Creating (or adjusting) a sales compensation plan can be tricky. Horror stories abound about poor sales comp plans that cost too much or encouraged bad behavior activity.
These are the 5 steps I walk clients through to make sure they develop an effective comp plan — one that aligns the objectives of the company’s bottom line, the individual rep, and the management team.
Step 1 was to identify the company’s core objectives for the reps. Step 2 was about setting the on-target earnings or total earnings at plan for a rep. And Step 3 was about the “slope”, which is determining incentives for overachievers and penalties for underachievers. Now we test what you have come up with, and send it to legal!
Step 4: Pressure-Test a mini model
Step four is where the finance folks come in. I call it the mini model and it’s separate from your overall company financial model. Rather, it’s a sales comp model where you can examine scenarios of performance for one rep. The mini model says, “If this rep executes this and does that, then this is how much they make.”
The mini model illustrates the mechanics of the comp plan and highlights its issues and flaws. All the formulas are in there. So you can see that, say, if a rep only sells three-year contracts and you value those more than one-year contracts, but he’s short on target revenue because he’s sold fewer but larger contracts… the model shows his compensation.
With the mini model, you can test the extremes. That’s what I would do in this step. Find out what happens when they don’t make plan. Find out what happens if they sell all of one thing? If you think they should sell $100K into 20 accounts, but they sell $500K into four accounts, is that better or worse for them? And which would you rather have as an organization (from setting corporate objectives in Step 2)?
The mini model lets you play with variables and see what you don’t want reps to do. In this way it helps you find weaknesses in your plan before the reps do, and helps you shore up some final tweaks. Especially if you have accelerators or kickers, you can see how those hit your margins. You might discover that if your reps oversell, you’ll make no money! (The classic historical error was Sun Microsystems. They comped on revenue but not on margin, so sales reps didn’t care about profitability.) This mini model helps work through those kinks.
When you want to change or adjust your comp plan, whether because it was not doing its job or because your company is growing and has bigger objectives, it’s also helpful to make modifications and adjustments via the mini comp model.
Invest time and pressure test your mini model to the best of your ability. The goal here is to think ahead as to how the plan will drive the sale team.
Step 5: Create a Term Sheet and Glossary
This may sound dull, but it’s super important to write out a summary term sheet and a glossary to share with the team. When your comp plan uses defined words like bookings, revenue, installed, accrual basis, or GAAP revenue, make sure there’s precision in how that is defined. Everyone needs to be on the same page to avoid future issues.
The summary term sheet lays out all elements of the plan in a readable document. For more complex sales comp plans, the final documents may require a lawyer to fully write up. The summary term sheet, however, illustrates pretty much everything the sales team needs to know in a condensed form.
The glossary is helpful because sales reps tend to key in on certain words, and it really can create the fine definition that’s needed to make clear what’s required and avoid confusion. It may seem like a lot, but it is very possible to do this.
Putting together a winning sales comp plan will tightly link together the company’s objectives, the target customer, and the reps’ behaviors so there’s deep alignment and focus. Invest the time to make sure you’ve got the right components in place to drive your organization!
In the comments, let me know if you have any questions about the process, or any points to add based on your experience.