David Cichelli definitely knows about sales force compensation. Compensating the Sales Force, his practical guide to designin winning sales compensations plans is smart and to the point. It is pure applied common sense. It makes a good structured checklist when thinking about sales incentives.
Sure, it is a very American centric book. And it focuses on financial incentives for sales forces with a strong share of variable pay. As a European sales performance manager, I may have to adapt a few things here and there.
Below is what I retain from the book. The synthesis is mostly rearranged copy-paste sections from my Kindle notes. Thus, it may be 90% plagiarism. Mostly it is authors’ paragraphs that I rearranged in an order I find more pracical for a short “How to” guide. I added an overlay from The Complete Guide to Sales Force Incentive Compensation, that provided selected additional insight; in particular about sales contests. Though, I would recommend reading Cichelli if you want to read only one.
Enjoy the read.
Understand the role of an incentive plan
A sales incentive program is complementary to other motivation factors such as pride of performance, supervision, affiliation, and goal accomplishment. In particular, day-to-day, hands-on committed sales supervision is probably the best way to optimize sales performance. It has much more impact than the incentives.
The financial incentive plan excite, control, and shape the sales force.
- In its role as a sales force exciter, the right incentive plan inspires and energizes a sales force to work hard to achieve challenging goals.
- In its role as a sales force controller, the incentive plan sets expectations that define what is important and directs sales force energy to the products, markets, and selling activities that are of the greatest strategic importance to the company.
- In its role as a sales force shaper, the incentive plan helps to define the sales force culture and influences the type of person that is attracted to the sales job.
The compensation plan influences the type of person who is attracted to the company. Changing a pay plan from mostly salary to a significant incentive component or eliminating a large incentive component is almost impossible to pull off while keeping the same salespeople. Incentive cultures and salary cultures are different, and the people that can succeed in the two cultures are also different.
Incentive plans have impact on customers, salespeople and the company. It is important to note that the company can decide upon only the plan. The other two decisions, sales force activities and customer purchasing, are not under its direct control.
- The best incentive plan from the customers’ perspective is one that encourages salespeople to engage in behaviors that meet customer needs. They want a good product at a fair price along with the appropriate mixture of advice, service, and support through an effective working relationship with the selling company. Customers also want a plan that allows the firm to offer reasonable prices.
- The best plan from a salesperson’s perspective is one that is easy to understand, is fair, and pays good money for reasonable work. Salespeople want good pay, recognition, and job satisfaction.
- The best plan from a company standpoint is one that produces the desired results, retains good salespeople, and helps the firm accomplish sales, profits, growth, or market share.
An effective compensation plan successfully balances these sometimes competing objectives to meet the needs of customers, salespeople, and the company simultaneously.
Understand what your sales team wants
A pay level that is not competitive is just one reason why good salespeople leave a firm. Salespeople have many explanations for why they leave their jobs, including lack of home office support, poor-quality products, unfavorable work environment, weak field management, poor coaching and training, and a lack of defined career paths.
Pay level decisions must also align well with the other sales force effectiveness drivers. A salesperson values:
- The work content—how interesting, fulfilling, and satisfying it is
- The work environment—how supportive and enjoyable it is
- The skills gained on the job—how “employable” the salesperson becomes (some companies, such as Johnson & Johnson and General Electric, are well-known “training” companies in their industries)
- The company itself—its reputation and career progression opportunities
- The pay the job provides
- The benefits that go with the job
There is a wide range of preferences within every sales force. No one plan will be preferred by everyone. Incentive plan designers must accept the fact that their plan will not be universally liked by everyone.
Design sales jobs and define who should be part of the plan
Art and science of crafting effective sales compensation programs rest with a commanding competency in sales job design—assessment, evaluation, and construction. Job design errors are the No. 1 culprit in sales compensation plan failure.
The highest value provided by sales personnel is to help customers make choices when there is uncertainty and risk. This event is known as the point of persuasion. The purpose of sales compensation is to reward seller success at the point of persuasion. Salespeople are ideally suited to be at the point where customers have risk and uncertainty—at the point of persuasion.
Until you have the personal expertise to reduce your risk and uncertainty, you will seek the assistance of an adviser such as an informed and respected salesperson. At some point, clients get used to the product and do not need a salesperson any longer to place their order. When this happens, the point of persuasion has changed. This is natural: sales force obsolescence is a natural occurrence for all sales departments. The point of persuasion is constantly on the move. Sales organizations and sales jobs can become obsolete as the point of persuasion moves beyond the current deployment model. You will have to change distribution channel.
Thus, two criteria define a sales job: (1) The job incumbent must have customer contact, and (2) The primary role of the incumbent is to persuade the customer to act.
Some field customer contact jobs appear to be those of sales representatives but are, in fact, marketing jobs. If the field person is executing a brand strategy such as providing product displays or training channel sales personnel without any influencing role, then the job might be a marketing job. Marketing jobs can be eligible for add-on incentives, but normally not sales compensation.
Sales jobs can include 5 steps : Demand creation (stimulating the market), Buyer identification ( finding the decision makers), Purchase commitment (securing the order), Order fulfillment ( delivering the product or solution), and Customer support (Providing ongoing support after the initial purchase). The number of unique sales compensation plans should be equal to the number of unique sales jobs.
Sales compensation is available for two types of sellers: income producers and sales representatives.
- Income producers: An income producer’s actions create business revenue. In essence, income producers are mini-business units. Their value is not in the products they offer, but the relationships they manage. Often, the products they represent are commodities and are sold by numerous people. What is unique is their relationship with their customers; they often have the power to take their customers with them when they change employers. Typically in the US, income producers have no base salary and are paid a flat commission rate on sales. Although management may identify a preferred earnings level, the percentage of sales dollars is a more important consideration. Income producers evaluate the competitiveness of pay by the size of the commission rate.
- Sales representatives: A sales representative represents the value of his or her company’s products, services, and solutions. The inherent value of the relationship between the company and its customer rests with the company’s value proposition. It’s the role of the sales representative to present this value proposition to all customers to affect sales. The ratio between base salary and target incentive pay as a portion of TTCC varies by job content. The more the salesperson can influence a customer to act, the lower the base salary as a portion of target total cash compensation and the higher the at-risk component. The opposite is also true: The less personal influence inherent in a sales job to affect customer buying decisions, the higher the base salary and the lower the incentive opportunity.
Income producers is a preferred model in high-causality environments: a considerable portion of total sales is determined by the skill, motivation, and efforts of salespeople in the current incentive period. Factors that decrease sales force causality (and thus favor sales representatives) include the following:
- Brand name. Brands that are well known and differentiated from competitive products often have high sales, even in the absence of effective sales force support. These products sell themselves.
- Non-sales force marketing instruments. When pricing, advertising, telesales, and direct mail play a significant role in generating sales, sales force causality is typically less.
- Team selling. Several people working together to create a sale muddies the causal link between individual effort and results.
Define the target cash compensation
The math is simple. Income producers get a percent of what they sell. Determine the preferred cost of sales and make that the commission rate. For sales representatives, determine what you want sales personnel to earn and how much volume they should produce, then simply divide pay by performance to get the payout rate. When building a compensation program for income producers, we start with a commission rate. When we build a sales compensation program for sales representatives, we begin with a target incentive amount.
The total remuneration for sales jobs includes the following cash and noncash components:
- Base salary: Most sales representatives receive a base salary.
- Sales compensation: Sales compensation is the variable pay tied to sales performance.
- Benefits: Sales representatives participate in the company’s benefit programs.
- Contests/SPIFs: Management uses add-on contests and SPIFs (Sales Performance Incentive Fund) to reward special efforts. Recognition events: Most companies provide a special annual recognition event for outstanding salespeople.
- Expense reimbursement: Expense reimbursement pays out-of-pocket costs of sales representatives.
Target total cash compensation includes both the base salary and the sales compensation components. It excludes benefits, contests and/or SPIFs, recognition events, and sales expense reimbursement.
Define the mix of salary and variable compensation (above 30% incentive in total compensation, the plan becomes the main control device)
The median salesperson in the United States earns approximately 40 percent of his total cash compensation through performance. At one end of the spectrum, approximately 15 percent of salespeople do not earn any salary at all—100 percent of their income comes from variable pay that is tied to performance. A small percentage of U.S. companies pay their salespeople 100 percent salary with no incentive opportunity.
When too little money is tied to performance, salespeople are not adequately motivated to perform. When too much money is tied to performance and salespeople feel stress about whether or not they can achieve their desired income level, the excessive stress leads to inferior results. The right stress level (or incentive level) depends upon the nature of the task to be performed. Sales force culture and values play a role in determining the degree of pay variation that is appropriate within a sales force.
For instance, sales forces composed of salespeople who are highly motivated by nonmonetary factors such as career advancement, learning, or socialization tend to have less variation in pay across salespeople than those that consist of salespeople for whom money is a primary motivator.
A sales force that encourages teamwork and cooperation among salespeople will want less variation in pay across salespeople than one that desires competition among salespeople to inspire individual success. A sales force that emphasizes personal development or encourages other nonselling activities will want less variation in total pay than one that emphasizes output and results.
A management team with little tolerance for sales force turnover will want less variation in total pay than one that expects and manages turnover. All other things being equal, a greater variation in pay will result in higher turnover of both high and low performers. On the positive side, low performers will get the message that they are not succeeding, and they will leave the firm. On the negative side, however, the plan will attract high performers who are more motivated by money, and therefore will be constantly in search of new opportunities for earning more money, including moving to a competitor.
Environments that emphasize team selling typically favor higher salary, while those that emphasize individual selling are more likely to favor incentives (meaning formula based individual incentives).
A highly leveraged compensation plan may influence sales force behavior to such an extent that the plan itself becomes the control. In particular when formula based incentives represent more than 30¨% of total compensation.
For example, sales management’s encouragement to the power tools sales force to sell high-margin products has diminished impact because salespeople believe that following this advice will result in lower personal earnings. Salespeople earn the same commission rate on sales of all products; therefore, it is in their personal best interest to sell the products that are easiest to sell, regardless of product margin.
A management team that desires a culture of significant control over salespeople and their activities should adopt a compensation plan that is at least 70 percent salary. If the plan has a greater than 30 percent incentive component, management must accept that the plan will be a primary means of controlling sales force behavior.
Misalignment could create dissension and a lack of consistency within the sales organization. Management says, “Be customer-centric,” yet a salesperson who is sales-centric makes more money. Management says, “Professional development is important,” yet salespeople who take time out of the field to attend training earn less money in the short term. Management says, “Focus on developing long-term relationships with customers,” yet salespeople are paid for producing short-term results.
Calibrate the financial lows and highs of the plan
When asked “What percent of the sales force do you think should make goal?”, CEO responses are evenly spread across a range from 50 to 80 percent. Try to design your incentive program so that two third of salespeople reach the target.
Upside earning opportunities are typically set at 3 times the at-risk component. Thus the payout level for outstanding performance is known as a “triple.” Performance measures are tied to sales production. Payouts begin below target performance and may or may not have a performance threshold. A preferred performance distribution features two-thirds reaching and exceeding quota and one-third not reaching quota. Sales management helps achieve this performance distribution through effective quota setting. While pay caps are generally avoided, fewer than 10 percent of individuals usually exceed the triple upside earnings level. Management accomplishes this control of upside earnings through sound formula construction and effective quota assignment. When communicating to participants, sales management presents the compensation program as a base salary (if present) plus an incentive formula.
Setting the correct TTCC requires collecting accurate external pay data and making judgments regarding internal equity among all the sales jobs, and perhaps other jobs within the company.
Define performance measure and weight
Most sales compensation plans provide for payment on net sales, that is, less returns and sales credits. Though, they can include measures of production, effectiveness, products, accounts, orders, price management, customer impact, resource utilization, channels, human resources or even individual management goal. It is best to limit to 3 measures maximum with no measure worth less than 15 percent of the total weighting.
Here is a long list of possible indicatore
- Volume production measures: Volume production measures are the most popular and appropriate performance measures for sales compensation purposes. Production measures include three categories: sales revenue (purchase, continuing, renewed, and estimated), profit dollars (gross margin, contribution margin), and items (units, contracts, and design-wins).
- Sales effectiveness measures: Sales effectiveness measures help improve sales results by focusing sales efforts in the areas
- Product (balance, mix, launch, cross-sell, packages, solutions)
- Accounts (new, retained, penetrate, growth, win-back)
- Orders (close rate, size, length of contract, linearity, and receivables)
- Price management (discounts, rebates, realization, and percent change).
- Customer satisfaction (customer surveys, number of complaints) and loyalty (order persistency, market share, and comparative loyalty)
- Resource utilization measures such as productivity (cost per order dollar, quota sales loading)
- Channels (partner success, partner participation rates, outlet performance)
- Human resources typically for supervisors (balance performance, turnover, and new hire ramp rate)
Paying incentives on activities, though usually not recommended, can be effective when it is used for a short period of time to encourage specific sales force behaviors.
The art of configuring effective sales territories requires superior interpretation of company business strategy, rigorous analytical investigation, and studied judgment about customer needs. The objective of effective territory design is clear: create sales territories with the best return on sales investment dollars. Although territory balance is important, focus is more important. Sales organizations need to focus sales personnel to optimize the learning process and selling time.
Territory sales have two components: salesperson sales and free sales. Salesperson sales are those sales that result from the skill, knowledge, motivation, and effort of the salesperson in the current year. Free sales will be realized regardless of what the sales force does; they can be the result of a strong brand identity, non-sales force marketing efforts, superior products, and/ or carryover from prior years’ sales efforts. True “pay-for-performance” plans link incentives to salesperson sales alone. Incentives on salesperson sales are called performance pay, since they are earned only if the sales force works for them. Since it is often difficult to isolate and measure salesperson sales, many pay plans tie incentives to total sales, which include both salesperson sales and free sales.
Market potential is often a better predictor of territory sales than any characteristic related to the salesperson, including experience, ability, motivation, or effort. Thus, territories with high market potential often have high sales, regardless of sales force effort.
A sales force compensation plan that ties rewards to total territory sales needs to be especially careful that market potential is equitably distributed across salespeople. Otherwise, salespeople in territories with high potential will have an unfair advantage over those in territories with low potential.
If it is not possible or practical to distribute potential equitably across salespeople, then the company should consider adopting a sales incentive plan that acknowledges territory differences, such as one that ties rewards to the attainment of territory-specific goals rather than to total sales.
Territories can be organized by Geography, Stratified/size, Account status, Vertical/industry, Product/application, Project opportunity territories, or an Hybrid of the before dimensions.Customers can be grouped by New accounts (prospects that are not current buyers), Existing accounts (former customers), Channel partners (who sell products on behalf of the company), Channel end users (in some cases, the manufacturer will deploy influencing personnel to call on end-user customers),Stratified (One of the more popular methods used to group customers is by size),Product/Application, Industry (Certain industries may require specialized sellers knowledge), or Geographic location.
Ideally, territories would be comparable. Comparable means sales personnel view the sales challenge among territories to have relative trade-offs, and sales personnel in one territory are not significantly advantaged or disadvantaged by territory configuration.
Sales management must provide explicit policies for addressing mid-year territory changes whether they occur on an across-the-board basis or as one-off changes. Reasons for a review include Strategic focus change, Staffing changes, Customer changes (openings, relocations, and closures), Customer request (occasionally, customers may request a change), Temporary changes (When sales personnel are terminated or when a salesperson cannot cover his or her accounts)
Motivational research shows that people who are given specific, challenging goals consistently outperform those who are not given any goals or who are given vague goals such as “do your best.” As a result, organizations and individuals that are goal-focused are typically more successful in the long run than those that do not set goals.
Territory goal setting is particularly challenging in environments with long selling cycles, where salespeople make just a few major sales every year. In such situations, sales can be difficult to predict. There are so few transactions that the statistical law of large numbers cannot help to balance out prediction errors.
In these situations, the account plans developed by individual salespeople often contain the only reliable information about what sales are in the pipeline and how likely they are to close. Thus, reliance on sales force input is the only feasible way for management to determine reasonable goals. In situations like this, where results are difficult to predict, it is common for salespeople to be given other types of objectives, such as customer service or activity objectives, in addition to company results goals.
The process of setting goals can be as beneficial as the goals themselves . Setting goals allows the company to communicate its strategy in a tangible way. The company tells its salespeople what they can do to help the company make its corporate goal.
Also, a well-administered process of quota setting allows the company to show its salespeople that they are being treated fairly. It also enables the management team to see who is performing well and who is performing poorly.
A preferred quota distribution target is to have two-thirds of the salespeople reaching and exceeding quota and one-third not. This distribution of performance allows for the cross-funding of upside pay to high performers by shifting a share of the low performers’ target incentive pay.
Some companies spend tremendous energy defining quotas in a scientific manner while ohers accept that it can never be perfect. The most popular quota allocation methods include top down/algorithm, Top down/negotiated allocation, Top down & bottom up and Account planning. No method is perfect.
The summation of all quota assignments should equal the company budget forecast. When sales leaders choose to over-assign or under-assign quotas, they run the risk of eroding their credibility or the credibility of the quota allocation process. At a certain point, sales personnel will learn that their quotas are not true quotas and therefore are open for adjustments, challenges and compromise.
Quota management includes two components: quota allocation and quota adjustments. For income producers with a flat commission, a quota might be merely a symbolic point, marking expected performance but without any financial impact. Quotas play a more important role for sales representatives as compared to income producers. The target quota defines the degree of difficulty where two-thirds of sales personnel will exceed this number and one-third will not.
Sales management may want to remove some elements from quotas. For instance in case of account seasonality, market uncertainty, long sales cycles, periodic mega orders, or incoming new products. For instancepredicting with accuracy the launch of new products affects the quota allocation process. If the launch dates are accurate and the sales performance expectations realistic, then sales management should include these new products in the quota. However, if the dates are not confirmed or the projected sales volumes are indeterminate, then exclude these new products from the quota. Give them their own launch incentive (an add-on) that expires at the end of the performance period.
Quotas are better changed once a year. Nevertheless they may be changed mid-year in case of account changes, currency and pricing changes, major economic crisis or acts of God.
Define payment periods
The most common frequencies of incentive payout are monthly and quarterly. Shorter sales cycles generally have shorter performance periods; longer sales cycles generally have longer performance periods.
Assign earned sales credit to the salesperson at the point where the customer purchase is assured because you want the salesperson to stop thinking about the order. It could be
Product specification, Booking,Invoice/ship, Installation/customer, Customer payment, Hybrid.
Incentives are most motivating when they are granted soon after the selling success. This argues that incentives should be attached to the order. However, often there are time lags between the time the order is placed, when it is shipped, and when money is collected. This creates a dilemma for compensation planners: should payment occur when orders are taken or when monies are collected? An intermediate strategy is also possible: pay some fraction of the total incentive at the time of the order and pay the rest at the time of collection.
The salesperson should be the only one to get credit for a sell. Though, in complex sales organizations with multiple channels, overlay sales specialists, and team selling, the definition of the salesperson may be more complex.
In any case it is best to avoid landlording (sales getting commission without effort because they officially own the account), appeasement pay (paying bonus twice because several departments or individuals claim the sell), and annuity business (paying more than once for persuasion).
Choose your formula for the incentive plan
Many formulas are effective within a proper context. They are neither good nor bad, but they can have suprising consequences.
Funding for income producers’ commissions comes from revenue production. For sales representatives, incentive compensation is cross-funded by the plan participants. For sales representatives, the target pay is reallocated among the participants with better performers making more than the target incentive pay for the job and less effective performers making less
Consider the following story :
Senior management was perplexed to learn that the gross profit measure in the incentive plan actually hurt profits. The key measure of sales success is gross margin dollars—sales price less loaded cost of goods. Management correctly provided sales personnel with pricing flexibility to meet competitive pressures. To reward high sales with high pricing, management structured the incentive plan to pay a flat commission rate on all gross margin dollars. Unfortunately, it had the unintended consequence of reducing pricing. Why? Rather than keep prices high and risk losing the sale, sales personnel would reduce pricing to save the order. A commission on a few gross margin dollars is better than a commission on no gross margin dollars.
Could you help this senior management team define a better incentive system through the below questions ?
- Should you follow industry practice ?
- How to account for opportunity teams ?
- Should bonus be individual or pooled ?
- Should bonus be adjusted for territory difficulty ?
- Should there be a threshold before bonus is paid ?
- Should there be a maximum to the bonus ?
- Shoud the commission rate be flat, progressive or degressive ?
- Should incentives include a matrix of several dimensions ?
- Should some products be treated outside the plan ?
- Could sales be managed by individual objectives ?
- How could promotion be used as an incentive ?
In some industries, the commission rate for income producers is so well established that few in sales management would even presume to question the rate, let alone alter it. Senior management simply accepts the rate for the income producers as a known constant built right into business planning assumptions of the company’s financial model.
However, like any economic statement, market forces have an ongoing influence on the development and refinement of income producer commission rates. No one should assume that commission rates are constant and cannot be changed.
Follow this industry practice only if your company is identical to your competitors and if they have found the ideal sales compensation solution. However, the likelihood that your products, customers, and customer coverage strategy are identical to your competitors is, at best, remote. Thus, consider additional dimensions.
Unexpected market opportunities, mega-deals or large Requets for Proposals (RFPs) can call for opportunity teams to assemble. These teams may require a large number of people to work hard outside the classical boundaries of the sales incentive plan.
Think about a specific incentive device for these opportunity teams. The event award could be paid at the time contract signing for instance. The incentive could also include a smaller amount to recognize the effort in case the contract is not won.
The use of bonus pools
Pools are primarily a mechanism for sharing results. Their effectiveness at driving or causing team performance is debatable. In some circumstances they can be an interesting peer pressure device, though they have drawbacks.
Some organizations use a hybrid individual and pool model. One hybrid approach features a commission paid to individuals for normal transactions and the earnings for mega deals partially allocated to a pool for distribution at the end of the performance period.
Another hybrid approach is to accumulate the pool based on performance, but allow manager judgment of individual contribution to affect some or all of the pool payout to participants.
Absolute dollar formula or formula adjusted to objective
A flat commission, with no base salary, is a very powerful and focused pay program. Expect the income producer sales force to look primarily to the pay program for direction and focus.
For sales representatives, accomplishment of sales objectives can be expressed as a percent of goal: 75 percent of goal, 100 percent of goal, or 125 percent of goal, for example. In this manner, the formula expresses payments as a percent of goal achieved and not as a percent of absolute dollars. It is useful if the territories have very different economic potentials.
Some organizations believe the salesperson should earn his or her base salary before an incentive is earned; therefore, the threshold is set at a number equal to the equivalent commission earnings for like sales volume.
Some organizations want to motivate the salesperson to achieve a minimum level of quota performance. The threshold ensures that performance is consistent with this objective.
Other sales organizations simply use a threshold as a statement of management intent of what is the minimal level of acceptable performance.
Although sales management should avoid the use of maximums, their use is necessary in certain cases. Variable commission rates assume that sales personnel can influence the customers’ buying preference among products. Thus, no variable commission should be paid for an order that is beyond the influence power of a sales person. In case such events can happen in your industry, you may want to include maximum pays.
Be prepared to explain and defend your maximum policy as it will probably not be popular within the sales team.
Progressive ramp commission rates
Progressive ramp commission rates provide added motivation for selling beyond target. In a progressive ramp, the second rate is higher than the first rate. The new rate is only effective when the target amount is reached and does not (should not) “retro-back” to pay the previous sales volume at the new, higher rate. Most incentive formulas feature a progressive ramp. This approach rewards additional sales performance.
Decreasing commission rates can be used in some cases when sales could gain unexpected incentives for mega-seals or rainfalls. Though there are good reasons to unclude decreasing commission rates on volumes, sales teams typically do not like them and they will require constant explanations.
Decreasing commission and maximum can be useful in case of high market volatility. In volatile markets, sales are very hard to predict. Sales that require minimal sales force effort relative to their value—often referred to as “windfalls” or “bluebirds”—are booked unexpectedly and frequently.
These random sales can be very high in one year and low in the next. Companies that develop highly leveraged compensation plans that ignore market volatility can incur two negative consequences.
First, the sales force develops high income expectations subsequent to a successful year in which random sales are high and salespeople receive considerable windfall gains. The sales force takes credit for the success and feels entitled to a similar income level in the future. Then, sales force morale suffers the following year when random sales are low.
Second, a perception of unfairness envelops the sales force when the windfalls are not uniform across all salespeople. Paying a higher salary and lower incentive in volatile markets is one way to ensure a more fair and predictable distribution of earnings. Another way is to try to measure and account for random sales. For example, some firms put a cap on earnings to limit the impact of windfall gains resulting from random sales.
The salesperson must resolve two conflicting measures, for instance sales volume versus profits. There is a double threshold at the low end. Average gross margin has a higher importance weighting in the matrix than sales volume goal attainment. Average gross margin is weighted 60 percent, and sales volume goal attainment is weighted 40 percent in the matrix.
Matrices are normally constructed with an odd number of rows and columns to provide a middle cell for presenting target performance and incentive rate. Most matrices are at least 9×9 and some are as large as 15×15.
Product mix multiplier
This device changes the bonus on product one depending on the sales of product two. It can be useful to force cross-selling. The multiplier can have only upside or both upside and downside.
Using a product mix multiplier with both upside opportunity. they will require constant explanations. and downside risk notifies the salesperson that cross-selling or achieving product mix goals is very important.
It is usually a mistake to treat a new product like an existing product in an incentive plan.
In the first quarter following launch, salespeople are paid a special commission on new product sales. For instance based on the number of sales rather than volume. In the second through fourth quarters following launch, commissions are paid for sales growth, thus encouraging the sales force to continue to build sales momentum and drive product success. By the second year following launch, the firm has gained considerable experience in the market, and sales become more predictable. At that point, the product is incorporated into the firm’s regular quarterly quota bonus plan.
Sales processes and roles often change as products mature. When products are new and sales are growing, a pay plan with a large incentive portion can motivate salespeople to work hard to generate trial among customers, seek new opportunities, build relationships, and create sales momentum. However, as the products mature, the role of the sales force changes. Instead of driving new sales and growth, salespeople must focus on customer retention and service. A pay plan with a greater proportion of salary and less incentive is often more compatible with this role.
Management By Objective
The use of a Management by Objectives (MBO) component provides the flexibility to craft unique measures per salesperson. Although MBOs have a long history in the corporate environment, the sales force has recently adapted the MBO concept for sales situations. Key Sales Objectives (KSOs) provide a handy framework for sales executives to develop incentive payouts tied to individual performance.
Balance Key Success Objectives (KSOs) by not letting any single measure be worth more than 50 percent and not less than 10 percent Limit KSO measures to five or fewer Select measures that impact sales results and are quantitative Provide KSO visibility through a database accessible by senior sales management Require two levels of supervisor review before final KSO objectives are established and payouts are made Require two levels of supervisor review for any modifications during the program period. Most KSOs are set quarterly, semiannually, or annually. One method is to create a 200-point maximum scoring scheme with 100 being considered par, or expected performance.
For some professional service firms, sales results are rewarded with promotions and eventual partnership without the use of sales compensation.
Consider adding sales contests
Sales contests, SPIFFs (Special Performance Incentives for Field Force), and recognition programs are powerful and relatively inexpensive ways to enhance a firm’s sales force incentive program. When used appropriately, such add-on incentives can effectively focus sales force attention on specific short-term goals, improve morale and team effort, or recognize the extraordinary efforts of top-performing salespeople. Yet contests, SPIFFs, and recognition programs harbor some dangers. Too many additional incentives can confuse salespeople or divert sales force attention from strategically important products, customers, or activities.
Sales contests and SPIFFs are nonrecurring sales incentive programs designed to motivate sales force behavior and reward short-term results. A typical sales contest or SPIFF lasts not more than a few months and focuses on specific products, customer types, or sales activities. Prizes can include cash, merchandise, and/ or travel awards.
Recognition programs typically reward performance over a longer period of time than a sales contest or SPIFF—usually one year or more. Winners of recognition programs are often entitled to a trip and/ or to membership in a select group, such as the President’s Club.
SPIFF refers to programs with a high participation rate, where a considerable proportion (at least 60 percent) of salespeople earn money and/ or prizes. Finally, contests are programs with a lower participation rate, where salespeople compete with one another to earn a limited number of prizes or cash awards.
Sales contests and SPIFFs are designed to motivate immediate sales force behavior and reward short-term results. When used appropriately, sales contests and SPIFFs have many advantages: They are generally well liked by salespeople, and they can create considerable sales force excitement. They are an effective way to focus sales force attention on specific near-term tactical events that might otherwise get insufficient attention—for example, launching a new product, combating a competitive entry, or providing a midyear boost to lagging sales. They are usually relatively low cost and have relatively low risk for the firm.
Although SPIFFs and sales contests usually represent less than 10 percent of the total incentive compensation budget, their impact has the potential to do serious harm to a firm if the programs are not centrally coordinated and strategically aligned with company priorities. SPIFFs and sales contests can redirect sales force effort from core products, diluting the impact of the main incentive compensation plan.
Some salespeople seemed to have the attitude, “It’s just a contest, so it’s okay to push the rules a little, just like in any game.”
In particular, they are useful to encourage support for underemphasized sales priorities. A new product needs to be launched hard. Market segments that are threatened by competitors need to be defended. Products that are not on track to make goal need an extra boost. The sales force may not exert the requisite energy to accomplish these objectives within the existing incentive compensation scheme.
Often the recognition and trophy value associated with a sales contest or SPIFF are more valuable than the tangible prize that a winner receives. Be sure to leverage this value by:
- Making a big deal out of the award presentation. Present even inexpensive awards (such as gift cards or sports event tickets) personally and offer sincere congratulations.
- Making it humorous and symbolic. For example, top sellers at a commodities firm get the Beaver Award (a stuffed beaver with an engraved plaque), because the beaver is the hardest-working creature in the animal kingdom.
- Making it fun. For example, a telemarketing firm gives its telephone sales reps pennies for closing sales, and these are dropped into a gumball machine. Small cash awards are given, depending on the color of the gumball that comes out.
- Announcing winners to the entire staff. For example, a bank publishes articles in an employee newsletter highlighting the accomplishments of top performers.
- Providing a lasting memory. Cash awards can be used to pay the bills and are soon forgotten. Merchandise awards, even inexpensive ones, are a visible reminder that the salesperson is valued by the company. Abbott Laboratories puts a star on the business cards of its top sales performers.
Studies have found that even though most salespeople say that their preferred reward in a sales contest is cash, a sales force will actually work harder for a noncash award. Research has identified five universal motivators that explain what drives salespeople: the need for achievement, social affiliation, power, ego gratification, and survival. Of these needs, only three—achievement, ego gratification, and survival—can be satisfied directly with money. Noncash awards will be much more effective for salespeople who are motivated primarily by a desire for power and/ or social affiliation. Noncash awards (in addition to money) can fulfill the need for achievement and ego gratification as well.
Back the plan with a strong administration process
Sales compensation requires attentive administration and, in some cases, powerful automation tools. When done well, effective administration acts as an unseen but indispensable program foundation. Administration is a combination of policies, procedures and accountabilities, automation, and reporting.
An effective plan administration system produces results that are accurate and timely, provides insights to the sales force and to sales leaders about ways to improve, and maintains an appropriate balance between flexibility and cost effectiveness. Timeliness of results is also very important. If reports are late, the value of prompt feedback is lost, and the motivational impact of the incentive plan is diminished. Late payments cause the sales force to get upset, and morale suffers.
Often considered a back-office function, underresourced administration can cause significant dissatisfaction in sales personnel and, even worse, create field flare-ups where frustration is so high that sellers stop selling as they await resolution. Ineffective administration can quickly erode participant trust. Inaccurate checks, incorrect crediting, late payments, and confused reporting will expend a sales force’s goodwill.
As sales force distrust of the system grows, sales force motivation declines, and salespeople spend more and more time on “shadow accounting” (chasing invoices, verifying pay calculations, and lobbying management for payout corrections) rather than spending time with customers. Unfortunately, IC plan administration can be highly complex and error-prone.
Plan administration costs typically add 2 to 15 percent to total incentive compensation costs. The percentage is usually at the lower end of the range for large sales forces and at the higher end for smaller sales forces.
The number of configurations for an incentive plan is almost unlimited. However, limiting the number of performance measures to three or fewer Will make your life easier. Additionally :
- Limit changes within the fiscal year and from one year to the next
- Exclude volatile and uncertain items
- Tolerate inequities (i.e., a plan is never perfect)
- Control exceptions (e.g., with a dedicated committee having the last word)
- Limit credit splits (i.e., double counting between several indivoduals or departments)
- Limit “following credits” (i.e., when a sales changes position or territory)
Communicate about the plan
Sales leaders are often too quick to assume that changing the compensation plan will solve their sales management issues. Clearly, changing the incentive compensation plan will solve some sales management problems. However, about half of the time, when we are asked to solve a sales force challenge or concern by redesigning the sales compensation plan, the primary source of the problem turns out to be some other aspect of the sales management system.
The difficulty of implementing a successful incentive plan change is influenced by a company culture, the circumstances surrounding the change, sales force customer power and the degree of income loss.
It is important to let salespeople know how they would have done last year if the new plan had been in place. Salespeople who are opposed to a sales incentive compensation change can react in several ways:
- Openly oppose the change by complaining or even slowing down work
- Quietly oppose the change through diminished loyalty and decreased motivation
- Leave the company (and possibly take accounts to a competitor).
The successful launch of a new sales compensation program requires the combination of exceptional program implementation and inspired communication. At its heart, sales compensation is a communication device: it tells salespeople what’s important and what’s not important.The launch of the new sales compensation program gives the sales executive a superb platform to articulate the sales objectives for the coming year and inspire commitment to sales results.Ideally this message would be delivered at the national sales meeting, in person, to all sales personnel.
Carefully plan the implementation steps. Leave nothing to chance. Confirm accountabilities, test and retest system solutions, and monitor progress. Think of the communication program not as an administrative event, but as an advertising and/or marketing event. Make use of the creative talents within your company to develop a theme to market the new sales compensation program to the sales force. Make sure all levels of sales management participate in the process. Use personal communication whenever possible. Your actions will tell the sales force how to act—if you think it’s important, they will think it’s important. If you don’t think it’s important—and you suboptimize your communication opportunity—your salespeople won’t think it’s important either.
Case study – The sales force is not developing enough new business.
This problem is frequently diagnosed by sales leaders as a compensation issue. Management believes that salespeople are comfortable with their earnings on easy sales to repeat buyers, and are not motivated to go out and prospect for harder-to-get new business. It therefore reasons that a change in the compensation plan to provide greater variable pay for sales to new customers will motivate salespeople to engage in more new business development activities.
While adjusting the compensation plan may be an effective way to stimulate new business development in some situations, there can be many other reasons why new business development is below expectations. Very rarely is the compensation plan alone to blame for this important sales management challenge.
For example, consider the following other reasonable explanations:
- The sales force size is too small. Salespeople are so busy managing the business from repeat customers that they do not have enough time for new business development.
- The sales force is not structured appropriately. Generating new business requires very different sales skills from generating repeat business, and it is not always possible to have a single sales force that does both well. A sales force specializing in new business development is needed.
- The company is not hiring the right people for the sales force. The current salespeople are good at maintaining relationships and servicing customers, but they do not have the right personality to aggressively pursue business from new customers.
- The company is not training salespeople adequately. Salespeople need guidance on the sales process for hunting new business successfully.
- The sales force does not have the data and tools that it needs for successful new business generation. Better targeting lists and tools are needed to help salespeople identify good prospects in their territory.
List of typical sales job design errors
When sales compensation plans become ineffective, it is usually because the plans attempt to fix a job design mistake.
- The Corrupted Sales or contaminated sales job. Responsibilities of other departments have crept into the selling job, such as collections, marketing, and customer service.
- The Blended Sales Job: too many goals overwhelm the focus of a sales job. Sales jobs function best when they have a single focus. Focus occurs when the goals are few and the cadence is uniform.
- Bandwidth Exceeded: too many products and too many dissimilar customers for the salesperson to handle.
- Undetected Job Transformation: some jobs transform from an initial job to a new, different job.
Roles who have to be coordinated about the program
- CEO/Business unit general manager: The CEO/business unit general manager must articulate the business objectives and goals to the sales department.
- Vice president of sales: The vice president (VP) of sales has overall responsibility for the sales compensation program.
- VP of marketing: The vice president of marketing provides information about product strategy and customer segments.
- VP of finance: The vice president of finance oversees the financial viability of the sales compensation program,
- Sales operations: Sales operations provide day-to-day management of the sales compensation program.
- Human resources: The compensation manager provides external competitive market practices by purchasing reliable survey data.
- Legal: The legal department approves plan documentation
- Sales personnel: Sales management solicits feedback from sales personnel
- Sales performance committee : Meeting once a quarter, this committee can review and make decisions on program adjustments, plan exceptions, and policy interpretations.
Appoint a process manager to oversee the whole sales compensation program including alignment, design, management, administration, assessment, audit, and legal. This person should never be tasked with the objective to design new plans. Assign this duty to the sales compensation design team and let the process manager manage the process.
Content of a sales performance plan
A sales performance plan is a communication device. Take the opportunity to communicate what is important and what is not.
- Introduction and strategic objective:
- Compensation philosophy
- Plan overview
- Plan elements
- Program policies
- Formula calculation example
- Employment status policies
- Rights and obligations
Content of the sales incentive policy documentation
Policies, procedures and accountabilities, automation, and reporting are key components of the overall administrative support for effective sales compensation programs. These administrative systems require substantial investment. While not highly visible to sales personnel when functioning correctly, they become very visible (and distracting) when not operating effectively.
While sometimes off-handedly referred to as boilerplate, do not be fooled into thinking that these policies are unimportant or that they exist as an understanding. Every sales compensation plan document should contain a policy statement section covering all of the above topics. Even if you are a small company. Size and management style cannot abrogate your responsibilities to prepare clear and unambiguous policy statements regarding the pay plan. Without such clarity, you run the risk of unpleasant legal action at worst, and distracted, wary salespeople at best.
- Account assignments: How are account assignment changes made—under what conditions?
- Quota management: How is quota allocation done? How
- Sales crediting: What is the definition of a sales credit for sales compensation purposes? Who gets direct credit for a sale? How
- Program timing: When are territories assigned?
- Program interpretations, exceptions, and adjustments: Who is responsible for program interpretations?
- Sales expenses: Which sales expenses are reimbursed?
- Governance: Who has final program authority for the sales compensation program?
- Rights and obligations: What rights and obligations do sales personnel have under the sales compensation program? What are management’s rights and obligations under the sales compensation program?
Assess the sales compensation program
5 dimensions to assess the sales compensation program
- Strategic alignment: How well does the plan support the company’s business objectives?
- Employee motivation: Do the sales personnel strive to earn incentive pay by excelling on the program performance measures?
- Best practice variance: While some companies will intentionally vary from best practices, knowing these variances may help identify unexpected consequences.
- Return on investment: Is the company getting an effective return on investment?
- Program management: Is the program management consistent with plan documentation?
A few analyses to run when assessing a sales performance plan
- Collect additional information on sales personnel motivation. Conduct field interviews and focus group interviews to learn what features of the incentive program are effective.
- Ask questions about the following items: Plan effectiveness: total compensation, target incentive pay, program focus Communication: understanding of the plan Administration: payments, issue resolution Quotas: allocation process, fairness Sales crediting: rules, consistency Recognition plan: impact Contests: effectiveness Sales management should also ask sales personnel this very simple question: Does the sales compensation program motivate you to achieve the company’s objectives?
- Examine both new hire acceptances and voluntary termination rates. Determine why applicants decline offers.
Check the impact of the plan on customers
To determine whether the sales incentive plan has the desired impact on customer results, survey or speak with customers to get their perspective on how the sales incentive plan affects their relationship with the firm.
Does the plan seem to encourage sales force behaviors that meet customer needs? does the plan encourage salespeople to engage in behaviors that are undesirable from the customer’s perspective, such as: Overselling Ignoring the customer Overlooking servicing or other important steps of the sales process Creating distrust Selling products that do not meet customer needs Selling to the wrong customers
Be wary of customer surveys as incentives, though. When a salesperson knows that he will be evaluated or possibly paid in part on customer satisfaction survey results, the salesperson has significant incentive to influence the results.
Effective design: Sales compensation plans have numerous features and components.
To effectively manage sales compensation, a company needs to establish preferred principles regarding plan eligibility, target total cash compensation, pay mix and leverage, performance measures and weights, quota distribution, performance range, and performance and payment periods.
- Plan management: Communication, training, interpretations, and adjustments are part of successful sales compensation program management.
- Program administration: Day-to-day administration of the program ensures proper sales crediting, payroll payment files, and management reporting.
- Program assessment: Regular assessment tests the sales compensation program for success.
- Audit and legal review: Finance audits and legal reviews keep the sales compensation program compliant with company guidelines and policies.
- Territory configuration: Territory configuration defines sales territories—“scope of responsibilities.” The territory configuration policies provide rules for account assignment and reassignment.
- Quota management: Quotas define performance expectations—“performance commitment.” Quota management encompasses two activities: quota allocation and quota adjustments. Sales crediting:
- Sales crediting defines sales success—“achievement measurement.”
10 steps to design a sound incentive plan
Follow these 10 steps to construct any sales representative sales compensation formula.
- Step 1. Identify target total cash compensation (TTCC): Begin by identifying the target total cash compensation for the job. Some organizations follow labor market practices very closely,
- Step 2. Determine the pay mix of the plan: The pay mix is the split of the target total cash compensation into two components, a base salary and a target incentive amount. The more prominent (influential) the salesperson in the buying decision of the customer, the lower the base salary. The mix is expressed as a split of 100 percent (for example, 60/40, 70/30).
- Step 3. Establish the pay leverage of the plan: The leverage of the plan provides the target upside outstanding earning amount for achieving exceptional sales. The most common leverage is “3x.” That is, three times the target incentive (added back to the base salary)
- Step 4. Calculate range of pay opportunities: The pay opportunities reflect the application of the company’s target total cash compensation, mix, and leverage.
- Step 5. Identify and weigh performance measures: Performance measures give meaning to the sales compensation program.
- Step 6. Confirm quota difficulty distribution: Make sure that quota difficulty achieves a quota distribution of a predefined percent of the sales personnel who will perform at or better than quota perfor-mance,
- Step 7. Set performance expectations: Set performance expectations for each performance measure: threshold, target, and excellence (see Figure 6-13).
- Step 8. Assign pay expectations with performance expectations: Each performance level is assigned a payout amount (see Figure 6-14).
- Step 9. Calculate the incentive formula for each performance mea-sure: The incentive formula for each measure can now be calculated. Again, we use the simple formula:
- Step 10. Publish incentive formula: Now the incentive formula can be published for the sales personnel
Checklist of good design characteristics
Well-designed sales compensation programs share similar design characteristics
- Eligibility for sales compensation should be reserved for those jobs that have have customer contact, persuade the customer to act, and contribute to the revenue production
- Mix: Pay mix, the split of total target cash compensation (TTCC) between target base salary and target incentive, should reflect the degree of influence of the job. Where sales personnel have high influence over the customer’s decision to buy, provide a low base salary and a high incentive opportunity. Where sales personnel represent only one factor affecting the buyer’s decision, provide a high base salary component while keeping the target incentive component smaller.
- Leverage: Ensure that the 10% best performers earn 3 times the target incentive. Avoid caps on the sales compensation plan.
- Performance measures and weights: Always have a revenue production measure to drive sales volume performance. Restrict the number of measures to 3 or fewer. Weight the measures to reflect importance of the measures.
- Quotas distribution: The target is for two-thirds of sales personnel to reach and exceed quota and one-third not to reach quota. There should be no bias in the quota allocation process. The size of territories should not have a positive or negative influence on the quota performance.
- Performance and payment periods: Match the payment period to the performance period. Use cumulative-to-date payments when payouts occur more frequently than the performance period.
- Formula type: Use a target incentive commission formula when territories are equal; use a target incentive bonus formula when revenue levels among territories are significantly dissimilar.
- Market data: Set pay levels consistent with market pay data. Participate in market surveys conducted by a third party featuring uniform data submission standards, mandatory job matching sessions, and incumbent-based data collection and reporting. Purchase surveys annually. Ensure to have more than one survey source for each benchmark job.