Fixed vs. Variable Pay
Most sales incentive plans include two components: a fixed component (in the form of a base salary), and a variable component (in the form of sales commissions). Base salaries normally depend on the exact position, seniority level, and responsibilities. Base salaries provide a guaranteed baseline income to sales representatives (ex: allowing them to apply for a mortgage). Base salaries protect representatives from seasonal sales cycles and other fluctuations. Your company has probably already defined base salary ranges for different roles. The numbers below are just for illustration purposes as they vary greatly from industry to industry:
Target Total Compensation
Commissions are variable because they are based on performance. The target total compensation is the base salary plus “expected” commissions. Defining a target total compensation helps you manage total spend. It also helps you communicate to sales representatives what their total earning potential could be. Here is an example, again using arbitrary numbers. You could also use ranges instead of fixed target numbers.
|Role||Target Total Compensation|
The pay mix is the ratio of fixed pay to variable pay. You can determine it by comparing the base salary with the target total compensation minus base salary. For example, if the base pay is 60K, and the target total compensation is 100K, then the pay mix is 60% / 40%. The pay mix normally varies depending on the role. For example, you could decide that more senior roles should have their total compensation leaning towards a higher base salary so as to provide more stability. Or you could decide the exact opposite, and increase the variable pay component, so as to signal higher performance-based upsides. Most pay mixes vary from 80% / 20% to 60% / 40%. Here is an example which could be considered reasonable:
|Role||Pay Mix (Base / Variable)|
|Junior ADR||65% / 35%|
|Senior ADR||70% / 30%|
|Junior BDM||65% / 35%|
|Senior BDM||75% / 25%|
There are two main ways to measure performance – revenue and profit. The main advantage of revenue is that it’s easy to calculate. You don’t need to take into account product margins or discounts. You just need to look at each transaction’s total. The disadvantage of revenue is that it oversimplifies things. For example, if your representatives offer generous discounts to boost sales volume, you could be paying large commissions for deals whose profit is very slim. So if profitability is important to you, you should use profit as a performance metric. Because profit is more complicated to calculate, you should consider a software solution. Finally, some organizations may prefer using a scoring method. For example, refunds could be punished by applying a negative multiplier (ex: -2x revenue), while the sale of certain products could be encouraged by applying a positive multiplier (ex: 1.5x revenue). Make sure the metric you choose is well aligned with business goals. Do you want to promote growth (choose revenue), require profitability (choose profit), or encourage specific sales behaviors (choose scoring)?
In most cases, commissions will be a percentage of total revenue or profit. Most revenue-based commissions range from 5% to 25%. Most profit-based commissions range from 10% to 50%. However, other approaches are possible – for example bonus-based approaches. Using a bonus-based model, if a target revenue or profit total is met, the sales representative will receive a cash bonus. This cash bonus can either be a fixed value (ex: $5000), or a percentage of salary (ex: 10% of salary). Note that the bonus does not need to be “binary” – it could be pro-rated to the attainment. For example, sales representatives meeting 90% of quota could receive 90% of their bonus. In short, you have to decide whether you see commissions as a “tax” on sales transactions (in which case you should use a revenue / profit percentage), or as a reward for attaining specific business objectives (in which case you should use bonuses).
Defining Attainment Levels
Many organizations will define multiple incentive plans (each with different thresholds and associated rewards) for different positions. You’re probably already quite familiar with the concept of a “quota”. In most organizations, if you are under quota, you only get a small percentage of revenue / profit. Once you reach the quota however, you receive a higher percentage of revenue / profit (or a bonus) – making it possible for you to reach your expected target total compensation. In reality, things often tend to get a bit more complicated:
- There could be more than just one attainment level
- There could be some SPIFFs, accelerators, or prizes at higher attainment levels
- Rewards at higher attainment levels could be cumulative or non-cumulative
- Rewards could be assigned to individuals but also to managers or split between team members
Below is a sample compensation plan created using an automated sales commission management solution. We recommend using an interactive, software-based plan designer to create your incentive plan as this is the best way to ensure you didn’t miss anything.
Setting thresholds (quotas) correctly is very important:
- If too low, you will likely over-spend and fail to differentiate based on performance
- If too high, you will likely under-spend and demotivate your sales team
Setting thresholds is the most difficult part of designing any incentive plan. Your goal should be to ensure that 70% of sales representatives can reach the main attainment level. Another 15% of your sales force should fail to attain it, and the remaining 15% should exceed it. In addition to this design constraint, you also have to make sure the total spend will be kept under control. We recommend running your plan through an automated calculation to ensure total payout looks acceptable based on your sales transactions. Some software solutions even offer simulations which replay past transactions to generate “what if” scenarios.
Protecting Your Plan
Once your incentive plan is defined, you need to make sure it’s protected. Here are 3 things to consider:
- Define legal terms and conditions (ex: who can change quotas)
- Implement process for enrolling participants (ex: obtaining e-signatures)
- Define payout caps (ex: for the entire plan, per participant, per transaction)
Again here your best bet is to use a commission management solution which can automate all these aspects for you.