Is your sales compensation plan driving the right business results?
In today’s changing business environment, firms are often challenged with designing and administering incentive compensation plans that are increasingly complex and support multiple organizational objectives—all while being fair, transparent, and compliant.
Organizations that lack a properly designed incentive compensation plan face significant risks: demotivation, high turnover, and misalignment with strategic goals. Without effective incentives, salespeople's productivity and performance drop, and top talent leaves for better opportunities, raising costs. The absence of strong incentives can also foster a negative work culture, affecting overall morale and business performance. In short, without a well-crafted incentive plan, organizations jeopardize their success and long-term growth on multiple fronts.
Research shows that organizations with best-in-class incentive compensation plans for their sales teams see a 20% higher lead closure rate than industry averages (Source: Aberdeen Group). In addition to improving close rates and growing revenue, effective compensation plans can also mitigate costs by improving retention and reducing costs associated with sales representative attrition. To achieve this balance, firms must consider the three guiding principles that underpin any successful incentive compensation plan: strategic alignment, motivational perception, and fiscal responsibility.
Any incentive compensation plan must align with the company's strategic goals, guiding sales teams toward activities that contribute to organizational success. This alignment motivates employees to focus on the tasks and behaviors that drive business growth and success. It also helps to avoid the risk of rewarding activities that don't contribute toward—or even conflict with—the company's objectives. Ultimately, a strategically aligned compensation plan fosters a unified direction, enhancing overall organizational performance.
There are two components that together contribute to an incentive plan’s motivational perception: clarity and performance-based payouts.
The focus of an incentive plan should not solely be on payouts; it's equally critical to ensure fiscal responsibility. An efficient incentive plan should motivate team members while keeping the cost of compensation in-line with expectations. From an on-target earnings (OTE) standpoint, this means aligning the pay level and pay mix to the organization's HR and talent strategies. Moreover, the incentive compensation should correlate with the company's performance. If the organization exceeds its targets, it can anticipate disbursing above-target compensation. On the flip side, if the organization doesn't meet its plan, the sales team's payout should reflect the miss accordingly.
Crafting an incentive compensation plan is like piecing together a complex puzzle. Each piece, or component, is crucial and interconnected, together contributing to the plan’s effectiveness of driving the right results.
Total cash compensation including base salary and at-risk pay
Percentage of pay that is base salary vs. at-risk (variable or incentive)
Mechanism of calculation used to determine payout (e.g., commission, quota-based, etc.).
Relationship between earnings and performance (e.g., gates, slopes, accelerators, etc.)
Key performance indicators (KPIs) used to calculate payouts (e.g., revenue, growth, etc.)
Period in which performance is measured and payouts calculated
How often team is paid (e.g., monthly, quarterly, etc.)
Inclusion of additional components (e.g., contests, SPIFFs, etc.)
The potential levers of incentive compensation designs components outlined above provide firms with multiple levers to fine tune their plans—but they also provide multiple avenues of risk if not carefully managed. These risks can impact sales representative trust in the organization, not only potentially impairing seller performance and effectiveness but also inadvertently increasing attrition.
A poorly designed incentive compensation plan can also encourage sales representatives to pursue activities and close deals that ultimately don’t support the firm’s overall strategic goals and can lead to worsening margins or missed plans. Organizations designing and implementing incentive compensation plans encounter a few common pitfalls:
Incentive compensation plans constructed without the intent of supporting the organization’s growth or revenue objections. To avoid this risk, ensure that the firm’s targets are top of mind at the beginning of every incentive design discussion.
Incentive compensation plan designers often will include multiple plan measures, citing the importance of each measure to overall objectives. However, incorporating too many measures can lead sellers in multiple directions and create goal confusion. To create clarity, each incentive compensation plan measure should be no less than 10% of a seller’s OTE.
Oversimplifying plans in the name of administrative ease is common for growing organizations, who have yet to meaningfully differentiate between different sales teams. Customizing incentives for different sales roles ensures equitable motivation and maximizes each team member’s contributions.
The plan should allow for adjustments based on changing market conditions and business strategies. Fixed plans can quickly become outdated as market conditions and strategies evolve. Flexible plans allow adjustments to remain relevant and effective, aligning with changing business needs.
An optimal incentive compensation plan is one that embodies the organization’s strategy, motivates its sales force, and upholds fiscal responsibility. By considering the unique needs of different sales roles and ensuring the plan is simple, clear, and directly tied to measurable outcomes, companies can fuel their growth engines effectively. Remember, the best incentive compensation plan is one that gets the sales team to wake up in the morning with a clear goal and the drive to achieve it.
Using these principles, design components and common pitfalls, constructing an effective plan can still be a challenging task. Ensure your organization meets the best practices outlined above by reaching out to our team of experts at West Monroe.