How to Write an Effective Sales Compensation Plan

Sales compensation plans (comp plan) are more than a formula for commissions. They are an integral element of your sales team’s success. An effective comp plan will drive success and revenue. A bad plan will drive everybody crazy.

I spent over 25 years analyzing, writing, and optimizing comp plans. Along the way, I picked up a lot of best practices. Let’s explore the elements of a comp plan and some of those best practices.

NOTE: this blog uses the word incentive to refer generically to both commissions and/or bonuses.

Comp Plan Types

There are different types of sales jobs and, likewise, different kinds of comp plans. Some of the more common types include:

• Salary + Commission: salesperson is paid a base salary and earns commissions on each deal. Most account executives have this kind of plan.
• Commission-only: salesperson is paid only commissions, no salary. These may include a draw on future commissions.
• Salary + Bonus: salesperson is paid a base salary and earns bonuses on meeting specific sales goals. Sales engineers and customer success roles often have this kind of plan.
• Territory / Team Volume: salesperson is paid a base salary plus commissions based on the performance of an entire team or territory. Most sales managers have this kind of plan.

There are many other variations, however these plans all share some common elements.

Comp Plan Elements

There are five key elements to a comp plan:

1. Opportunity Types
2. Incentive Basis
3. Incentive Rate
4. Accelerators
5. Payout Process

Let’s take a look at each of these and why they are important.

1. Opportunity Type

Not all customers are the same. Some deals are more difficult to close, and some customers are more desirable. Opportunity Types provide a way to differentiate, categorize, and scale incentives appropriately to the desirability and complexity of each customer type.

For example, let’s say your company wants to break into the healthcare industry. Using opportunity types, you can create a category named “Target Accounts.” Then provide each salesperson with a list of healthcare companies. Any deal a salesperson closes with an account on the list receives an increased incentive payment. This encourages the sales team to focus their efforts on these target accounts, thus driving the business you want.

Ideally, your plan should have three to five opportunity types. Too many types and your plan will become convoluted and difficult to enforce.

Here is a suggested structure:

The definition of each type is important. If there is confusion about what constitutes each type, this may lead to arguments and disillusioned salespeople.

2. Incentive Basis

This is the starting value to compute an incentive payment. For many companies, this is the gross profit (GP) on a deal. For example, a salesperson closes a deal classified as organic for $50,000 and it has $15,000 in costs. The incentive basis (GP) would be $35,000.  Based on the opportunity types listed in the previous section, the commission would be 10% of $35,000 or $3,500.

The key to incentive basis is an ultra-clear definition. A good comp plan never creates ambiguous incentive calculations. Therefore, when you write your plan, make sure to precisely explain how you compute incentive basis. If direct costs are included, but not indirect ones, then you need to describe what constitutes a direct cost. Always provide examples, to ensure there are no misunderstandings.

3. Incentive Rate

This is how much the salesperson earns on a sale. Typically, this is expressed as a percentage of the incentive basis value and scaled to each opportunity type. Percentages are always preferable as they scale up and down based on the size of the deal. Fixed commission payments are only effective when you want to reward specific, non-income-generating accomplishments, such as setting up meetings.

Be careful with incentive rates. They need to be high enough to motivate results, but not so high they hurt your overall profitability.  Moreover, you may need to alter the rates based on margin. Low margin sales will naturally create smaller incentives. This may discourage salespeople from selling low-margin items.

4. Accelerators

Accelerators reward salespeople with additional compensation when they exceed quota.  For example, if a salesperson hit 125% of quota for a quarter, their incentive rate could go up 1%, increasing all their incentive payments.

Here is a suggested quarterly accelerator schedule:

Accelerators can have a huge impact on a salesperson’s income and motivation. However, if the accelerators are too aggressive, they might hurt profitability.

Work with your finance manager or bookkeeper to run financial models on different accelerator structures based on historical values. You may need to implement flat-rate accelerators or limit the total amount that can be paid.

5. Payout Process

For sales incentives to work effectively, salespeople must be able to quickly and reliably compute their incentive payments. Documenting the exact process the company follows to pay incentives reassures salespeople they will get paid.

Documenting the process also creates consistency and a check-and-balance process. Here are suggested steps for a payout process:

1. Sales manager submits incentive payout request to Controller (bookkeeper, CFO, finance team member, etc.) This request details each deal closed as well as the expected incentive payment.
2. Controller reviews and validates the requests are correct and eligible to be paid. Controller works with sales manger to make any corrections or adjustments.
3. Controller obtains approval to pay incentives from CEO (COO, etc.)
4. Controller returns payout request to Sales Manager indicating which incentives are approved to be paid in the next payroll cycle.
5. Sales Manager communicates this approval to appropriate salesperson.
6. Controller processes incentive payments in payroll

Additional Guidelines

Ultra Precise Language

Among all the challenges of developing a comp plan, the most insidious is the words themselves. The language of a comp plan must be simultaneously extremely precise and easy to read. One confusing word or ambiguous definition could land you in court with an angry employee demanding more compensation than you intended.

Consider these two examples:

BAD: Account executives (AE) earn 10% commission on gross profit for all consulting sales.

BETTER: Account executives are eligible to earn 10% incentive based on the gross profit of deals the AE was assigned and closed.

The first item is too vague and lacks key qualifiers. An employee could interpret this as they earn 10% on all sales, regardless of whether they closed the deal or not.

The second item uses some important qualifiers. For example, rather than “earning” a commission, the salesperson is merely “eligible.” This gives you more room to control what is or is not a legitimate commission. Moreover, the word “commission” is replaced with “incentive.” Commission is a loaded word with a specific, legal meaning. Incentive is more generic, giving you more freedom to define what an incentive is (or is not).

If you are not familiar with writing a comp plan, hire an expert (like me) or use well-vetted template. Furthermore, have your legal counsel review the plan to ensure it is defensible in court or arbitration.

Different Plans for Different Roles

One comp plan does not fit all. Depending on the sales roles you have, you will likely need as many as five different plans. For example, the most common roles are:

1. Business Development Representatives (BDR): work on in-bound leads, set appoints, and so forth.
2. Hunters / Account Executives: actively work to drive new business.
3. Farmers / Account Managers: manage existing customers
4. Subject Matter Experts / Sales Engineers: provide subject matter expertise to close deals
5. Managers: oversee the team, set quotas, etc.

Each of these jobs is different and likewise must be compensated differently. For example, closing new business is more difficult than managing existing customers. Use the same plan template, but alter the Opportunity Types, Basis, and Rates to match the relevant effort for each role.

Reward Results, Not Effort

I spent countless sales meetings listening to struggling salespeople complaining about the effort they were pouring into sales. While I empathized with their struggle, effort without results is meaningless.

Comp plans must focus on rewarding the results of hard work, not the work itself. Moreover, do not reward “almost” results. Accelerators or bonuses should only kick in when quota is exceeded.

Everything Must Be Public

Finally, the entire sales process, comp plan, and quota attainment must be open and public to the entire company. This ensures that everybody in the company can trust the sales process and see overall performance. This also ensures the sales team is accountable to their quote.

Final Thoughts

An effective comp plan will supercharge your sales efforts and attract top talent. It will also ensure that successful salespeople are rewarded, lucratively. This is a key attraction for a sales career – the ability to make a lot of money when you hit your numbers.

Successful salespeople, armed with a good product, effective sales tools, and a generous well-defined comp plan equals a successful company.

Always be closing!

Need help with your comp plan? Zenaciti offers comp plan analysis, development, and optimization services. Contact us to setup an introductory discussion.