Sales Commission Strategies: What you Need to Know

Erik W. Charles
Erik W. Charles
In Sales, Sales Comp
Erik Charles is the Vice President, Product Marketing, at Xactly Corporation where he is responsible for driving the product strategy, defining the product vision, and developing a strong team of product owners and designers.

Corporate strategy should cascade down in an organization to a sales strategy and then to the sales compensation strategy. In this article we will use a specific type of sales compensation plan, the sales commission plan as an example. Too often, organizations will start with the prior year’s sales commission plan as a baseline to make changes and end up changing, “rates and gates”, i.e. the commission rates paid at different points of attainment. In terms of sales commission strategies, this is a sub-optimal way of designing a sales compensation plan, as it fails to take into consideration the appropriate inputs and is not structured within the necessary framework.

This article is meant to provide a different way of thinking about sales commission strategies and sales commission planning. True sales commission strategies will address the output of  the sales commission plans themselves as well as the associated quota, territories, communication plan, operational plan, metrics, and success monitoring.

A sales commission strategy is one of the key levers that an organization has to drive top-line revenue. The most visible output, the sales commission plan is traditionally designed to reward performance and reinforce positive behaviors with a goal of maximized return on sales compensation spend. Sales representatives will, in general, strive to maximize their earnings, also known, as “gaming the plan” to make commissions and/or bonuses. An oft forgotten stakeholder to consider when planning a sales commission strategy is the prospect or customer who in the current sharing and reoccurring revenue economy must be treated fairly or risk negative reviews and lost future revenue.

Best practices for a sales commission plan has been to “pay for performance” instead of paying for activities which is good advice if you lack the operational capability to design with the current understanding of maximizing motivation. The limitation of pay for performance is the backwards view into something that has already happened. The ability to closely tie the reward to the behavior is paramount.

Leading companies following the pay for performance design philosophy provide real-time reporting at the time of the sale (or other business event – booking, invoice, revenue recognition, cash receipt, etc.) into how much a sales representative will be paid for the activity. The reporting is a proxy for actual pay and is largely effective in a creating a strong reward. Lagging organizations will have a dark period of 4-8 weeks when the sales representative has performed the desired behavior and is unaware of how much compensation they will receive until a lump sum is deposited into their banking account. This break between the behavior and the reward creates a weak to non-existent reinforcement and is considered poor design.

The latest line of thought in sales commission plan design is to build a framework to help sales representatives make decisions throughout the sales process to maximize their personal earnings, align with the company’s strategic goals, as well as consider the acquisition, penetration, and retention of prospect and clients. This is enabled through technology that estimates future commissions based on opportunities in the CRM system or quotes from a CPQ (Configure, Price, Quote) system.

From initial opportunity to closed-won business the sales representative can see their potential earnings. As they make adjustments by adding a line item or negotiating on price, they can see the real-time impact of those decisions. The reward of having well thought out sales commission strategies is a much great potential for the corporate goals to be met, whereas a poor strategy, or in many cases no strategy, put the viability of the company at risk.

Inputs

An effective sales commission strategy for your organization is dependent on a number of internal and external factors and must include execution considerations and planning. The key input is the overall corporate and sales strategy as the compensation plan must be in alignment with these strategies to be successful. What is important for the current plan period could be revenue growth, margins, profits, market share, etc. This corporate level strategy is balanced out by external factors such as the political & legal environment, the competitive environment, and the social environment.

Depending on the level of regulatory oversight for your particular industry the elements of your sales compensation plan may be impacted. Two industries in particular that have legal rules around sales compensation include the Insurance and Pharmaceutical verticals with significant financial penalties for failure to be in compliance.

Your sales compensation plans must be competitive or your organization will struggle with recruiting, engagement, and retention of sales representatives. The cost to replace an employee, and the time for a sales representative to become a full quota bearing rep are key economic reasons to have a competitive plan for base salary, total target compensation at plan, and potential upside earnings potential. Leading companies are using up to date real world benchmarks with peer organizations, lagging companies are relying out outdated manual survey information or worse – nothing at all.

When designing the sales compensation plan consider the social environment as well. The region of the world could help define the pay mix, with certain countries and regions having a greater appetite for more money at risk and greater potential for upside than others. Transparency in reporting how a sales representative is paid with the appropriate level of detail and the ability to initiate a dispute is valued in North America and Europe where the employer and worker are often at odds, but other regions of the world aren’t as comfortable with sharing these details with the individual as trust in the company is more culturally ingrained.  The desire for individualized choice within the plan (pay mix, quota, and upside) vs. one plan per job role is yet another social environmental factor to consider.

Stakeholders

There are three primary stakeholders invested in the success of sales commission strategies: The company, the sales force, and the prospect & clients of the company. The company is looking for maximum return on its sales compensation investment and will drive sales performance through effective on-boarding, training, and coaching, sales management, tools, and reporting. Equally as important as the performance of the plan, is  minimizing risk for the company. To that interest the company will strive to remain in regulatory compliance, provide fair pay, accurate calculations, a strong audit trail, accrual capability, modeling of potential changes, and reporting showing key success metrics such as spend vs. budget.

The sales force is looking to maximize their individual earnings and will look to game the plan. Of great importance to the sales force are transparency and visibility into earnings, timely and accurate payments (so they don’t have to individually track it), easy to understand reporting available on mobile devices, a fair territory, an attainable quota, and competitive pay with both internal and external peers.

The third stakeholder is the prospects and clients. The compensation plan design can reinforce social stigma and impact perception around sales rep honesty and mutual interest. One need to look no farther than the recent debacle at a large North American bank where a sales compensation plan was designed in a fashion to not take into consideration the customer and created a cascading series of unintended consequences.

Outputs

In this article we mentioned a specific type of sales compensation plan, the commission based plan. A commission based plan is suited for industries and products where an individual sales representative has control over the sale, the sales cycle is relatively short, territories are difficult to balance, and the forecast for the market is difficult to predict.

Other selling environments may indicate a different preferred sales compensation structure. A key consideration to a successful commission plan is that the plan be uncapped and the sales representatives have unlimited earnings within the plan period. There are many components of a plan that must be considered as part of the final design including: Pay Level, Plan Type, Pay Mix, Metrics, Payout Period, Payment Calculation, Eligibility, etc.

As a representative example, let’s take a little deeper dive into just one component of the sales commission plan, the payment calculation:

Commission plans pay for every  business event you can compensate for (this is the metrics or measures) at a commission rate. There are many types of rates:

  • Fixed (example 3% on all revenue)
  • Variable such as a rate table with accelerators or possible de-accelerators (3% on first 10 units, 5 % on 11-20, 10% for 21+)
  • Multi-dimension look-up table (example – achievement to goal & profit margin)
  • Relative commission rate sometimes referred to as an individual commission rate. Example ((targeted commission amount / quota or goal) / 100)).   Target commission amount of $35,000 / $1,500,000 = 2% commission rate.

When measuring success of sales commission strategies, effective and efficient operational administration of the plan is tantamount to the plan design itself. One cannot succeed without the other. The ability to gather the necessary high quality data from source systems, apply crediting, accurately calculate the results, provide reporting and ongoing monitoring of the plan against internal metrics and external peers are all critical aspects to the successful fruition of the strategy.

Conclusion

To maximize the return on your sales compensation spend, start by defining your sales commission strategy. The strategy should be based on the higher level corporate and sales strategies. It has key inputs, stakeholders, and outputs, which include the people, process, and tools needed to successfully execute.

A well designed strategy help companies with sales performance, recruitment, engagement, and retention. If your company needs help in defining a comprehensive sales commission strategy or in refining a piece of your overall strategy, Xactly’s Strategic Services can help.


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Sales Commission Strategies: What you Need to Know

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