Sales Compensation Design – Where to Begin

BY CLIFF SANDSMARK

It’s Martha’s first week on the job as a brand-new HR Director for a consumer goods company nestled in the Midwest. The VP of Sales called her into her office and wanted her to redesign the Sales Representative Commission Plan for her department. The VP isn’t happy with the current plan since she feels the reps are overpaid and gaming the plan. The program was never tested and consisted of a generous base salary plus a commission rate that is creating huge payouts on existing business with zero focus on obtaining new clients. Eager to make a good impression, she promised to get on it right away and have a recommendation by the end of the week. Anxiety set in when she acknowledged to herself that she is ‘the’ HR Department and only had the one class in Sales Compensation she took for her compensation certification. She located her class binder, dusted it off, and began her review as to how to design a sales incentive plan.

Her first task was to do fact-finding with the sales department: what are their sales goals, their ‘go to market’ strategy, the sales channels they use to deliver their product to the customer, etc.

She knew that compensation for the sales associate depends on the type of sales the job: would it be New Market Selling and Conversion Selling to new prospects, Fulfillment Selling which sells to Current Customers, or Penetration Selling to existing customers to offer additional goods and services the company has to offer? Each market will require a different type of sales role due to the amount of effort required to close the sale. She understood that selling to new, prospective customers is harder than selling to existing customers and compensation would be driven by the amount of effort required to win the sale.

She was familiar with the traditional Hunter and Farmer roles, selling to prospective customers vs. existing ones - sometimes known as Business Development Reps. Customer Service Reps service existing customers to ensure they are receiving their products and services. There may also be a position for Lead Generation which frees up the traditional hunter sales role to concentrate more on the actual selling process.

She had some survey resources to determine pay. With a major portion of sales compensation being ‘pay at risk,’ it is a practice to price the job for Total Target Cash Compensation (TTCC) rather than just focusing on the base only. TTCC clearly shows the actual market value of the role. Her next task would be to determine would it be salary only, commission only, or a combination of base salary and incentive (either commission or bonus or both).

It was then she remembered the sales compensation instructor for her certification class. He was an SVP for a nationally recognized sales consulting firm and had published several books on the topic. She remembers what he said like it was yesterday:

“Finding, defining, and measuring the point of persuasion is the focus of effective sales compensation design” (Cichelli, 2018). The point of persuasion is where the sales associate helps the customer make a buy decision where there is uncertainty. It is at that point we reward the sales associate.

Salary only is typically used for long sales cycles, where the time from initial contact to the final delivery of the product is 18 months or longer. Here one might use ‘milestones’ to create incentives at certain points of the project like receiving the LOA, contract signing, delivery/installation of the final product.

Straight commission is used for those products or services that are considered a ‘commodity’ where the sale of the product depends on the efforts of the salesperson and not on other external factors. In other words, factors such as brand awareness, company reputation, etc. are a minor influence on the decision to buy. Products sold through multilevel marketing programs as well as life insurance and real estate are sold with straight commission.

The most common arrangement is a mix of base salary and incentive pay. The amount of incentive is based on the amount of persuasion required by the salesperson to close the sale. For example, the decision to buy is influenced by the product’s uniqueness and has no other competitors, excellent brand name recognition, and the company’s reputation in the marketplace. Here the product can literally ‘sell itself’ with a little push by a sales professional who just writes the order. If this is the case, then a smaller percentage of incentive is used, and a 90/10 plan might be appropriate: 90% of the TTCC would be base salary and 10% incentive pay.

Products that have many competitors, competing brands, and would require more effort by the sales associate to book an order receive a higher percentage of incentive pay in relation to base salary. This could range from 80/20 to 50/50 plans – but it is recommended not to exceed 50/50 since it begins working closer to a straight incentive plan and increases the chance of losing control of the sales associate and their book of business.

The next step is to decide the types of measures that she’ll recommend. The use of proper measures will drive the desired behaviors and focus on those elements that indicate success. A measure should provide a clear ‘line of sight’ – which means those elements that the sales associate has control over and are strongly correlated to their individual payout. A successful plan has a maximum of three measures. Using more than three typically results in the sales associate losing focus on the measures that are important to the organization. Some common items used are unit measures (number of products sold), gross revenue, gross margin, number of new accounts, price management, milestones achieved, etc. The important point to remember is, does the sales associate have control over the measure? For example, they can’t be incentivized for pricing goals if all product pricing is controlled by Finance.

For quantitative measures, they can be incentivized with a commission payout. A commission is a ‘percentage of’ the total cost. For example, a car salesman gets 10% of the sale price he negotiates with the customer. Some of these measures can be qualitative: Customer Satisfaction Scores for example. You want to reward associates with high Customer Satisfaction scores, you would use a bonus as part of their incentive plan. A bonus basically means, “if you achieve this goal, you will be paid $XXXX.” Back to our car salesman example: his manager tells him that if he sells 10 cars during the month, he will receive an additional bonus of $1,000 in addition to their commission earnings.

Once you’ve decided on your measures, you can also weigh them for importance. This helps the sales associate focus on those measures that are important to the organization. She has chosen three measures: price realization, number of units sold over last year, and customer service satisfaction. Since price relates directly to gross margin and with the ability to negotiate prices, Martha weighs this as 50% and the remaining two at 25% each. She also added a ‘hurdle’ where none of the measures will pay out until the goals for new units sold are reached.

After completing plan design, she will perform a simple ‘what if’ analysis and a ‘Who Gets Helped, Who Gets Hurt’ analysis. The ‘Who Gets Helped, Who Gets Hurt’ analysis takes last year’s sales data and plugs it into the new plan. When compared to the results of last year’s actual payouts, it is easy to see how the new plan will work, it’s impact on the sales force, and what the Compensation Cost of Sales will be for the upcoming plan year.

She presented the new plan and analysis to the VP of Sales, and it was approved for the next plan year. The final steps are to prepare a plan document which will cover who is eligible, how the plan works, how it pays out, when an incentive is considered ‘earned,’ payout of earnings under FMLA, employment termination, dispute resolution, etc. For the roll out she created an information campaign with a simple calculator to show how a rep will be paid under the plan at different levels of performance.

Martha can chalk this one up as a win, time for the next project.