What is Incentive Compensation?

Blog
Jul 01, 2022
6 min read
Incentive compensation is the variable income sales reps earn based on their performance in addition to their base salary, and there are a lot of ways to go about it. Discover everything you need to know to get it right.

Incentive compensation is the variable income sales reps earn in addition to their base salary. This income is not guaranteed and is contingent upon the representative meeting certain goals. Learn how to structure an effective incentive compensation plan.

The Importance of Incentive Programs

Incentives are a powerful motivational tool. They can help sales representatives stay engaged and motivated to close deals, upsell or follow up on leads, increasing the department's revenue. There are many other options for promoting best practices and inspiring good performance, but incentive compensation is perhaps the most effective option.

Companies pay incentive compensation on top of the representative's basic salary, and it is just one part of a sales compensation plan. In some cases, there may be more than one incentive program. For example, a company may reward individual representatives for their own performance with additional compensation if the entire department meets its goals.

What is incentive compensation? What: the additional variable pay that sales reps earn on top of their regular base salary. Why: motivate and engage your sales reps and tell them what to do and how they can earn more money. How: align incentives with goals to guide sellers to prioritize certain deals and how to best structure them.

The Goal of Incentive Compensation: Driving the Right Sales Behaviors

Incentive compensation promotes positive behaviors by showing sales reps what they can do to earn more. In a study from Mckinsey, a company challenged one of their teams with a $40 million target in 40 days. With these clear and concise goals, the team over delivered on the goal and did so several days early.

Good reward structures that mesh with your organization's goals motivate sellers to prioritize the deals that will meet those goals. This could help encourage sales reps to upsell, promote higher-margin offers or more proactively pursue leads in their work.

Key Types of Variable Incentive Compensation

There are several forms of compensation you can use to motivate your sales team, including:

  • Sales Commission Structures: This is the most common form of incentive compensation. Commission structures can be as simple as paying a sales representative a fixed amount per sale or a straight percentage of revenue from every deal closed (known as a “straight commission”). Some commission structures are more complex, taking into account the percentage of quota completion.
  • Sales Performance Incentive Fund (SPIFs): SPIFs are a highly effective short-term incentive when used with a sales commission structure. Companies can employ SPIFs to encourage a sales representative to focus on a specific product in the run-up to a new launch or to increase sales volume for a short period. 
  • Bonuses: Bonuses motivate both sellers and non-sales employees to work toward specific initiatives. A bonus is usually a fixed amount, paid out to an individual when they meet their targets. Companies can also award bonuses on a department-wide (or company-wide) level for meeting broader goals.
  • MBOs: Companies can use Management by Objectives, or MBOs, to encourage sales reps which are also useful for incentivizing non-sales employees to meet individual goals set by a manager. 
Types of incentive compensation: sales commissions; SPIFs; bonuses; MBOs.

Designing an Effective Incentive Compensation Program

For an incentive program to work effectively, the program must receive buy-in from management and the sales representatives themselves. Consider using a phased approach to designing and introducing a new compensation plan:

  • Design phase: A short period where the initial ideas for the program are drawn up.
  • Consultation phase: Key stakeholders review, discuss and revise the proposed program.
  • Implementation phase: The company implements the program and monitors its performance.
  • Review phase: An ongoing phase where the company reviews, changes and monitors the program based on organizational performance.

The nature of the incentive compensation program and the duration of each phase may vary depending on the organization's size. When considering sales incentive management, it's important to look at not only the monetary value of the rewards but also what behaviors they encourage. 

For example, a program could incentivize:

  • The volume of items sold.
  • How many times a specific package was upsold.
  • Additional rewards for promoting a loyalty program.

Where an employee incentive compensation plan focuses on a specific issue such as upselling or attracting customers to a loyalty program, it's essential a company clearly promotes these conditions so the sales team understands how to get the most from their incentive pay.

Optimizing Your Incentive Compensation Programs for Maximum Benefit

Employees should clearly understand how the program works and know what they can expect based on their performance. Straight commission bonuses are the easiest to calculate and optimize since companies pay them as a fixed amount based on the employee's performance. 

Calculating department-level bonuses can be more complex. If a department has eight employees and the budget for a bonus this quarter is $15,000, each employee can expect a maximum bonus of $1,875 ($15,000 / 8). Managers must decide whether it makes sense to tie this bonus to individual achievement. For example, they can have tiered goals for sales representatives to meet to encourage those who may not be top-performers to still make an effort to earn a portion of the bonus.

Bonus amounts are just one part of the equation. The next challenge is tracking the performance of each sales representative, or the team as a whole, so companies can accurately award any incentives.

Team vs. Individual Incentives

There are many arguments for and against employing team incentives. In general, individual incentives are an effective way of motivating employees, especially the strongest performers. However, in some organizations, it is hard to measure an individual employee's performance. Therefore, the best option is to provide sales incentive compensation at a team level. Some environments lend themselves to a hybrid approach, where the best performers on a team have the opportunity to earn an additional bonus on top of the allocation for the team as a whole.

Pros and Cons of Individual Incentives

Pros:

  • The top performers feel well rewarded.
  • There's a clear line between strong and weak sales performers.
  • This kind of variable incentive compensation plan creates a strong emphasis on sales.

Cons:

  • Weaker sales staff may feel demotivated.
  • Sales staff may compete against each other, creating a negative work environment.

Pros and Cons of Team Incentives

Pros:

  • Sales representatives are encouraged to work together.
  • The emphasis is placed on fulfilling customer needs rather than chasing credit for sales.
  • Fewer disputes about who deserves credit for a sale.

Cons:

  • Stronger performers may feel they're carrying weaker performers.
  • It's harder for employers to tell what factors impact performance when measured at a group level.
  • Top performers may leave the company for somewhere offering higher potential compensation.

ICM vs. Sales Performance Management 

In addition to ICM, many organizations can benefit from using Sales Performance Management (SPM). There is a significant overlap between ICM and SPM, and the two practices can augment each other. Where ICM focuses on collecting data about sales, crediting the correct agent with the sale and compensating them, SPM takes a broader view, with capabilities including:

  • Designing and building sales models
  • Defining/allocating quotas
  • Quota agreements
  • Administration and reporting
  • Sales coaching
  • Sales operation analysis

When these tools are combined, they help businesses not only calculate incentive pay but also find areas where sales representatives may need support and training to help them earn these incentives. Through monitoring and coaching, sales staff can gain the tools they need to improve their performance.

The power of automated incentive compensation: accurate data; accessible to everyone; simplifies calculation and payout; reduces errors; view pay in real-time.

Automating Incentive Compensation Management

The process of managing, calculating, and paying reps their earned commissions is known as Incentive Compensation Management (ICM). This process involves far more than just writing sales reps their paychecks. You need to be able to calculate seller pay and look at the effectiveness of your sales incentive plans.

Using Incentive Compensation Management solutions ensures your compensation data is accurate and in one place for everyone in the organization to access. Having easy access to sales data means you can improve your compensation even more by benchmarking it against industry pay insights. Comparing your compensation against your industry allows you to develop competitive incentives that attract and retain top talent. 

In addition, an ICM may allow sales representatives to view their own performance and compensation data in real time. This can boost morale and improve retention, as representatives feel more motivated and recognized for their performance. Retention is critical for today’s organizations, considering 58% of organizations experienced increased turnover in the past 12 months.

Discover more ways you can improve your sales incentive compensation planning and management in the “2021 Guide to Successfully Managing Sales Compensation.”

  • Incentive Compensation
Author
Xactly "X" logo, left half orange and right half grey.
Xactly News Team
,
Staff

The Xactly News Team reports on the latest product, events and market trends taking place within Xactly and throughout the revenue intelligence industry. Be sure to subscribe to get the news delivered straight to your Inbox.