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how to create a compensation plan

7 Steps to Develop an Effective Sales Compensation Plan

Did you know that the average sales rep turnover for companies is 35%? That’s 23% higher than the average for all other industries. That’s a staggering number which shows that, in sales, it’s extremely hard to attract and keep the best talent. That’s where an attractive sales compensation plan with the right on-target earnings (OTE), quotas, and transparency come in.

The thing is, in the world of sales, you could be the best manager in the world, but sometimes that's still not enough. Employee job satisfaction is also about the company, culture, and making sure your team members are happy, engaged, and motivated.

The sales compensation plans mentioned earlier are the best way to ensure this. In simple terms, they tick all the boxes mentioned above. In other words, they keep sales reps motivated, engaged, and satisfied.

In turn, this translates into better performance and gives your company the ability to generate more revenue.

But what is a sales compensation plan, and what goes into designing an effective one? In this post, we’ll look at these questions in more detail and we’ll show you how to create a compensation plan that will motivate your sales reps to perform better and prevent you from losing the best talent.

What is Sales Compensation

Before looking at these steps in more detail, it’s important to understand what sales compensation is. Broadly speaking, sales compensation is the total amount of money that you’ll pay your sales reps per year.

In other words, broken down, sales compensation is the combination of base salary, commissions, and other incentives like bonuses you offer to your sales reps. So, it's the incentive for certain outcomes, the reward for specific behaviors, and the satisfaction of a job well done at the end of every quarter.

compensation philosophy

With that in mind, a competitive compensation plan should encourage high performance, or, in other words, your sales reps to meet or exceed their sales quotas.

Keep in mind, though, that there's no "one-size-fits-all" approach to developing effective sales compensation plans. This is simply because every company differs and has different goals,

needs, and requirements. As such, a sales compensation plan should:

Align.

Align with your company’s goals and sales roles. In other words, it should be specific to what you want to achieve and your sales reps’ roles and responsibilities in your company.

Be competitive.

To attract and retain the best talent, your sales compensation plan should be competitive compared to other similar businesses in your industry and in the way it differentiates between top-performing and underperforming reps.

Motivate.

Motivate your sales reps. The unlimited goal with your plan should be to incentivize your sales reps to motivate them and drive them to perform better. In this way, they’ll be more productive, and you’ll be able to generate more revenue.

Be clear.

It’s vital that your sales compensation plan is simple and clear enough for your sales reps to understand your company’s goals, their sales quotas, and the benefits they’ll get if they meet their targets.

Considering the above, there a quite a few things you need to consider when developing your plan. As a result, it can be a challenging and complicated process to determine the right plan for you.

With that in mind, here are our seven key steps in designing a sales compensation plan that will stop you from losing talent and prevent sales reps from underperforming and missing their quotas.

compensation planning process

Step 1: Identify your company objectives and values

As mentioned earlier, your sales compensation plan should align with your company’s goals and sales roles, which means that determining your goals is a crucial step in developing your sales compensation plan. In turn, setting your goals will show you what aspects in your company to focus on and develop incentives that will allow you to reach these goals.

Typically, these goals could include:

  • Increasing sales for specific products.
  • Increasing your customer retention rate.
  • Increasing the customer lifetime value of your customers.
  • Lower your company’s expenses.
  • Growing your company’s revenue.

Once you’ve identified your company’s goals, write them down. Here, you’ll write down both short and long-term goals for your team and company.

Based on these goals, you’ll then be able to see what products and services you want to focus on, identify your ideal customer profiles and industries, and profitability goals. Finally, you’ll understand how much and what type of sales talent you will need to meet those goals.

compensation program

Step 2: Define concrete actions and behaviors

Once you’ve determined your goals and objectives, you should align each company objective with a desired action and outcome. By doing this, you’ll be able to identify which behaviors you want to encourage, reward, and see repeated. It also gives you the ability to eliminate behaviors that do not contribute to your company’s profitability.

For example, considering the goals we mentioned about, you could implement specific additional incentives for every product sold if you want to increase the sales of a specific product. Likewise, when focusing on increasing repeat business or increasing the lifetime value of every customer, you could offer tiered incentives for future products bought by the same customer.

Ultimately, by aligning your business goals with actions, you're creating a system that reinforces and rewards positive behaviors.

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Step 3: Equip the plan with basics

Every sales compensation plan requires three components, base pay, variable or incentive pay, and the pay mix. You should use data to calculate and forecast these numbers and let your team know where these numbers came from. One of the best ways to do this is by determining the on-target earnings or OTE. This is the total amount of compensation you’ll pay your sales reps provided that they meet their sales quotas.

Determining the OTE 

Now, how do you determine the OTE?. The most important consideration when determining the OTE is what a competitive market compensation for your industry is. If it isn’t, you’ll struggle to attract and retain the best talent.

Although this could be challenging to determine, websites like Glassdoor can give you the salary range at similar companies in your industry. This can then be a great starting point from where to determine your OTE. From here, you should then adjust the OTE either up or down depending on your specific market, the products your selling, and the experience required for the role.

The key in determining the OTE is finding the right balance. In other words, you should avoid either overpaying or underpaying. If you overpay, your customer acquisition costs could be too high. Conversely, if you’re underpaying, it could lead to low morale and poor performance. In turn, your bottom line will suffer, and your sales rep retention rates will plummet.

Determining the Pay Mix

Once you’ve determined the OTE, you’ll need to determine the pay mix. This is the ratio of base pay to variable pay in the total compensation. To illustrate how OTE works, let’s look at a simple example.

Let’s assume that you offer your sales reps an OTE of $90,000 per year with a pay mix of 70:30. This means you’ll pay your sales reps an annual base salary of 70% of their OTE and a commission of 30% of their OTE. As a result, you’ll pay them a base salary of $63,000 and a commission of $27,000 per year if they hit their targets. 

Like OTE, it’s crucial that you get the pay mix right. This is because it determines the amount of risk involved for sales reps in earning their OTE. So, if the ratio leans too far towards variable pay, the risk for sales reps will be too high, or, in other words, they stand to lose too much if they fail to meet their targets.

It goes further than this, though. If your base salary is too low, it will impact your sales reps’ morale, their motivation will drop, and their performance will suffer. Conversely, if your base salary is too high, your sales reps’ motivation will decrease because they won’t have a large enough incentive to keep them motivated.

To determine the pay mix, you can also consider the average pay mix ratios used by similar companies in your industry. Based on these averages, you can then adjust your pay mix based on your products, the complexity required to sell the products, sales cycles, and your sales reps’ experience.

Ultimately, if you get the OTE and pay mix right, it’s an excellent tool to motivate your team and can determine the level of talent on your sales team. 

job descriptions

Step 4: Decide when to provide compensation

Once you've determined the OTE and pay mix, you’ll need to determine when you’ll compensate your sales reps in terms of your sales compensation plan. Here, the idea is to reward your sales reps as quickly as possible.

This is simply because the sooner you reward them, the more motivated they'll be to perform. In addition, if they know they'll be rewarded soon after reaching a goal or closing a sale, they'll be more excited about and satisfied with the compensation plan.

Keep in mind, though, while quicker is better, this approach isn't always possible. This is because it depends on your industry, your products, your company's size, and your team.

For example, if you sell products with long sales cycles and complex sales journeys, it would typically not be possible to implement faster payouts. Likewise, the frequency of your payouts will, to some extent, also depends on how long the period during which you assess your sales reps’ performance is.

Ultimately, you should find the approach that works best for your company and its specific requirements. However, as a guideline, standard commission payouts may vary from monthly to quarterly, or even bi-yearly.

You should always remember, though, that the longer the wait between closing a deal and receiving the commission decreases satisfaction and leads to higher employee turnover, underperformance, and lack of motivation.

employee compensation

Step 5: Pick your payroll software

If your company already uses payroll software, this should be easy to implement and start using. If not, you should find and implement payroll software that can help you compensate your sales reps. Fortunately, there are many options available on the market that you can choose from.

The key is that the payroll software you choose, should:

  • Automate tax calculations.
  • Ensure paycheck accuracy.
  • Eliminate errors and miscalculations.

Ultimately, the right payroll software must make your life easier without requiring you to spend hours learning how the software works. So, the goal is to stay away from manual entry into spreadsheets and other time-consuming data entries that can lead to errors or data loss.

pay grades

Step 6: Establish expectations for compensation

Your next step is to set your sales reps’ quotas or targets. Now, you can develop quotas with top-down or bottom-up target setting, and you could set them separately for sales reps individually or for the whole team. The important thing is, however, that you communicate with them often, so your team knows what's expected of them and how they can maximize the compensation plan.

More importantly, though, is that you set the right quotas. If you don't, it could have the opposite effect of what you want to achieve or, in other words, it could make your sales reps less productive.

For example, if your quotas are too high, it could decrease your sales reps’ motivation, morale, and performance. Also, when quotas are too high, your sales reps will discount them accordingly. This means they'll calculate their earnings on not hitting their targets. In contrast, if your quotes are too low, most of your sales reps will achieve them with ease and you'll likely overpay for performance. 

Considering the above, the key when determining your quotas is that they are achievable by most of your sales reps. This will then serve to motivate those sales reps who fail to achieve their quotas while, at the same time, rewarding those that do.

The question is how do you find the right quota? Like with determining your OTE and pay mix, industry averages are a good starting point. Once you have the average for similar companies in your industry you can use it as a baseline and adjust your specific quota from there.

fair compensation plan

Typically, you can do this by using your sales reps’ historical performance. For example, if your sales reps, on average, made more sales historically compared to the industry average, you can adjust the baseline figure up. Keep in mind, though, that you might need to adjust your quota based on current market conditions. 

If you don't have any historical data available, you can consider using the baseline on a quarterly basis and then adjusting throughout the year as more data becomes available. Over time, this will give you an idea of a quota that's achievable by most of your sales reps.

Another consideration when it comes to setting quotas is the implementation of sales accelerators and thresholds. Accelerators involve paying sales reps higher commission rates once they exceed their quota. In contrast, thresholds are minimum performance levels below which your sales reps will not earn any commission.

These strategies allow you to maximize the performance of your high-performing sales reps while, at the same time, motivating your underperformers to perform better.

The key takeaway here is that your quotas should be extremely detailed and well-defined. Here, it’s also a good idea to legally review your compensation terms so that there's no unnecessary tension or conflict down the road. This ensures that your sales reps know what is expected of them and what they need to do to achieve their quotas.

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Step 7: Remain flexible

Once you’ve followed all the steps above, you’ll be able to implement your sales compensation plan. Before you do, however, there’s one important thing to remember.

As mentioned earlier, for sales compensation plans to be effective, they must be tailored for different sales roles, experience, and industries. Remember, the sales compensation strategy is designed to increase desired outcomes by rewarding certain types of behaviors – not deter or scare people off.

That means you’ll need to consider how each unique team member's perspective and experience impact their performance and adjust your plan accordingly. Here, it’s also important to make sure your team knows that you're dedicated to finding a plan for everyone.

comprehensive compensation plan

Benefits of Having a Sales Compensation Plan

Now that you’ve seen how you can develop and implement your own sales compensation plan, the immediate question is what your company can gain if you implement it. In simple terms, what are the benefits of having a sales compensation plan?

More Structure in Your Team

A well-developed sales compensation plan is an excellent way to create more structure in your team. This structure, in turn, allows your sales reps to see on what basis you differentiate between different levels, and how you compensate them based on the level they are.

As a result, they’re able to see that there are opportunities for them to advance in the company and what they’ll be able to earn if they advance. This makes them less likely to leave and improves your sales rep retention rates.  

Increased Motivation

When your sales reps can see exactly what they’ll earn, they’ll be more motivated to sell more products. And when they’re motivated to sell more products, they’ll perform better, and your company will be able to generate more revenue.

It doesn’t stop there, though. If you include other incentives in your compensation plan like, for instance, incentivizing education, they’ll be motivated to attend and complete additional training, which, in turn, will make them more effective at selling.

job analysis

More Engagement

Sales have historically been one of the industries with significant employee turnover rates. One of the solutions to this problem is to increase engagement among your sales reps. In fact, it’s estimated that about 70% of Americans aren’t engaged with their jobs. And where sales reps are disengaged, it leads to lower sales numbers and overall morale.  

When you introduce a well-developed sales compensation plan where they’ll be able to see how they perform and how much they can earn, you’ll be able to increase their engagement. It’s also possible to incorporate other strategies into your sales comp plan to achieve this. These include everything from competitions with added rewards to incentivizing them with other non-monetary benefits.

This will, ultimately, ensure that you keep engagement and morale up, which will not only allow you to increase your sales but also your sales rep retention rates.  

Increased Sales

Increased sales are probably one of the main reasons why should consider developing and implementing an effective sales compensation plan. It’s easy to see why when you consider that sales comp plans have been proven to increase sales and, by implication, company revenue.  

This is based purely on the fact that, by implementing a sales compensation plan, you’ll be able to increase motivation and engagement. In simple terms, if sales reps can earn more when they’re able to meet their targets, they’ll sell more.

Better Planning and Budgeting

One of the keys to your company’s success is effectively managing its finances. A well-developed sales compensation plan allows you to do this. This is because it gives you the ability to know exactly how much you’ll pay every sales rep. It also allows you to see exactly how much your company earns based on your sales teams’ performance.

This, in turn, gives you the ability to plan and budget better which means your company’s finances are always under control.

basic compensation plan

What’s Next?

For your company to generate more sales and be successful, it's vital that you maximize your resources and support your sales team.

If you do, your goals will be met as quickly and efficiently as possible.

One of the best strategies to do this is an effective sales compensation plan that allows you to motivate your sales reps, increase their performance, and make more sales. However, developing a sales compensation plan can be challenging and, for it to be effective, there are several things you need to consider.

That's why Performio developed easy-to-use sales commission software. Your sales reps will receive timely, easy-to-read reports and leader-board rankings, so they're motivated and performing at their best.

Best of all, Performio is so easy to use - sales reps will be able to understand how it works without any additional training. And you won't have to worry about processing late or incorrect compensation payments.

A SaaS-based system, Performio has saved more than 500,000 administrative hours and calculated more than a billion dollars in commissions. Request a tailored sales commission software demo today and see how we can help your business.

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Our demos, like our commission software, are customized for you and your business.

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