 50 percent on commission. Other strategies include a high-risk, high-reward structure in which reps are only paid on commission with no base salary. This gives them the freedom to earn as much money as they can, but with no guaranteed income.

Dorsey, however, believes the commission format is broken. It makes recruiting more difficult because income isn’t guaranteed, and the stress involved in earning that income leads to high rates of employee churn, he said.

“It gets away from the words ‘incentivizing.’ It’s about defining your job. Here’s what your job is, now go and do it.”

If he had his choice, he’d opt to offer salespeople a salary just like any other employee. Reps should be motivated to do their jobs, he said, because that’s what they’re paid to do. If they don’t meet their targets over multiple sales cycles, then they can expect to be fired, just like any other professional.

If they overperform, they have the opportunity to earn bonuses. All that changes is a salesperson’s peace of mind, he said.

“It gets away from the words ‘incentivizing,’” Dorsey said. “It’s about defining your job. Here’s what your job is, now go and do it.”

Not everyone believes this structure will work. In Li’s opinion, commission helps to bring out the natural competitiveness of salespeople. It’s an effective way to measure performance and drive sales activity toward specific goals.

Dorsey has experimented with a salary structure for a portion of his team. The result? They did their jobs, he said.

More on Sales CompensationDitch Commission and Pay Your Reps Full Salaries

 

What Not to Do in Your Sales Compensation Plan

As much as compensation plans can motivate salespeople and shape their behavior for the positive, they can also encourage bad habits. Here are some examples of what not to include in your compensation plan.

 

Don’t Include Cliffs

If there’s one clause that Dorsey will never incorporate into his compensation plan, it’s a cliff.

A cliff is a provision that states if a rep doesn’t reach a specified minimum — say 75 percent of their sales goal — they earn zero commission. It’s motivation by way of punishment, and it changes the goal salespeople will work toward.

Rather than trying to reach their full quota, their sights will be set on doing whatever it takes to meet the minimum requirement. That could mean stuffing deals with unwanted features or focusing on high-payout deals that meet their minimum targets but not the revenue numbers. Either way, it discourages overperformance and leads to high rates of churn.

Don’t Increase Quotas Without Providing Support 

Increasing a quota is always a delicate dance, Li said. Sometimes, it needs to happen for the company to bring in more revenue, but it also adds more pressure on the individual reps.

That’s why any increase in quota needs to come with a plan for attainment. It’s on the sales leader to figure out what resources they need to provide to the team to help reps hit their new numbers. It could be bringing on sales automation tools to boost productivity or hiring additional SDRs to increase pipeline.

It’s easy to tweak quotas to meet the new revenue target, but without a plan in place, salespeople will be quick to feel demoralized or start gaming the system. When that happens, expect high rates of customer churn due to bad deals, and, eventually, employee churn.

“The worst thing is for reps to feel like, ‘This [quota] is impossible,’ and they give up,” Li said. “It’s much more of a morale thing, and, by then, they’re probably looking for a new job.”

 

Don’t Be Late With Your Compensation Plan

Imagine starting a new year without any idea how much you’re going to be paid. It sounds absurd, yet Page has come across sales reps without a compensation plan as late as March.

No matter what obligations a sales leader may have, it’s their responsibility to distribute the plan by the start of the year. Sales is hard enough. At the very least, reps should have the benefit of knowing how much they’ll make for the year.

“Communicate it, and get them excited for their compensation plan,” Page said. “And don’t be late. There’s nothing worse than when I talk to reps in February or March, and they say, ‘I don’t have my comp plan yet.’ That’s just crazy.”

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