Some of the most common questions we encounter is about OTE or on-target earnings.
It’s easy to see why, as it allows businesses to plan their finances better. Apart from that, it also makes it easier for sales representatives to see how much they’ll be able to earn if they achieve their sales quotas. In turn, this increases their motivation and allows businesses to up their performance, revenue, and growth.
To be most effective, however, there are several vital considerations businesses need to take into account when using OTE in their compensation plans. If they don’t, it could lead to reduced morale, poor performance, and, ultimately, a loss of revenue for the business.
What should you consider when using OTE? In this post, we’ll look at this question in more detail and show you how to create a compensation plan using it.
What Is OTE?
In simple terms, OTE or on-target earnings is the sum of a sales representative’s annual base salary and their on-target commission. In turn, OTC or on-target commission is simply the commission sales reps earn if they reach their sales targets.
In simpler terms, OTE is the total compensation sales employees can expect to earn if they manage to achieve 100% of their targets or quotas. Typically, this quota will be an annual figure, rather than a monthly or weekly number.
Now, that's a lot to unpack. So, to illustrate the concept better, let's look at an example. Let's say you place an ad to find a new sales employee. You intend to pay the employee an annual base salary of $80,000 provided, of course, that they reach their annual sales quota. The job description in your ad will then typically refer to the compensation for the job as “$80,000 OTE”.
In turn, this means, if a sales rep gets the job, they'll be able to earn $80,000 a year. This compensation is then subject to them reaching 100% of their sales targets for that year. Keep in mind, though, that the on-target earnings figure of $80,000 is an approximate number. So, it can, in some cases, end up being larger.
Benefits of Using On-Target Earnings in Sales Compensation
There are several benefits to using on-target earnings in your compensation plan, both for you and your sales reps.
Forecasting Sales Commissions
When using on-target earnings, you'll be in a better position to forecast sales commissions accurately. This, in turn, makes it easier to budget and manage your finances.
Estimating Earning Potential
For your sales reps, using OTE means they can see exactly how much they'll be able to earn if they manage to achieve their sales targets. An added benefit is that, if your OTE is competitive, your sales reps will be more eager to achieve their quotas.
Determining a Realistic Commission Rate
When you use an OTE number that's both realistic and competitive, you'll be able to determine a commission rate that's appropriate. In other words, you'll be able to determine the right base salary for your sales reps.
Using OTE in Your Compensation Plan
Now that we've recapped what on-target earnings is and what its benefits are, it's time to look at how you can use on-target earnings in your compensation plan. There are three important things to consider when you intend to use this incentive compensation structure:
- Setting the OTE. As mentioned earlier, as the sum of a sales rep's annual base salary and on-target commission, OTE is the total compensation sales reps will be able to earn. As a result, you must get this number right if you want to attract and keep the best talent.
- Determining the Pay Mix. This is simply the ratio of base salary to on-target commission. It shows sales reps the degree of risk associated with achieving their OTE. Generally, the higher the ratio, the higher the risk.
- Setting the quotas or sales targets. These sales targets are the goals a sales rep must reach to receive the full OTE as compensation. Here, it's vital that these goals are achievable, otherwise sales reps will discount them accordingly.
Setting the OTE Compensation
As mentioned earlier, to attract and keep the best talent, it’s vital that you get your OTE right. So, the first thing you need to consider is what the market-related compensation is for your industry. This is because sales reps must feel like they’re earning a similar compensation compared to employees at other companies. If they don’t and your OTE is not comparable to other companies in your industry, you’ll struggle to hold on to good sales reps.
Keep in mind, though, there are no hard and fast rules when calculating OTE. So, it will differ based on the market you’re in, the type of products you’re selling, how complex the sale is, and how much experience you want the sales rep to have. Here, a website like Glassdoor can be very helpful. It can give you some insights into what a market-related compensation for the job and your industry looks like.
Another consideration when setting your OTE is that it should be comparable to other sales and non-sales roles in your company. The key here is to ensure that you offer similar levels of pay for similar levels of impact that a specific position has on your company and its profitability.
As a result, you should avoid overpaying or underpaying for sales performance. When overpaying, your customer acquisition costs will be unnecessarily high while underpaying could lead to poor performance, low morale, and reduced employee retention rates. Ultimately, it’s about finding the perfect balance.
Determining the Pay Mix
As mentioned earlier, Pay Mix is the ratio of base salary to the commission payout. This ratio is used to determine what the on-target earnings will be for specific roles. In our experience, OTE plans are on average, 65% base salary and 35% commission, but will differ based on factors like the specific industry or the experience of the sales rep.
However, the most important thing to consider when determining the ratio is the degree to which a sales rep can influence a sale which will, in turn, affect the ratio. For example, if a sales rep, generally, has little to no control over the outcome of a sale, the base salary should make up a bigger portion of the OTE. In contrast, if a sales rep can heavily influence a sale, commission should make up a higher percentage of the OTE.
Setting the Sales Quotas
From a sales reps’ perspective, one of the main considerations for them, when they are evaluating their compensation plans, is the sales quota or target. This is because, to earn the expected total pay, they’ll need to achieve their sales quotas. As a result, a sales quota should be achievable. If not, sales reps will, as mentioned earlier, simply discount them. In other words, they’ll calculate their compensation based on not meeting their quotas.
In our experience, sales quotas should be attainable by about 60 to 70% of your sales reps. This will give most of them the opportunity to earn their OTE while those who don’t will see that it’s possible. In turn, they’ll be motivated to perform better.
On the other hand, if your quotas are achievable by less than 60%, it will have the opposite effect. As a result, overall morale will suffer. In contrast, if it’s higher than 70%, you’ll likely overpay for performance.
Keep in mind, though, like setting the OTE and determining the pay mix, many factors could influence your quotas. Here, most companies start with historical performance and adjust the quotas based on market conditions.
However, this means, for newer products and less mature markets, it could be more challenging to set quotas. Often the best solution here is to set quarterly quotas and adjust them during the year as more data becomes available.
The Bottom Line
Using on-target earnings or OTE in your compensation plan is an excellent way to increase your sales reps’ performance and drive them to make more sales. However, you need to carefully set the OTE, determine the pay mix, and set sales quotas.
Once you’ve done this, you need to calculate the compensation for every employee. And this is where Performio comes in. We automate your sales commission process, so you can spend more time running and growing your business.
We love helping businesses reduce the pain of calculating sales commissions. If you’d like to learn more about on-target earnings or how we can help you, let’s talk. So contact us today to find out more.