At Sales Cookie, we help customers automate their commissions. Our consultants have reviewed hundreds of incentive programs. Over time, we’ve learned to understand commission structure DNA. While no two companies have the same exact same commission program, we’ve identified one type of commission structure which works great and is popular with fast-growing organizations.
Those organizations aren’t bogged down by ad-hoc incentive commission structures – those with with countless “special rules” accumulated over time. Instead, they use streamlined commission structures. They’ve learned to scale their sales operations, and have established systematic ways to calculate sales commissions.
In this article, we’ll show you how you can organize your commission structure the same way as those fast-growing sales organizations. Without further ado, here is the magic formula those winning sales organizations consistently use to calculate commissions. Don’t worry, we’ll explain everything!
Ad-Hoc Commission Structure
At the opposite side of the spectrum, ad-hoc commission plans include many special rules, often accumulated over time. For example:
- If Joe closes more than 100K in revenue in a month, he’ll get an extra 5%, except for hardware sales which will be 3% – unless it’s a 3 year commitment. Also, customers A and B only count for 50% because “they’ve been with us for a long time“.
- Jane’s commission rate will be 8% for all sales. However, her commissions are conditional on her closing at least 10 hardware sales every month. However, if Jim helps Jane, then her commission rate is reduced by a factor which depends on the product category. But her hardware quota is reduced by the same percentage.
As you can see, those types of commission structures get “corrupted” over time. They increase in complexity as more special rules are added. For example, when a client approached us looking for help with their commissions, we reviewed their documentation. We received one commission plan description which was 14 pages long with 2 large appendixes listing 50+ special rules.
What does all this “fine-tuning” mean? Calculating commissions requires significant administrative time and remains error-prone. Reps have no way to understand their commissions. Nor do they have clear sales objectives. And many resent nickel-and-dime rules that cost more in overhead than they save in commissions.
Systematic Commission Structures
Our #1 most popular scalable sales commission structure is based on following principles:
- Define a payment frequency
- Define a variable for each rep
- Define targets (ex: quota) for each rep
- Calculate payouts using [attainment] x [variable]
Here is a simple example for account executives:
- Commissions will be paid monthly
- Variables for January are
- Barbara: $9K on-target commission
- Eric: $7K on-target commission
- Targets (quotas) for January are
- Barbara: $120K in sales
- Eric: $100K in sales
- Payouts for January are
- If Barbara’s January revenue is $150K, her attainment is $150K / $120K = 125%
- Therefore she will be paid 125% of her monthly variable = $11.25K
And another simple example for BDRs:
- Commissions will be paid quarterly
- Variables for Q1 are
- Bob: $6K on-target commission
- Sarah: $4K on-target commission
- Targets for Q1 are
- Bob: 200 confirmed customer appointments
- Sarah: 100 confirmed customer appointments
- Payouts for Q1 are
- If Bob’s Q1 appointment count is 100, his attainment is 100 / 200 = 50%
- Therefore he will be paid 50% of his quarterly variable = $3K
Here is an example of time-dependent sales targets:
Defining Multiple Goals
How can you have more than one sales goal, yet use this systematic approach to calculate commissions? Our best customers define various commission components, each with a different weight. For example, they might define goals like this:
- Component A – Renewal Revenue
- 70% weight
- Renewal quotas for January are
- Barbara: $50K in sales
- Eric: $60K in sales
- Component B – New Customer Revenue
- 30% weight
- New customer quotas for January are
- Barbara: $70K in sales
- Eric: $40K in sales
When calculating commissions, simply apply the weight to each rep’s variable before multiplying by the attainment percentage. For example, assume that Barbara delivered the following sales results in January:
- Renewals = $80K
- Attainment is $80K / $50K = 160%
- Payout is $9K (variable) x 70% (weight) x 160% (attainment)
- New Customers = $35K
- Attainment is $35K / $70K = 50%
- Payout is $9K (variable) x 30% (weight) x 50% (attainment)
Barbara probably focused more of her time on renewals because of the higher weight. She didn’t completely neglect new customer revenue, though.
Our commission model can still go off-rails. For example, if you defined a goal of 100 appointments per month, but a BDR successfully scheduled 500, do you really want to pay 500% of variable? What if overperformance was not sustained but temporary? What if this BDR leaves your organization next month and runs away with the money?
You can cap payouts, but should do so temporarily. For example, you could cap commissions for each pay period to 200% of variable. Obviously, some reps may be unhappy about caps. To address this concern, include a make-up adjustment. For example, at the end of each quarter, re-evaluate totals without any caps and pay the delta. This means that your caps are only temporary. In the end, you promise to pay in full.
For example, if a BDR scheduled 300 appointments in January (well above the 200 cap), he/she is still eligible to receive the full payout at the end of the quarter. However, if the same BDR only scheduled 50 more appointments in February and March, their overall total of 300 for the quarter will result in a more modest delta. This approach allows you to smoothen ups and downs.
Everybody in sales experiences a bad month or quarter. Sometimes it’s due to illness, a failed product launch, heavy discounting, competitive pressure, bad debt, etc.
This said, you may decide that commissions shouldn’t be paid if results just aren’t acceptable. For example, if 50% of target was met during an entire quarter, you could decide to pay nothing. Or you could decide to apply a reduced rate to our magic [attainment] x [variable] formula. You can still use the same “make up” correction at the end of the quarter. Therefore, if underperformance was only temporary, the punishment will be lifted.
In this example, a rep was punished due to poor January results. Even though the rep closed some deals in January, the payout was zero! Compensation was also capped in February. At the end of Q1 however, we can re-evaluate quarterly totals and pay the delta. This rep really made up for a poor January and won’t lose all commissions associated with January revenue, because the overall quarter total is OK. Also, the rep will receive some delayed compensation for the February cap.
Commission Structure Complexity
None of the tweaks we described compromise the robustness or integrity of our systematic approach to sales commissions:
- Defining multiple commission components is easy
- Adding temporary caps works great
- Setting temporary minimums is not a problem
The fundamental structure remains the same. And as we’ve seen previously, this approach works across a variety of positions (account executives, BDRs, territory managers, etc.).
Next time you’re thinking about adding one more “special rule” to your commissions, consider this:
- What are the true savings in terms of payouts?
- What is the incremental cost in terms of managing commissions?
- What is the impact on a rep’s understanding of payouts and key goals?
- What the message does adding the rule send to your reps?
If you have a commission program with many special rules, it’s probably time to redesign it and adopt a more systematic approach. You can still retain a lot of flexibility using components, caps, etc. And don’t forget to reach out and start automating your commissions! We’d love to help.