5 Golden Rules of Sales Compensation

By December 29, 2012Compensation, Sales
sales commission compensation

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, within legal and ethical boundaries.  They do so assuming the company has put a lot of thought into how they are incentivized 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.

5 Golden Rules of Sales Compensation

Business Strategy Alignment

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

Charlie Munger, longtime vice chairman of Berkshire Hathaway, is quoted as saying “Show me the incentive and I will show you the outcome”.  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.  If you’d like to get inside the mind of a money-hungry sales rep that is looking for loopholes, read my related article titled “Is Your Sales Incentive Plan Driving Bad Behavior?”.

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.  Then, stress test your compensation plan by modeling various simulated results – especially the ones that simulate a sales rep far exceeding their targets.

Most compensation plans are established for a year at a time.  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 commission before the change.  Some concessions and “grandfathering” might be called for.

If your 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.  But even in this case, you might want to let your sales team know you realize a mistake was made and that you’re going to stick with the plan through the end of the period.  That way, they understand things won’t be that way for the next period.

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.

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 explain back to you how they will get paid.  Then ask them how they would go about maximizing their earnings on the plan.  And if you absolutely don’t want to do this ahead of time, do it immediately after announcing the sales compensation plan.  If you have a sales manager that manages the sales team, they can be an ideal proxy for pre-review.

Be Very Clear.

This can sometimes be at odds with keeping things simple, but it’s important to minimize accidental misunderstandings.  One way to do this is to include some definitions and examples in the official documented compensation plan.  If you don’t have such a document, read my 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 period.

Avoid Earning Caps.

Even if you think it’s extremely unlikely that a sales rep could make $500K or more using the commission 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?  If you followed golden rule #1 (business strategy alignment), this hopefully will not be an issue.

In most cases when this happens, 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.  Such a rep often achieves 150% of quota or more.  This is hopefully 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 top handful of sales reps at Fortune 500 software companies often make $1.5M or more.

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.

An alternative to setting a hard cap is to 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:

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