Absolute Versus Relative Sales Commission Plans

Compensating a sales team is a tricky and sensitive endeavor that requires a lot of advanced planning.  I previously wrote about my 5 Golden Rules of Sales Compensation.  But even if you follow those rules you’ll need to decide about the underlying structure of the sales commission plan.  And while there are almost infinite number of ways to compensate a sales team, most of them fall into two categories: absolute or relative.  This blog article will explain the fundamental differences between these two methods to help you decide which is best to use for your sales team.

Absolute Commission Plans

Absolute commission pay based on some financial metric or specific accomplishment and can be paraphrased with the following statement: “You will get paid $___ for every _____.”  The “do this, get that” attribute is what makes it absolute.  Here are some examples:
  • $500 for each new account
  • 10% of the annual contract value (ACV) sold for new accounts, upsells and cross-sells

Notice that with this approach, quotas don’t come into play.  This doesn’t mean you can’t set quotas and you probably thought about what a reasonable performance target was before coming up with the $500 for each new account or 10% figure for ACV.  But imagine three sales reps all with different quotas.  On an absolute plan it doesn’t matter how the reps perform against their quotas.  It only matters how they perform period.

Advantages of Absolute Plans:

  • Usually very simple to explain and understand
  • Sales reps often like the “do this, get that” attribute because it’s easy to figure out how much commission will be earned on a given deal
  • Don’t have to figure out quotas

Disadvantages of Absolute Plans:

  • All sales reps in a given role are usually compensated equally, which might not be fair (some territories usually have lots more opportunity than others).
    • If you vary the payout amount (the “get that” part) amongst the members of the sales team, you’re effectively creating a relateive compensation plan.
  • No direct linkage between the sales commission plan and the company-level targets.
    • In other words, the sales team isn’t marching towards specific targets that align with the company objective but rather are just trying to do things that pay them the most money.

Relative Commission Plans

Relative commission plans pay based on attainment (performance) against a pre-set target (called a “quota”).  It is almost always the case that exactly meeting the quota results in exactly making the “on target” or “at plan” commission amount.  This means that in addition to setting the quota you’ll also need to communicate the “at plan” commission amount that can be earned.

A single sentence summary of a relative commission plan might look like this: “Your quarterly sales quota is $150,000 in new ACV and your at-plan commission amount is $12,500 per quarter.”

A relative commission plan doesn’t need to payout in a straight line (ie – 88% performance = 88% of commission opportunity).  There are usually methods of instilling more “pain” for especially poor performance and more “pleasure” for exceeding the targets.  One way to do this is to implement decelerators and accelerators and another way is to use a modified straight line payout calculation.  These are described further, and with a sales commission calculator available for download, in my blog article titled Two Variants of the Straight Line Sales Commission Plan.

Advantages of Relative Plans:

  • Ideal for sales territories/roles with different levels of opportunity but similar required effort.
    • For example, a new account rep charged with bringing on 5 new customers per quarter but each with little revenue might put in the same effort as a rep covering a large, established customer that orders $500K worth of new stuff each year. You can give these two reps fair, but different, quotas so they can be rewarded for their effort.
  • Can gradually increase quotas for new or evolving territories
  • The sum of the assigned quotas can tie to the company’s overall financial and operational targets – provides alignment

Disadvantages of Relative Plans:

  • Setting quotas isn’t easy and the sales reps will negotiate them like crazy

Summary

There’s no right or wrong answer as to which of these two sale compensation approaches is best.  It purely depends on what you’re trying to accomplish, how evolved your sales function is and which areas you’d like the most flexibility to make changes over time.  At the end of the day, the most important thing is that your sales team clearly understands how they are compensated and they trust that the executive team will treat them fairly if they are doing exactly what is expected of them, if not more.

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Wait, there’s much more!!!

The information in this article is just a very small piece of what I cover in my Founders Academy Video Library, which includes more than 35 topic-specific modules and 6 themed compilations.

I’m talking about more than 13 hours of educational and advisory content to help you grow a great company.  Click Here to Learn More

“The way you convey the material is great and the examples you give makes things clear.” (startup founder)

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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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