There are many ways to incentivize a sales team—bonuses, SPIFs, commissions, etc. Regardless of your strategy, the goal is the same: to motivate sales reps to close deals and hit their quota. The most common form of sales compensation and motivation is through one of many types of sales commission structures. A tiered commission structure helps encourage reps to continuously improve their sales performance to meet and exceed quota.
What is a Tiered Commission Structure?
A tiered commission structure motivates reps using commission rate tiers. Unlike flat commission plans, tiered commissions encourage sales reps to hit sales milestones. As performance increases, reps earn a higher commission rate. This type of compensation plan is meant to motivate reps to meet quota, exceed quota, and continue closing deals. And, they can be as specific or simple as you need, depending on your product/service offerings. So let's break down the real differences.
Flat-rate Commission vs. Tiered Commission Structure
The most basic sales incentive plan awards a flat rate—X% or $X on every deal. This makes it easy to administer, communicate, and understand. Flat-rate commission structures pay out the same rate for all items sold (e.g., flat percent of revenue or profit).
A variation of the flat-commission structure pays a flat amount, rather than a rate. This is used when the price does not change with each deal. A flat rate works best for companies without specific sales goals (i.e. quota) that want equal compensation for each deal. Again though, flat rate or flat amount plans don't reward over-performance.
Tiered commissions, on the other hand, pay a flat rate until a rep hits a certain dollar amount in sales or number of units sold. At this point, the rate increases to motivate reps to maintain high levels of performance. When well-designed, these plans can increase overall performance, while remaining easy to administer, understand, and communicate.
Designing a Tiered Commission Structure
Tiered commission plans are fairly easy to design: the steps are to 1) set a quota, 2) set pay sales milestones 3) assign increasing payout rates for each milestone. As always, it's important to ensure that the increasing payouts are still profitable for the firm, or you might run into some big problems.
This specific plan design allows for additional payout tiers as well. For example, there could be three tiers of commission rates:
One rate for below quota
A rate when above quota
A third rate for significant over-achievement (e.g. >200% of quota)
Tier measurement can be based on the number of deals/units, total revenue/profits, new customers, etc. A few companies go so far as to offer the higher rate for every deal closed, going back to the first one of the year (often called a “back to dollar one” rule, or retroactive payout rule). However, most plans pay the higher rate for each marginal addition to performance, and not back to the first deal.
When Should You Use a Tiered Commission Structure?
In short, like many business questions, the answer is it depends. Companies often put tiered commission structures into play when they feel that the flat rate plan is not driving the desired performance. Thus, they opt for a plan where they can specifically reward reps who over-perform and, at the same time, motivate "the middle" tier to increase their performance.
Companies often initiate tiered commission plans when they want to encourage the sales team to meet and surpass their quota. To make this extra level of effort enticing, the payout rates increase based on easily understood levels of measured achievement.
The plan now provides an incentive to the sales rep to not only hit a goal but to also keep going so that they can earn the higher payout rates. (Learn more about other commission structures and planning best practices from Xactly's Strategic Services team—they can analyze your current plan, provide compensation tips, and help you design a strong incentive plan.)
Other Sales Compensation Factors to Consider
Sales performance is often the driver behind changing up a compensation plan. However, before you completely throw out your compensation plan, confirm that any performance issues are truly the result of a flat commission rate. Ensure that your current incentives are driving the right behavior, competitive enough to attract and retain top sales talent, and simplified as much as possible to avoid compensation errors and ensure reps understand what is expected from them.
As you take on compensation planning for a new year or as a redesign of a current incentive plan, there are a few major considerations that will help ensure your sales compensation plan is strategic and successful (in fact, see how Salesforce tackles their sales planning, execution, and optimization here).
Balanced Territories are Best
Believe it or not, territories have a huge impact on sales performance. Organizations need to design fair, balanced sales territories before they can build a strong compensation plan. Companies using automated territory planning software to design balanced territories can see up to 30% higher sales performance and goal attainment than the average. Balanced territories maximize your sales coverage and provide each rep equal sales opportunity.
The ABCs of Strong Incentives
Compensation plan success relies on many factors, but a strong foundation is the first step to reaching sales goals. All sales incentives should be designed based on the ABCs of Compensation Planning. They should be Aligned with sales roles, Based on company culture, and Constructed to drive the right sales behaviors. (Discover other compensation best practices for different sales roles in our Complete Guide to Sales Team Compensation).
Continuous Analysis of Performance
Checking in on how your sales incentives are impacting performance is key. Companies should monitor sales performance continuously (quarterly at the very minimum). Frequent analysis ensures forecasting is accurate, goals are on track, and adjustments can be made sooner rather than later. That way, planning is proactive rather than reactive, and leaders strive for and meet aggressive growth and revenue goals.
Discover more sales compensation planning tips, trends, and best practices in the 2018 Sales Compensation Administration Best Practices Survey.