If you are wondering how to structure sales commissions for your new venture, this article is for you. Perhaps you are ready to hire your first sales representative and need to figure out what their compensation should look like? Or perhaps you’ve finally hired more than 1 sales representative and must deal with new complexity you’re not quite ready for (such as sales territories, account ownership partitioning, etc.)?
While bootstrapping our fledgling data migration company into a 100+ employee company, my co-founder and I hired many sales representatives. But what I remember most clearly is all the planning that went into hiring our first sales employee. We had to improvise and innovate because we didn’t know what was acceptable (we didn’t have any sales experience) – nor could we predict our growth.
As computer science graduates with a strong preference for logic and algorithms, it was in our nature to ignore common sales wisdom. Therefore, we ended up creating a complex mathematical model called the “contribution ratio“. In short, this model tried to estimate the real contribution made by each salesperson to each deal.
For example, did our sales representative find the customer first, or did the customer find our website? How much correlation was there between sales representative engagement and probability of closing? Should per-deal commission percentages “decay” over time as customers transformed from first-time buyers into recurring buyers?
Our approach was innovative, fair, and logical. It was also somehow bulletproof. No one could game the system and get away with it (for example, by calling a customer after they had made a purchase trying to get credit for the transaction). At the same time, our model was a bit paranoid, hard to understand, and treated with suspicion. Not to mention some cost in terms of implementing the complex logic.
I would not recommend this type of approach (unless you have software engineers with some cycles to spare). Even if you decide you need a one-off approach, there are better ways to streamline sales commissions and automate calculations without requiring developers. One truth remains however – conventional commission structures do not work well in startup environments. Consider the following typical approaches:
- Revenue-based quotas
- Typically, in an early venture, growing revenue is the priority, but the exact trajectory or growth rate is unclear. There often isn’t enough data to reliably predict future revenue and setting realistic quotas is difficult. In fact, hiring your first sales employees is often an experiment in revenue growth.
- Profit-based commissions
- The main advantage of profit-based commissions is that they protect the business from unreasonable discounts. However, in most early ventures, there is no profit, and growing revenue is the priority. And should there be a profit, it means that the venture is so successful that compensating employees based on profit could be a mistake.
So, what are you left with? Many approaches are possible but producer-based payout models can be a great option (until revenue can be predicted). In producer-based models, commissions are based on measuring concrete actions such as:
- Setting appointments
- Giving customer demos
- Calling customers
- Preparing quotes
As a side benefit, producer-based models force new ventures to be organized because they do require measuring essential sales productivity metrics. Establishing a high level of analytical discipline early on can result in significant payoffs down the road. Finally, producer-based models provide a high degree of employee supervision, preventing early sales hires from going rogue (which can be catastrophic in many startup environments).
In producer models, some actions are often worth more than others (and you probably should know by how much). A point-based model can be used to represent this:
- Set up a regular customer appointment = 1 point
- Set up a Fortune 500 customer appointment = 5 point
- Complete a regular customer demo = 2 points
- Complete a Fortune 500 customer demo = 10 points
This point-based approach may seem a bit too math-oriented, but it frees you from unrealistic / unpredictable revenue-based quotas – and some commission automation management solutions do support scoring. This approach also encourages raw sales productivity while forcing your team to set clear priorities.
So how can those magic scores be converted into predictable sales commissions? One option is to apply scores to base salaries. You know that a sales representative cannot give 50 demos a day, so it’s relatively easy to calculate what a “very productive” vs. “somehow productive” total score might look like. You can then apply a final multiplier to the employee’s base salary, for example:
- Total monthly score is 300-400 = 10% of salary in commissions
- Total monthly score is 400-500 = 17% of salary in commissions
- Total monthly score is 500-600 = 25% of salary in commissions
Which other approaches have helped you manage commissions when your company was in its infancy? We look forward to your feedback!