Everyone is familiar with the Principal-Agent Problem, whether they realize it or not: someone wants something, but they can’t get it on their own, so they pay someone else to get it for them. Where’s the problem? The difficulty arises when the person hired doesn’t want the same thing as the person who hired them, so they don’t try very hard. Rather, they exert the minimum possible energy to get paid.
That’s putting it very simply, but a smart sales operations leader will recognize this dilemma instantly. The company (the Principal) wants profits, but the sales rep (the Agent) wants an income. Those aren’t the same thing; therefore, their interests don’t align. The solution is straightforward: align the interests of the two parties by allowing the rep to earn a percentage of the revenue on the products they sell, aka a commission.
Variables in Sales Commission Strategies
As sales operations leaders also know, creating the right sales commission strategy can be a complex endeavor. There are many variables to consider, such as the customers in your market, the scope of the territories you’re accessing, your product offerings and sales cycles, the specific demands of your industry, and the skill and experience of the sales reps, among others.
However, a smart sales compensation strategy overcomes the Principal-Agent Problem, and it drives the right sales behaviors, inspiring reps to adopt and express desired business objectives in all their customer interactions.
Choosing the Right Sales Commission Strategy
Once you’ve done a detailed cost-of-sale analysis and established the compensation mix of base salary and commissions, you’re ready to create an incentive plan that drives the sales behaviors that will help you achieve company goals and objectives. Sometimes this may mean developing commission plans for different sales roles (luckily, you can set one up in six easy steps).
Here are four types of commission strategies to consider when developing your plan:
- Flat – A flat commission strategy is the most common and easiest plan to implement. No matter what product a rep sells, the commission stays the same. Flat commissions (sometimes called “fixed commissions”) can be calculated by the dollar or by the widget.
This type of incentive is often used in insurance and real estate markets, and can be reassuring for customers, who know they won’t be needlessly oversold. That, in turn, makes the rep’s job easier, and can drive sales.
- Tiered – Tiered commission plans give top sellers extra incentives and rewards them for their quality work by increasing their commission once they pass pre-established sales targets, or quotas. It also has the secondary benefit of motivating reps who produce fewer sales and see their colleagues earning more.
Whereas the flat commission is broadly categorized as a “commission-based plan,” tiered commissions are treated as “achievement-based plans.” Tiered commissions increase marginally (applying to all revenue earned in the upper tier) or retroactively (including revenue earned previous to meeting sales target).
Without tiered compensation, reps might be tempted to “sandbag” their sales, or save them to ensure they meet quota in the future. But the success of the tiered plan depends on realistic and attainable sales goals, for which you’ll need accurate, up-to-date information along a variety of metrics.
- Hybrid — As the name suggests, the hybrid plan combines flat and tiered commissions strategies. In this system, commonly used in the pharmaceutical industry, a rep is initially paid a percentage of their target achievement, until they reach their goal. After that, they earn a flat commission on anything sold above their quota.
- Multipliers — Multiplier plans are more complex, and so they allow companies to create more nuanced compensation strategies. They’re useful when you want to apply multiple components—or performance measures—to an incentive plan.For example, you might start with a flat commission, but multiply it by a percentage factor of quota achievement. To fine-tune how you motivate your reps, use multipliers that reflect the sales cycle and other factors specific to your industry.
Which Commission Strategy is Best?
In cases where sales reps sell a wide variety of products with different pricing, it can be better to use a variety of commission types. Alternately, a company may want to incentivize its reps to sell specific products.
For example, you can emphasize the products with the highest gross profit margins by setting custom parameters for the commission on that product. This ultimately motivates reps to exhibit the desired sales behavior and to sell at a higher volume in the targeted area.
Companies need the flexibility to adjust their priorities to market demands and motivate reps to share the same goals. The easiest way to align company and sales objectives is through a well-designed commission strategy and compensation plan. Appropriate incentive plans help the company and variable-pay employees align their behavior and expectations.
Need help designing your compensation plan to drive results? Learn more about Xactly’s strategic services offerings.