Building a Sales Compensation Plan

Building a Sales Compensation Plan

9 Tactics for Building a Sales Incentive Structure That Fits Your Company’s Revenue Model

January 22, 2020

Equipping your team to build a successful sales compensation plan is no small feat. We have identified 9 tactics that can help you lay the groundwork for creating the right compensation plan for your company.

Simplicity is key, especially when scaling your sales force. By the time you’ve finished your plan, it should comfortably fit on a 3×5 card or one phone screen.

After crafting a sales playbook and mapping sales territories for your team, this is your next step toward building a high-performing sales team.

Let’s dive in.

Building a Sales Incentive Plan

1. CONSIDER YOUR REVENUE MODEL

Start by aligning incentives with your company’s bookings-to-revenue conversion model. Most companies tend to fall into one of two categories: Contract-based (predictable revenue) companies and transactional (variable revenue) companies.

Contract-based companies
Predictable revenue model

Contract-based companies can rely on a predictable revenue model because their revenue is based on fixed contracts that tend to be longer time periods (e.g. annual, 3 years, etc.).

In this case, the sales commission structure should have payment up front when the customer signs and/or goes live.

Transactional companies
Variable revenue model

Though transactional revenue model companies may have an estimate (e.g. 2.9% + $0.30 per transaction x projected number of yearly transactions) their revenue fluctuates.

In this case, what reps earn should be closely tied to cash flow. Transactional revenue companies should pay on actuals. This may require a portion as a forward upfront, but the clock for commissions should start once the contract is signed to create an incentive for maximum revenue in the first year with potentially 1-2 years of residual commission.

 

2. SET COMMISSIONS

Generally, companies set sales commissions somewhere between 7-15% of annual recurring revenue (ARR). The exact percentage depends on the profile of the business and sales rep performance to date Commission should be set based on recurring revenue — not one-time revenue. You can include small commissions for one-time revenue. But to maintain price discipline around smaller one-time sales, don’t allow sales reps to give away the one-time deals — or you can find yourself losing potential sales.

 

3. COMPENSATION ACROSS YEARS

Contract-based companies
Predictable revenue model

For reps who ink multi-year contracts, compensation should mostly be paid out in the first year. Our contract-based portfolio companies do not compensate reps across multiple years. Typically, there isn’t a bonus for 3-year vs. 2-year contract. If this is particularly important to your business, you can give a one-time bonus (or “kicker”) for longer contracts, but you don’t want to be paying out revenue for all four years.

Some of this comes back to how sticky the product is. If your product is a core, business-critical system with wide adoption across an entire organization, then the probability of the customer leaving in 2-3 years is low. You don’t want to give sales reps credit for contracts like this going forward.

Transactional companies
Variable revenue model

On the transactional side, you should compensate reps across two but no more than three years. Reps should be compensated a high percentage in first year with a sharp drop in second year. You should design their compensation plans to have some residual, but new bookings should generate the vast majority of their yearly income. Set the expectation that as soon as reps sign customers, they should push to them get onboarded ASAP.

But that second year can be important because the ramp can take time. You want your reps booking big deals with the ability to see through size of revenue into the next year. This creates an incentive to keep talented reps on the team.

For transactional revenue companies, you should give your reps a “forward” — some money up front.

Example: Let’s say the estimated amount for Year 1 revenue is $200,000. Your rep is going to make a 10% commission on that amount, $20,000 for the year. We can assume 25% of that is likely going to happen. By giving your rep a $5,000 forward as soon as they sign a big contract, they remain motivated to close more deals and you can pay the remainder, once revenue starts coming through.

 

4. COMPENSATING FOR DIFFERENT PRODUCTS

Sometimes setting compensation by product is important to help drive adoption of a certain new product or the products of a new company acquisition.Keep in mind, however, that sales reps tend to gravitate toward selling the products they know best. You may benefit from offering incremental incentives for new products to inspire reps to learn and begin selling them.

At the same time, you don’t want the launch of a new product to cause a downward sales trajectory for your existing product line. Consider incentivizing sales that involve both existing products and new ones. Always remember to protect your core sales.

Some teams overcome this problem by giving reps two sales quotas: an overall quota and a new product quota. And if they hit both, they get a kicker.

 

5. COMPENSATING ON ACTIVITY

Certain sales teams want to incentivize good habits like CRM hygiene or number of calls. But in our view, when the dollars are coming through, your reps are performing. We recommend focusing on revenue as much as possible.

 

6. INCORPORATING ACCELERATORS

Accelerators (bonuses for hitting targets above quota) are advantageous for incentivizing your top reps to keep closing above quota.The key to accelerators is setting quotas right.

Your quota should be set somewhere between 10-30% above the budget set by your CEO and board for the year. If you set quotas too low, the accelerators can quickly outpace your budget.

Accelerators are most advantageous for companies that are good at setting accurate quotas.

If you’re not quite sure on your optimal quota, it’s better to create wider bands for accelerators.

For first time sales comp plans:

  • 80-120% of quota — standard commission
  • 120+% — kicker to the next level
  • < 80% — lower commission rate

As you get better at setting accurate quotas, your accelerator strategy can get more sophisticated.

 

7. SETTING COMPENSATION LIMITS OR MINIMUMS

We recommend that you do not set limits to how much a sales rep can earn.As for setting a floor, if a rep is below 60-80%, they should still earn their base salary. But setting a floor can put zero dollar incentive in front of a low performing rep, which can prevent them from trying to close.

It’s critical to always give reps a reason to close the next deal.

 

8. RESETTING QUOTAS AND STRUCTURING OVERLAYS

An annual reset structure is standard for long sales cycles. For fast sales cycles, we recommend resetting every month or quarter. But with monthly or quarterly sales, if a rep is doing poorly they may just hold out on closing until the reset. In this case, you should avoid this disincentive by using incentive overlays.Some teams tell reps that if they miss a month they must “work to make it up in the next month.” But you don’t want a couple of bad months to massively demotivate your reps throughout the remainder of the year. If a rep misses a quarterly quota, then an overlay still gives them a percentage of total bookings that factor into their annual quota.

While most compensation should be tied to individual performance, there are benefits to having some team-based overlays, particularly when you want senior reps to help the whole team hit a certain goal. Sometimes there are pod-based bonuses with a field-based rep and an inside sales rep.
But be careful with team overlays, because the quota discrepancy between reps’ cumulative quotas vs. the team quota can be demotivating.

 

9. SETTING SPIFS

SPIFs (sales performance incentive funds or sometimes “special pay incentives for fast sales”) can be very powerful for achieving certain goals. SPIFs encourage:

  1. Behavior change: For example, if you see that 60% of your bookings come in at end of the quarter, you can set a SPIF for whoever gets the first sale of the new quarter. This will encourage reps to get their pipeline set up faster after each reset.
  2. New product sales: If you’re launching a new product or partnership, smaller SPIFs can incent your reps to push it.
  3. Getting back on track: Occasionally, you’ll have a year where you’ll be hard-pressed to hit your quotas due to unforeseen circumstances (e.g. change in competitor dynamics, economic environment, etc.). But it’s dangerous to change quotas mid-year. By adding a one-time SPIF for the last quarter to help you get back on track for next year (e.g. an extra $100 for every $1,000 booked), you will help you keep the team motivated and the integrity of your quotas intact.

 

When it comes to sales incentive plans, motivation is the name of the game. After setting quotas, finding the right mix of base pay, commissions, and kickers will keep your reps focused for their next deal.

Serent Capital invests in growing businesses that have developed compelling solutions that address their customers' needs. As those businesses grow and evolve, the opportunities and challenges that they face change with them. Principals at Serent Capital have firsthand experience at capturing those opportunities and navigating these difficulties through their experiences as CEOs, strategic advisors, and board members to successful growing businesses. By bringing its expertise and capital to bear, Serent seeks to help growing businesses thrive. Learn more about our portfolio companies.

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