Like Alec Baldwin famously said in one of the greatest sales movies of all time, "We're adding a little something to this month's sales contest. First prize is a new Cadillac… Second prize is a set of steak knives, third prize is you're fired!" Incentive compensation plans have come a long way since the Glengarry Glenn Ross sales era. While depicted very bluntly and somewhat harshly, there is something to be said about the intense, competitive atmosphere whose close partner is always on-target earnings models.
On-target earnings (OTE) is a popular compensation model that companies use to pay and motivate salespeople. Also known as “on-track earnings” or “on-target incentive,” OTE represents the total compensation a sales rep can expect to earn. OTE combines both fixed salary and variable commissions, giving employees a clear idea of their total earning potential.
When done right, an OTE model will keep your sales force motivated and your commissions expense forecasts accurate.
To help you get a handle on how OTE models work, this guide covers:
- What OTE means in sales
- Benefits of using an OTE model
- Potential pitfalls of using an OTE model
- How to calculate OTE
- How to set up your OTE model
What is OTE in sales?
On-Target Earnings (OTE) refers to the total expected annual pay for a sales role, combining a fixed base salary with variable commission. OTE represents the earnings if a salesperson hits 100% of their sales targets. Determining your OTE model is a key component of creating your sales compensation plan.
The subject of OTE usually comes up in conversations around hiring salespeople. It’s common for hiring managers to list OTE in sales job descriptions to give hopeful candidates an idea of how much money they can expect to earn if they win the role.
For example, a candidate might apply for a sales rep role with a listed OTE of $100,000. During the interview process, the candidate might find out that the role’s base salary is actually $75,000—but if they hit their sales quotas, they can expect to make an additional $25,000 in commission. (And if they exceed their quotas, they could earn even more.)
Benefits of using an OTE model
OTE is used to properly compensate or reward sales reps for hitting their quotas, and it comes with a number of advantages.
Boosts motivation and productivity
One of the biggest benefits of OTE is increasing employee engagement, motivation, and participation. By providing sales reps with a transparent view of their potential earnings based on realistic efforts, OTE motivates them to strive for their targets, improving engagement and performance.
It taps into the psychological principle known as loss aversion, which posits that people are particularly motivated to avoid losing something they already have. Since OTE is presented as expected earnings, sales reps will be highly motivated to ensure they don’t miss out on any part of what they should be able to earn.
A good sales commission OTE that is easily achievable can create brand ambassadors and long-term employees. If your organization struggles to improve productivity, establishing a new OTE could make a substantial change.
Aids forecasting and budgeting
OTE is a powerful tool for forecasting compensation costs and sales revenue. Its structured framework allows businesses to plan budgets more accurately, predict commission expenses, and forecast revenue based on past performance.
By calculating the OTE based on historical data, organizations can estimate how many sales their team is likely to close. This helps to create revenue forecasts, and allows businesses to make strategic decisions, such as scaling operations or entering new markets.
OTE also allows companies to predict maximum potential payout for commissions, helping to allocate funds appropriately. This reduces the risk of unexpectedly high compensation costs due to outperformance or poorly structured commission plans.
Attracts talent
OTE is a great way to simplify even complex plans, giving job seekers an easily understandable figure to base their decisions on. Assuming you’re able to offer a competitive OTE, this makes for an attractive offer for prospective hires.
This is especially true in comparison to other positions which (intentionally or unintentionally) obfuscate the earning potential, requiring job seekers to wade through tedious details in order to get an idea of how much they can expect to make. By contrast, OTE offers a level of openness and transparency that can promote trust in your organization—assuming the OTE is accurate
Potential pitfalls of using an OTE model
While OTE can be an effective tool when used appropriately, the issue is that organizations don’t always use it appropriately. And this misuse of OTE can cause serious problems. Here are the three main pitfalls to avoid.
Inflating OTE to attract talent
The OTE you use to promote a position should always be based on an honest evaluation of the realistic amount a sales rep can expect to earn. Unfortunately, hiring managers have at times been known to inflate OTE numbers in order to make the position sound even more appealing.
This practice may be effective at getting new sales reps in the door, but it isn’t a sustainable strategy. It won’t take long for reps to realize that OTE they were promised isn’t actually achievable. When reps realize their OTE is unattainable, it causes frustration, loss of trust in the company, and low morale, often resulting in high turnover rates.
Treating OTE as a stretch goal
Your OTE numbers should represent what a sales rep can realistically expect to earn with a reasonable amount of effort. Stretch goals, on the other hand, are intentionally more difficult to reach, requiring a much greater amount of effort to reach—and thus being rewarded with a greater amount of compensation.
Setting OTE to a stretch-goal level of effort is just another disguised way to inflate the OTE, and it will result in similar levels of burnout, frustration, and high turnover. OTE should be the baseline that was promised, and stretch goals should exist to motivate sales reps to push beyond OTE levels of earning.
Lowering OTE after hiring
Another tactic some hiring managers use is to advertise an OTE based on realistic performance numbers, but then simply lower the OTE after a position has been filled. This is nothing more than a bait-and-switch, and it essentially amounts to a demotion the moment a new hire walks in the door.
Although there are some legitimate reasons why OTE may at times need to be lowered, these situations should be avoided unless absolutely necessary, and then they should be approached with transparency and collaboration. Otherwise, it’s sure to infuriate sales reps and lead to poor retention.
How to calculate OTE
To calculate OTE, add the yearly base salary to the commission a salesperson would earn at 100% of their sales quota. The formula is straightforward:
[Base salary] + [Commission at 100% quota] = OTE
Calculating OTE gets more complicated when you start looking at all the different ways that commissions are assigned. For example, a sales rep in SaaS might earn a 10% commission rate for new customer accounts and a 2% commission rate for any professional services sold on top of the SaaS subscription.
Payment periods can complicate OTE calculations, too—you need to account for when these commissions are considered “earned,” when they’re paid out, and when you balance for attrition (such as a new customer that unexpectedly terminates their engagement).
Guidelines for setting up your OTE model
Sales comp administrators and stakeholders who want to determine the best course of action for a sales role’s OTE should consider a few general guidelines.
To start, it is usually a good idea to base the OTE on approximately a fifth of the total annual sales quota. Standard commission rates vary across industries, and your own OTE model should be informed by various factors, including:
- Internal sales processes
- Industry norms and standards
- Sales representatives’ experience
- Sales role popularity
- Revenue goals
- Sales cycle complexity
- Management expectations
Understanding the pay mix
Pay mix is the ratio of base salary to commission: it describes how much of an employee’s OTE is guaranteed (base salary) and how much is dependent on their performance. In the example we used earlier, a sales rep was paid $75,000 as a base salary, with expected commissions of $25,000—which translates to a pay mix of 75/25.
As a general rule, a pay mix of 50/50 is a good starting point. It’s a common mix and provides a good balance between base rate and commission. A high pay mix is weighted more toward fixed income, while a low pay mix is weighted toward variable income. Neither is inherently better or worse than the other—they just appeal to different kinds of salespeople.
A well-balanced pay mix not only helps you project expenses and keep employees motivated—it helps you attract the right kind of salespeople to your company in the first place.
For example, a pay mix of 10/90 means the majority of the employee’s pay will come from commissions. This can be very appealing to people who embrace a “high risk, high rewards” mentality, but it’s going to turn away folks who want a steadier paycheck.
On the other hand, a pay mix of 90/10 communicates a lot of stability, but much lower expectations around commissions. This can be a turnoff for more achievement-oriented candidates.
Determining the pay mix
OTE pay mix can vary from role to role, and it’s usually smart to set pay mixes differently for the various roles involved in the sales process. When determining a role’s OTE pay mix, it’s best to consider these important factors.
Prominence of the sales role
High-risk roles like account executive or new business executives are often more directly responsible for signing new business. Conventional wisdom tells us that these types of roles need a low pay mix (commission-heavy) to encourage a more aggressive approach.
Sales cycle length
If your company has a short sales cycle, a lower mix makes sense: the sales team should be closing plenty of deals in any given period. However, for longer sales cycles, a higher pay mix may be necessary to motivate salespeople to stick with it. (A higher commission percentage is often in order, too.)
Complexity of products and services
The more complex your offering is, the more likely it is you’ll need your salespeople to really understand the industry they’re selling into. Experience and expertise don’t come cheap, so these kinds of candidates will expect a higher base salary.
Ramping up your OTE for new hires
In many sales commission scenarios, reps will need additional time to get the hang of the role. It’s considered good practice for sales organizations to offer sales reps a draw (or pump up their overall commission rate) to compensate for initial low quotas.
OTEs are usually “fully ramped,” that is, the OTE figure doesn’t take on-ramping quotas and payouts into consideration.
Be sure to communicate what this will look like during the hiring process.
Get the most out of your on-target earnings model with Performio’s ICM software
As you can imagine, managing the OTEs of an entire salesforce by hand involves a lot of math and/or a lot of spreadsheets. This is why more sales compensation admins are turning to Performio’s ICM software.
Performio helps sales comp admins easily manage OTE plans, automate their sales compensation processes, and create a more efficient and cohesive sales environment. Performio makes it possible to set up plan permutations out of the box in minutes using the pre-built target and payable components. To date, we’ve saved companies more than a million administrative hours—and calculated more than $2 billion in commissions!
Ready to see what Performio can do for your organization? Request a demo today.