Variable pay is the portion of sales compensation determined by employee performance. When employees hit their goals (aka quota), variable pay is provided as a type of bonus, incentive pay, or commission. Base salary, on the other hand, is fixed and paid out regardless of employees meeting their goals. Together, variable pay and the base salary make up what is known as pay mix.
Types of Variable Pay
There are many ways to motivate reps. Often, when it comes to variable pay, a commission plan is the most common. Regardless of the type of variable pay, your goal should be to motivate employee performance and encourage sales reps to meet their quota (Learn more about quota planning).
Sales Commission Structures
Sales commission structures lay out the path for sales reps and employees to earn variable pay. Commissions are typically a percentage that reps earn as a result of closing a sale. Commission structures can be a flat rate, calculated on gross margin, or determined by percentage of quota completion (multiplier structure).
The most common commission structure is a tiered commission plan. Under this variable pay structure reps earn a percentage based on deals closed. However, there are commission tiers that reps achieve as they close more deals and work towards quota.
For example, reps may start out a new year with a 7% commission rate on any deal they close. Once they've hit $100,000 in total sales, they now earn a 9% commission rate until they meet quota. Then, after they achieve quota, any deals earn an 11% commission rate.
Bonus vs. Commission
Some companies decide against a commission structure all together and opt for a bonus structure. When it comes to bonus vs. commission, there are several differences to note. For example, commission are typically paid alongside base salary pay in each pay period. Depending on how bonuses are set up, they may be paid with each pay period, quarterly or annually.
In addition, both bonuses and commissions often depend on performance. However, bonuses are typically a fixed payment amount, while commissions may differ from rep to rep based on individual performance.
Management by Objectives (MBOs)
Management by Objectives, or MBOs, help employees set individual goals to work towards incentive pay. This is a popular tactic for non-sales or non-commission employees to earn variable pay.
These goals are typically set by an individual employee and their manager on how they can contribute in their role and/or expand beyond their day-to-day responsibilities. Often, MBOs encourage collaboration and welcome innovative, creative ideas to help the company reach it's goals.
How to Implement Your Compensation Plan
Money motivates, and therefore, your sales compensation variable pay should motivate sales reps to close deals. By rewarding or paying for rep performance, you are establishing a direct link between results and pay, which is one of the best methods companies can use to motivate sales teams to hit goals.
More importantly, your variable pay structure must drive the right sales behaviors to reach company goals. Variable compensation pay is an amazing motivational tool, but it can certainly miss its mark without proper implementation and setting the correct pay mix.
If your sales team is given opportunity that weights too heavily on incentive payment, you run the risk of encouraging reps to work independently, and perhaps shy away from taking chances for the organization. Too little variable performance pay and sales reps may not be inspired enough to work at high levels.
To effectively manage your system, here are a few tips when sorting out your compensation strategy and developing sales compensation plans:
- Incent based on a salesperson’s degree of control. If reps enlist help from other staff or your brand’s positioning does most of your selling, incentive compensation can be lower than when reps influence a sale entirely on their own.
- Variable incentive compensation should be based on individual achievement. Sales reps should be held accountable for things they can control. Placing an individual’s pay at risk based on team results may not be seen as fair, and could lead to increased turnover.
- Avoid a skewed variable pay system. As mentioned previously, if incentive comp makes up too much of a sales person’s salary, you can create independent operators who may be unwilling to take direction. Starting with a 50/50 ratio is a good base for most plans, with regular sales performance reviews and tracking to reassess. Sales team roles often determine the level of variable pay incentives. For instance, variable pay is greater when you have more control over results. So, an account executive will usually have the highest variable pay level on the team, and more than say a customer success rep, because the AE has more direct influence on the deal closing.
The Impact of Variable Performance & Pay Mix
Winning companies are well aware of the positive benefit of incentive pay, and aim to offer competitive compensation in order to reduce turnover while retaining top talent. It's also why, according to the Society for Human Resource Management, “The percentage of organizations using variable pay vehicles, such as annual or quarterly bonuses based on individual, team and organizational goal achievement, rose to 84 percent in 2016,” as stated in WorldatWork’s 2016-2017 Salary Budget Survey. This is an increase from 80% in previous years.
But how do you know how your practices compare to others in your peer group? And, what would you do with such valuable information? For starters, you'd be able to tell if you were paying less than others in your vertical, or more. But then what?
According to Xactly Insights, smaller companies paid 46% more in incentive compensation than larger companies with comparable quotas. So, smaller companies paid an average of 54,787 in variable compensation, while those larger companies ended up paying just 33,777. If you’re one of those smaller companies with variable incentive pay far below industry averages, the mystery of why you're losing some of your top performers might have just been solved.
Again, it’s all about balance. Relying on commission only introduces difficulty in measuring sales performance beyond what the numbers are telling you. With a portion of fixed pay, you’re directly influencing how reps go about completing administrative tasks and how they're going to work with the rest of the sales team. This is the main point of concern when it comes to holistically handling performance and the overall competitiveness of your sales compensation plans.