The Complete Guide to Sales Force Incentive Compensation: How to Design and Implement Plans That Work by Andris A. ZOLTNERS, Prabhakant Sinha, Sally E LORIMER
Five major components of the sales management system
- Salesforce activities: lead generation, needs analysis, solution development, proposal presentation, negotiation, installation, customer service, and account maintenance and expansion
- Customer results
- Company results
- Salesforce effectiveness drivers
- Sales strategy: specification of a customer segmentation (whom will we sell to?), a customer offering (what will we sell?), and a sales process (how will we sell?)
- Go-to-market strategy: definition of the marketing channels, including the sales force, that will be used to carry out the sales strategy?
- Salesforce design: development of organization structure, sales roles, sales force size, and sales territory alignment
- The processes that shape the skills, capabilities, and values of the sales team, including strategies for culture formation; processes for hiring, training, and coaching salespeople; and processes for hiring and developing the management team. Sales compensation plays an indirect role in shaping the sales force, as it influences what type of person is attracted to the sales job and helps to shape the sales force culture.
- The processes that provide the sales force with customer insight, enabling salespeople to understand the marketplace, prioritize opportunities, solve customer problems, and use their time more effectively. Customer research, targeting, product prioritization, sales process design, CRM, and account planning are programs that fall into this category.
- The decisions and programs that affect the selling organization’s inspiration and motivation, including how sales leaders inspire, the fulfilling nature of the work, and motivational programs. The sales compensation plan has a major influence within the exciter category of drivers.
- The systems that manage performance by defining success, setting expectations, and tracking performance. Sales compensation can also play a role in controlling the sales force. For example, by paying a higher commission rate on sales of the most profitable product lines or by paying a bonus for sales to strategically important customers, the company encourages sales force behaviors that are aligned with firm objectives.
3 Cs of Aligning Incentive Compensation Within the Sales Management System
The creation of specific sales compensation plan objectives is a critical first step in a successful new plan design process.
- The incentive compensation plan should be consistent with corporate and marketing strategies and with the firm’s upstream decisions (sales strategy, go-to-market strategy, and sales force design) that define the sales job.
- Compatibility: The incentive compensation plan should be compatible with other salesperson-focused effectiveness drivers (such as hiring and training programs, performance management systems, sales force motivators, and the sales force culture).
- Consequences: The incentive compensation plan, jointly with the other sales force effectiveness drivers, should produce the desired consequences for the downstream components of the system (salespeople, sales force activities, and customer and company results).
Plan Design Part 1: Determining the Correct Pay Level
- Determine the average target pay for the position
- Pay can be lower when the work offers intrinsic rewards: (a) is interesting (b) is done in an enjoyable environment (c) offers skill development (d) provides formal recognition for achievement (e) promises career progression
- Pay must be higher when (a) there is strong labor market demand for the given position (b) the salesperson pays a substantial role in demand creation – hunters typically make more than farmers
- Most firms benchmark sales compensation externally once a year with specificity on (a) industry (b) company size (c) sales role (d) geography (e) performance ranking
- Gather information about pay levels through recruiting and exit interviews
- Determine the pay variation across different performance levels and tenures
- Median pay variation: (a) low performers = 0.67x (b) average performers = 1.0x (c) high performers 1.63x
- Most firms have a single national pay level range with local market variations
- If undesired turnover of strong performers is high, increase the compensation of top salespeople. While not always appropriate, top performers (2 sigma or top 5%) should earn 3x variable pay.
- It is normal to have variations in pay due to tenure even for AEs at the same level.
- To encourage teamwork among salespeople, if desired, then craft a plan with less variation in pay across salespeople
- All other things being equal, a greater variation in pay will result in a higher turnover of both high and low performers.
- Budget their total sales force costs to a percentage of sales. The U.S. average is 6.8% though some industries spend up to 20%+.
Plan Design Part 2 Finding the Best Salary–Incentive Mix
- The pay mix decision affects which salespeople will be attracted to the firm, as well as the motivation of salespeople, who carry out the sales force activities that in turn affect customer results and ultimately influence company results.
- The primary drivers leading to higher incentive pay mix are (1) well-defined, short sales process (2) clear job role (3) results measurability – accuracy and timeliness (4) high causality with a good estimate of “free sales.” (5) low market volatility (6) lower salesperson focus on customer service/satisfaction – sales incentives for customer satisfaction are rare (7) significant variation in salesperson performance since high incentive pay mix helps retain top people and lose bottom ones (8) a separate service delivery/customer success organization.
- Median salesperson pay from incentives is 40% and varies by role, even within the same company. Low incentive plan is less than 20%. Moderate incentive plan is 20 to 50 percent. High incentive plan is 50% or greater. Non-incentive control mechanisms have little impact above 30%.
- A 100 percent commission plan attracts self-directed, ambitious, results-oriented, and highly motivated individuals. Plans with 100% variable pay usually offer a safety net for new salespeople to allow fair compensation while learning the job.
- A salary only plan is appropriate when it is paramount to direct salespeople toward activities (problem-solving, training) which support long-term customer interests.
- Incentive plans that tie earnings to specific salesperson activities are generally most effective when used for only a short period of time.
- Salary rewards salespeople for (a) developing knowledge and skills (b) attitude (c) pre- and post-sales activities. Incentives typically reward salespeople for accurate and objectively measurable results such as sales, sales growth, etc.
- An effective way to neutralize territory inequities is to have a goal-based plan with goals that account for differences in territory opportunity.
- A culture that is customer-centered, team-oriented, and focused on long-term success is compatible with a pay mix with a high proportion of salary.
- Team selling is common in sales forces with broad, complex product lines, where a single salesperson is unable to perform all the necessary selling tasks effectively. It is also common in sales forces that cover large national or global accounts with multiple locations. Team incentives are often paid into a pool based on the team’s total results. This pool is then divided appropriately among team members based on the nature and content of each member’s role and his perceived contribution to results. Alternatively, some firms double-count sales and give each salesperson on the team credit for the entire sale.
Plan Design Part 3 Selecting Performance Measures
- Keep it simple: Paying on Multiple Measures Leads to Sales Force Confusion. At most, use 3 (rarely 4) total measures. If the plan cannot be summarized on a business card that fits into a salesperson’s wallet, it needs to be simplified.
- To compensate for differences across sales territories, companies frequently set territory-specific goals and base incentive pay on goal attainment (i.e. performance to quota rather than commission).
- When launching new products (1) First, pay on activity to drive trial (2) Then pay commission from the first dollar. Once a product is mature and sales are forecastable, switch it goal-based quotas rewarding retention and profitability.
- A territory sales metric says to the sales force, “Sell!” while a gross margin metric says, “Sell profitable product lines at the highest possible price.”
- Metric focus is the emphasis or level of aggregation. For instance, one may focus attention on products – new and/or high margin. Or, one may focus on market segment – paying higher incentives on new accounts. Or channel – direct versus indirect.
- It is OK to have individual product goals but pay accelerators, if any, on combined attainment.
- To reduce claw-backs in year-to-date performance-to-quota based plans with quarterly commissions, some companies hold-back a percentage of commissions until the end of the year.
- Almost all sales incentive programs tie the majority of sales force incentive compensation to company results metrics. Company results metrics include sales or sales growth (88% of companies), gross margin (23% of companies), and market share (14% of companies but difficult).
- Common customer results metrics include customer satisfaction, customer retention and repeat rates, and customer returns or complaints. Warning: 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. Under 8 percent of salesforces reported the use of customer satisfaction as an incentive pay determinant.
- Examples of activity metrics include calls per day, customer reach and frequency, and the number of demonstrations, proposals, or service calls. Only 15 percent of sales forces reported using activity metrics as a measure for determining incentive pay. However, many companies use activity measures to enhance their performance management system.
- Metrics can be absolute-level (ex: sales dollars), goal-attainment (82% of companies; ex: % sales quota achievement), or comparisons (stack ranking; etc.). Absolute level and most comparison metrics are most appropriate when (a) territories are equal potential, or (b) reliable forecasting is difficult such as during introduction of a new product. Forced ranking should be used with caution since they generate a lot of internal competition; ranking components should be <15% of total pay.
- An aggressive management team can demoralize a sales force if it asks salespeople to achieve unrealistic sales goals.
- Salespeople tend to dislike group incentives if the “team” consists of salespeople who work individually with their own customers but who happen to report to the same unit.
- As a general rule, an incentive plan should pay incentives as frequently as is possible without compromising customer focus, generating excessive administrative overhead, or making the award size trivial. The most common frequencies of incentive payout are monthly and quarterly. With goal-based plans, less frequent payment allows more time for goals to drive behavior, and less time is consumed by the difficult and resource-intensive task of goal setting.
- Forecast accuracy metrics are especially useful when the company relies on the sales force forecast to set its production and manufacturing requirements.
Plan Design Part 4 Determining the Right Performance–Payout Relationship
- Decision 1: Bonus Plan, Commission Plan, or hybrid? Use Commission Plans when Short-Term Sales Force Causality Is High. Use Bonus Plans when Considerable Management Flexibility Is Needed. Tie Payout to Territory Goal Attainment when Sales Territories Have Unequal Potential
- Decision 2: Linear, Progressive, or Regressive payout curve? If “make the plan easy to administer” and “prevent undeserved sales timing behavior” are primary objectives, then a linear plan is preferred. If “increase sales force motivation” and “reward top performers” are primary management objectives, then a progressive plan is the best option. If “provide cost protection when there is significant demand uncertainty” or “moderate demand when capacity is tight” are primary objectives, then a regressive plan is preferred; salespeople dislike regressive plans.
- Decision 3: Caps or No Caps? 24 percent of companies placed some sort of cap on incentive plan earnings; caps are more common in startups. Income caps have an advantage in volatile markets, where it is difficult for management to predict future demand accurately. To mitigate the adverse effect of caps on sales force motivation, consider adding a special discretionary bonus such as a “President’s Award” to a capped plan.
- Decision 4: Pay from the First Dollar/fraction or from a threshold?
- Decision 5: Single Measure or Multiple Measures? Aggregate Plan Measures Whenever Possible. Occasionally, plans require simultaneous achievement of subgoals, referred to as qualifiers. A point-based plan is one way to integrate diverse measures into single plan.
- Adapt Performance–Payout Strategies for Volatile Markets. If commission rates are revised regularly while managing stable target earnings, salespeople get used to such changes.
Evaluating Proposed Sales Incentive Compensation Plan Alternatives and Selecting a New Plan
- Selling every other period is a common concern with plans that restart every period and have accelerators at goal. This behavior needs to be managed if this type of plan is adopted. A plan paying on cumulative goal attainment can moderate the sales-timing behavior.
- No single incentive plan can solve every sales management problem.
- The incentive plan design process begins with an assessment of the current (or incumbent) plan to identify shortcomings or gaps that need to be remedied in order to adapt to changing conditions and improve the sales organization.
- During plan structure changes, evaluate: (a) Who gets helped/who gets hurt (b) how the plan will get ‘gamed’ in desirable and undesirable ways (c) impact on customers (d) alignment with company strategy
- Incentive plan designers must accept the fact that their plan will not be universally liked by everyone. It is especially important to consider the preferences of the better-performing salespeople in the organization.
- Plan administration costs typically add 2 to 15 percent to total incentive compensation costs.
Setting Effective Goals and Objectives
- Sales leaders employ two important and complementary sales force effectiveness drivers to manage goal achievement: sales incentives (esp. for company & customer results) and sales performance management (esp. for activities & behaviors).
- Many sales forces use a KPI (key performance indicator) or an MBO (management by objectives) approach, in which each salesperson works with her manager to set specific capability and activities objectives for skill development and effective activity focus.
- Motivational research shows that people who are given specific, challenging, yet realistic goals consistently outperform those who are not given any goals or who are given vague goals such as “do your best.”
- Systematic padding of sales forecasts from the top down resulted in unrealistic goals for the sales force.
- In selling situations with low levels of free sales (for example, in competitive commodity markets), setting goals based on last year’s sales penalizes salespeople who have high sales already, particularly if differences in market potential between territories are not accounted for.
- When activities goals are tied directly to monetary rewards, they often motivate an increase in the quantity of the desired activities but a decrease in the quality of those activities.
- The best goal-setting processes incorporate elements of both centralized/top-down and decentralized/bottom-up goal-setting approaches.
- A “payout calculator” to compute their incentive payout for different goal achievement scenario can be very motivating.
- Many sales organizations that allow midyear changes to goals limit the number and scope of changes by having policies and approval processes that limit changes to the most compelling situations.
- Contest Generates Sales Force Excitement When Goal Is Out of Reach
- In Volatile Business Environments and with new products, Goals with Short Time Frames, Broad Payout Ranges, and Earnings Caps Are Appropriate
- For products in the high-growth stage of their development, growth in sales or market share is a good measure for goal setting. For companies that are attempting to maintain and penetrate existing customers, goals stated in terms of customer service, customer satisfaction, and revenue growth are appropriate. In mature markets with limited growth opportunity, profitability must be watched carefully. A company sacrifices profits if it generates too many sales at a reduced price. Territory goals focused on profitability work well.
Increasing Sales Force Motivation Through Sales Contests, SPIFFs, and Recognition Programs
- 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.
- Research has identified five universal motivators that explain what drives salespeople: the need for achievement, social affiliation, power, ego gratification, and survival.
- Too many additional incentives can confuse salespeople or divert sales force attention from strategically important products, customers, or activities.
- A typical sales contest or SPIFF lasts not more than a few months and focuses on specific products, customer types, or sales activities.
- Recognition programs typically reward performance over a longer period of time than a sales contest or SPIFF—usually one year or more.
- SPIFFs and sales contests are much less effective in environments that have high free sales—that is, in environments with high carryover sales or long selling cycles, or where other factors besides current sales force effort, such as brand name and non-sales force marketing instruments, have a large impact on sales.
- The best performance measures for sales contests and SPIFFs are: (a) Consistent with business strategy (b) Objectively and accurately measurable (c) Directly affected by the sales force (d) Fair
- Sales contests with high award desirability and a reasonable chance of winning (10% to 15% of salespeople) are most effective.
- Activity awards can spark new product sales.
- 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 (President’s Club or right to serve on an advisory council to the company’s top executives).
- In large sales forces, recognition is usually limited to the top 5 to 10 percent of the salespeople. In smaller sales forces, the percentage is slightly higher, usually 15 to 20 percent.
- Include special short-term features in the incentive plan during good years, such as special sales contents, SPIFFs, or incentive trips.
Making an Effective Transition with a Major Incentive Compensation Plan Change
- A company that changes its sales force incentive plan frequently is likely to face less sales force resistance to any change than a company that rarely alters its plan.
- When cutting sales force pay, be prepared to lose some salespeople, particularly if the pay cut makes the firm’s sales force pay scale less favorable than that of other firms in the industry.
- It is easier to cut incentive pay than it is to cut salary.
- Significant mix changes are usually driven by changes in sales force causality,
- A salesperson may end up owing the company money if her performance does not meet expectations. Draws can be costly and difficult to administer. Draws can dilute the motivational power of incentives.
- Consider testing your communication materials and training process with a pilot group of salespeople and/or first-line sales managers prior to finalizing the content.
- Ask first-line sales managers to conduct the new plan training sessions for their salespeople.
Incentive Compensation Plan Administration
- IC 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.
- It is often advisable to make desired managerial adjustments outside the formal IC administration systems rather than burdening the systems with nuances that threaten accuracy and timeliness.
- Companies usually have special rules for dealing with midplan changes in employment (for example, new hires, terminations, deaths, or retirements) and midplan changes in job responsibilities (for example, transfers or promotions, temporary assignments, leaves of absence, sickness or disability, or sales territory changes).
- Policies and procedures: sales crediting, order returns or cancellations, and sharing credit among multiple salespeople
- Scorecards are the regular reports provided to salespeople tracking their performance and payouts.
- Plan Health Reports. The focus of plan health reports is to provide sales leaders and incentive plan designers with timely information for assessing whether the plan is doing what it was designed to do, and at the same time not producing undesirable side effects such as unfair payouts.
- General-purpose tools (like Excel) usually work best for small to medium-sized sales forces (typically less than 100 salespeople) with low to moderately complex IC plan administration needs.
- Some firms manage their IC administration exclusively with in-house staff, while others use partners extensively.
- Analytically test new sales incentive plans prior to implementation
- Most companies fine-tune their incentive compensation plans at least every year and make major changes to those plans at least every two to three years. The decision to change a sales incentive compensation plan is never taken lightly, as it can have a significant impact on customers, salespeople, and company performance.
Reviewing a Current Incentive Compensation Plan and Setting Objectives for a New Plan
- Test A: Sales Force Attraction and Retention Statistics: Does the Current Plan Attract and Retain the Best Salespeople?
- Test B: External and Internal Benchmarking: Is the Current Plan Competitive?
- Test F: Analysis of the Relationship Between Incentive Pay and Performance Evaluation Ratings: Does the Current Plan Reward Performance?
- Test H: Sales Tracking Analysis: Does the Current Plan Motivate a Sufficient Quantity of Sales Force Activity?
- Test I: Time Allocation Analysis: Does the Current Plan Direct Effort Appropriately?
- Test J: Engagement and Excitement Decomposition: Does the Current Plan Direct Effort Appropriately?
- Test K: Evaluation of Plan Complexity: Does the Sales Force Understand the Current Plan?
- Test L: Customer Input: How Does the Current Plan Affect Customer Results?
- Test M: Cost Analysis: Does the Current Plan Cost Too Much?
- Test N: Qualitative Diagnosis: What Is the Role of the Incentive Plan in Delivering Company Results?
- Test O: Check for Consistency with Corporate Strategies.
- Test P: Check for Consistency with Sales Job Definer Decisions. A compensation plan that does not align well with the firm’s sales job definer decisions, including sales strategy, go-to-market strategy, and sales force design, sends mixed signals to salespeople and may not encourage the right sales force activities.
Plan Design Fundamentals
- Total pay = (a) base salary (b) target incentive (c) excellence incentive
- Leverage multiple = (total incentive paid to a top 10% performer) / (target incentive)
- Sales force causality (aka prominence) = ability of a sales person to affect results through skills, capabilities, motivation, and effort.
- Usually, a pay plan with a large variable component will have greater upside opportunity but lower guaranteed earnings
- Free sales = Franchise sales (sales that can be attributed to non-sales force factors, such as dominant products, effective branding, competitive pricing, and effective advertising) + Carryover sales (sales that result from prior years’ sales force effort)
- Random sales are sales that come in unexpectedly and require very minimal sales force effort relative to their value. Random sales can also be negative.
- Performance management = ongoing planning, coaching, measurement, communication, coordination, evaluation, and course-correction
- Engagement Rate = what percentage of a sales force receives incentive pay with a plan.
- Excitement Index = the rate at which salespeople earn their last incremental incentive dollar
- Guiding principles include: (1) Understanding – simplicity; communication (2) Fairness (3) Motivation (4) Budget
- In a successful sales management system, the incentive compensation program works together with sales force hiring and training programs, performance management systems, sales information systems, sales force culture, and other sales force motivation programs.
- Salespeople typically start pricing discussions with the preauthorized 20 percent discount and then push their managers for deeper discounts.
- A common bias is that a salesperson with high achievement one year is saddled with an even larger goal the following year, creating a consistent pattern of high achievement one year followed by low achievement the next.
- Cisco salespeople receive equal compensation, regardless of whether sales go through the channel or direct to the customer
- Focused sales objectives (FSOs) reward salespeople for strategic, nonrevenue accomplishments, such as engaging with a new business partner to develop a customer proposal, improving customer satisfaction, or increasing sales on a specific product line.
- The best incentive plan from the customers’ perspective is one that encourages salespeople to engage in behaviors that meet customer needs. The best plan from a salesperson’s perspective is one that is easy to understand, is fair, and pays good money for reasonable work. The best plan from a company standpoint is one that produces the desired results, retains good salespeople, and helps the firm accomplish its corporate objectives.
- Non-compensation plan reasons for underperformance: (a) not enough sales capacity (b) poor sales structure – ex: using hybrids when acquiring new business and renewing business require differing skills (c) hiring the wrong people (d) poor training (e) lack of data & tools (f) territory definition & alignment problems (g) weak managers (h) a weak sales force culture.
- 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.