5 Golden Rules for Setting Sales Compensation Plans

Sales incentive plans are really delicate things.  This stems from the fact that the best sales reps/managers intuitively do whatever puts the most money in their pocket.  They do so assuming the company has put a lot of thought into how they are incented and, therefore, whatever pays them the most surely is good for the company too.  Because of this, don’t expect a sales rep to read your mind.

Never break these rules when setting commission plans for your sales team.

  1. Make sure the compensation plan drives behavior that is consistent with your business strategy.

    And remember that the best sales reps do whatever puts the most money in their pocket and it’s your duty to make sure that behavior is consistent with your business strategy.  This requires some advanced thinking and scenario planning to identify loosely defined rules or “gray areas” that can be exploited.  For additional insights into this particular golden rule, see my related blog article titled “Is Your Sales Incentive Plan Driving Bad Behavior?”.

  2. Never change the rules in the middle of the game.

    Instead, before officially announcing the details, try to identify accidental loopholes or opportunities for bad behavior that maximizes earnings.  If you absolutely have no choice but to make a change mid-cycle, come clean with your sales team by explaining the rationale and also think about how to handle in-flight opportunities that are about to close and would have paid more before the change.  Some concessions might be called for.  And if the exposure isn’t significant, you might be better off looking the other way and “biting your lip” until you approach your next plan cycle and can modify the commission plan.  In other words, think about the risk-reward trade-off and understand that changing the rules in the middle of the game might cause you to lose some of your best sales reps.

    In the very early days after hiring your first one or two sales reps, you might not even know what makes for a reasonable quota or target.  In this case, don’t lock things in for a full year because it leaves you with too much risk of being way off on either the high side or low side.  Instead, set quotas only 3-4 months or 1-2 quarters at a time until you gain some maturity.  This will minimize the need to change quotas or other elements of the commission plan in the middle of the set cycle.

  3. Keep it simple.

    If the plan requires the sales reps to have a magic decoder ring to figure out if/when/how they will get compensated, you’re in trouble.  Minimize the number of things the sales team gets paid on by prioritizing what’s really important and use simple language to communicate the commission plan.  If you have a sales rep you can really trust, get their opinion ahead of time and ask them if the plan is simple and clear.  After reading the draft plan, have them put it down and explain back to you how they will get paid.  And if you really don’t want to do this ahead of time, do it immediately after announcing the sales compensation plan.

  4. Be very clear.

    This can sometimes be at odds with rule #3 but it’s important to minimize accidental misunderstandings.  One way to do this is to include some definitions and examples in the compensation plan (see related article titled “Documenting Your Sales Compensation Plan“).  This is especially true if timing requirements are involved (ie – no commission payment until the customer pays their invoice) or claw-backs are included (reversing a previously paid commission if _____).  If after announcing the plan you quickly discover misunderstandings or different interpretations, you have a very short window in which you can add clarification.  Clarification is different from changing the rules, especially if done very early in the sales plan year.

  5. Do serious soul-searching before implementing caps that limit earnings beyond a certain level. 

    Even if you think it’s extremely unlikely that a sales rep could make $500K or more against the compensation plan, if they did the things necessary to achieve that would it harm the business to pay it?  I know you’d rather not pay it if you don’t have to but would it harm the business?  In most cases it means the sales rep sold a ton of stuff that brought a ton of revenue and profit to the company.  Companies with more than 10 field sales reps will often discover they paid the highest performer more than the CEO over the course of the year if the rep had a really good year (more than 150% of quota and especially if more than 200%).  This is usually something to celebrate and can be used not only to energize the rest of the sales team but also to attract additional high-achieving sales reps.

    The only exception to this rule comes in the very early days with your first sales employees and very limited maturity in setting quotas.  If during this period you decide to implement some sort of cap to commission earnings potential, have a discussion with the sales team to make sure they understand why it’s in place and also let them know you plan to remove it as soon as the company is more mature with measurements and forecasting capabilities.  Additionally, rather than set a hard cap, instead message that “management judgment” may be imposed for commission calculations that exceed $____ (don’t get greedy with the number but instead let the sales rep see their way to very nice earnings if they greatly exceed their target).

Related Reading:

Wait, there’s much more!!!

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Author: Gordon Daugherty

Over the past 15 years Gordon has seen nearly 1,000 startup pitches, advised more than 200 entrepreneurs and been involved with raising over $45M in growth and venture capital. Throughout his 28 year career in high tech, serving twice as President and three times as CMO, Gordon has both an IPO and a $200M acquisition exit under his belt. Now his emphasis is purely focused on helping startups and early stage tech companies. Through his Shockwave Innovations advisory practice and as Managing Director for Austin’s Capital Factory startup accelerator, Gordon is an active angel investor, VC and startup advisor.

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