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The Ins & Outs of Variable Pay Compensation Structure for Sales Teams
With increasing focus on grit and many claims of meritocracies in organizations across the country, why does variable pay compensation even exist? On top of that, why are sales people some of the few employees subject to variable compensation structures? I wish I could say it’s all about incentives, but the truth is a bit more nuanced than that.
Yes, the goal of variable pay is to incentivize people to perform higher than they otherwise would, but why is that necessary? Do other roles have employees that are all equally internally motivated while sales just attracts the classic “slimy” stereotype that everyone loves to hate? Not quite.
What is Variable Pay Compensation Anyway?
Variable pay compensation consists of paying employees based on (usually) some fixed “base” salary as well as a variable component based on performance. Performance is typically highly quantified and clearly laid out in a legal document called a compensation plan. Employees on variable compensation will receive their base salary in typical payroll payments, while their variable component will be paid at a separate pay period (e.g. monthly, quarterly, annually) as stipulated in the compensation plan.
Why Variable Pay Compensation Structure For Salespeople?
Queue the picture of the stereotypical sales person on stage with a massive check. Most people think it’s that extroverted cutthroat personality that fits with variable compensation, but allow me to offer a more data-based approach.
Sales performance is easier to measure than other roles. You set a customer-based metric target for each individual, and their performance is just whatever percentage of that target they achieve in the specified time period.
It’s not that salespeople perform more variably than other roles, it’s just that customer metrics are defined at the top level for almost every company – but products shipped, models built, IT tickets resolved, etc. are usually not.
I think most leaders and managers would love to find a way to better quantify the performance of their teams. The challenge is setting something up that incentivizes the right thing and is also defensible. Those are also the biggest challenges for sales, but they often get trivialized due to the expectation that sales teams will receive variable pay compensation.
As a proponent of performance-based compensation, I’d like to think we’ll one day live in a utopian meritocratic business world where every employee’s annual compensation is based on some highly objective quantifiable assessment of their performance. Unfortunately the means and appetite for this may never exist, but one can still dream.
How to Implement Pay Variable Compensation for Your Sales Team
You’ve decided it’s time to implement variable compensation for some part of your sales team, or you want to scrap your existing plan and start from scratch. Here’s a step by step process:
- Set High Level Goals
- Set Metrics
- Set Specific Targets
- Accurately Measure Progress
- Make Sure It’s Fair (Your Reps Should Agree)
- Determine Payout Structure
- Determine Additional Incentives (With Caution)
- Refine & Improve
Step 1: Set High Level Goals
First, the goals should all be linearly aligned and cumulative. That is to say the goals (revenue, profit, customers, etc.) of the company should be the sum of their parts (organic + sales + account management + marketing), and everything should add up. The sales leader’s goal should be the sum of all the AEs’ goals (less sum buffer for potential attrition or hiring challenges).
Step 2: Set Metrics
You should really pick one metric like revenue vs trying to incentive multiple high level metrics. The more metrics, the harder it is for reps to know how to spend their time. Again, the goals of the rep should be aligned with the goals of the company.
Here’s a list of metrics to consider:
- Revenue – most common and best in many ways
- Profit – harder to calculate but maximizes ROI
- Deals closed – good for teams where volume is high and revenue per customer is consistent
- Deals qualified – good for inside reps passing deals
- Deals sourced – good for reps that are doing email lead gen (usually early on in lieu of marketing)
Step 3: Set Specific Targets
How you approach target setting is critical to explaining your plan to your AEs (and managers) and getting their buy in that the goals are achievable.
There are two ways to do this: top down or bottom up.
Top down means the executives set an overall sales team target and you figure out what that amounts for individual AEs. It will typically differ for individual AEs by segment or vertical.
Bottom up means you start with lead projections or targets then do some math on deal cycle, average deal size, and incorporate human limitations (e.g. an AE probably can’t close 200 deals a month, and prospecting vs closing is a zero sum game) to get to an individual target then add them all up.
Step 4: Accurately and Reliably Measure Progress
Now that you’ve got your metric set and your targets laid out, you have to make sure you can measure everything accurately and reliably. By accurately I mean you have to pay within +/-5% of the what was reported (ideally this is 100%, but that can be harder than you’d think for non-ACV revenue models).
By reliably, I mean you can’t miss a pay run or do a correction more than once a year. If you can’t operationally support the transition from base to variable pay right now, you should hold off until you can.
Additional complications here include usage-based metrics and rolling pay periods, which you should budget incremental time and people to help address as they add multiplicative complexities.
Step 5: Make Sure It’s Fair (Your Reps Should Agree)
One last thought before going live is that it should feel fair to your sales people. They will probably have some benchmark on how they’ve been doing to date or how far they can push.
While you may think the numbers all speak for themselves, salespeople typically have high EQ and thus are usually a bit more emotionally influenced themselves (maybe one of the other reasons sales has variable pay).
If they don’t think the metric is the right one, the target is achievable, or you don’t clearly explain how you got to both, your team will start to lose confidence in the plan or you as a leader. A few quarters of not hitting targets and a team that doesn’t believe in you can head downhill fast. It’s also a lot easier to start with everyone hitting quota and ratcheting up than vice versa.
Step 6: Determine Payout Structure
This is where things can get pretty tricky, but they will be expected from any experienced rep. It’s hard to have the downside of not hitting OTE without the upside of overachieving. It’s also not reasonable to expect your new hires to hit quota in their first pay period. You also need to figure out what the pay period should be.
The payout structure should is a combination of:
- Pay periods
- Base/Variable Split
- Decelerators (optional)
Pay periods are the simplest and should be roughly commensurate with the deal cycle. For insides sales roles these should pretty much exclusively be monthly. You could make them quarterly, but setting meetings or passing deals (whatever your metric is) won’t be weighted towards EOQ the way signing deals is.
Base/Variable split is a crucial element to every comp plan. This is the percent of their On Target Earnings (OTE) that is guaranteed (base) vs variable. In general this should increase with seniority and market segment. For example, you could start inside roles at 80/20 and then increase up to 50/50 as you get to Enterprise. The things you’re balancing here are upside (more variable equals more upside when AEs over-attain) and risk (if an AE only hits 75% can they still pay rent).
Ramp is typically a hot topic among AEs and front line managers. Your best bet is to just start it at 2 pay periods and then keep an eye on it. In general ramp should be hard enough that most people don’t hit it but not so hard that you demoralize your new hires. This is a tough balance to strike, and you’re rarely going to make everyone completely happy while ramping new hires as fast as you want.
Accelerators vs Decelerators
Accelerators and decelerators can get pretty complicated, but there are a few guiding principles to go by:
Decelerators can be tempting, but they are also demoralizing for reps that get a rough start. If you have a hire fast fire fast mentality and high confidence in your target, then go for it. If you’re new to sales comp, are hiring people that have more potential than experience, or pulled the metric or target out of thin air, be careful here. Decelerators can start to feel pretty unfair pretty fast, so you may be better off just paying 1:1 up to 100% attainment.
Accelerators can be made very complicated, but the basic calculation is similar to tax brackets. Up to 200% you should typically keep accelerating (e.g. pay at 1.25x from 100% – 125%, 1.5x from 125% – 150%, etc.), and then you should either head back down like a bell curve or have a cliff that drops back to 1:1 immediately.
Keep in mind this looks different for different segments. For example in Enterprise you’ll probably want a cliff as one massive deal could bump an AE from 150% to 400% which carries pretty big risk for the company, whereas in SMB you’re typically hitting human limitations when you get around 300%. As for accelerators during ramp, cap them at a pretty low level to balance sandbagging with incentivizing over-performance.
Step 7: Determine Additional Incentives (With Caution)
So what do you do when you want to run a SPIF (Sales Performance Incentive Fund), add a new product with different ACV or margins, AEs start asking for split credit on a deal, or you expand internationally and cover the same company with multiple reps?
This is where things can get out of hand fast, and I’d generally urge sales ops and leaders to think carefully before implementing any additional financial incentives. One other thing to keep in mind is the more complicated your plan is, the more loopholes there are and the more there is to exploit.
My general rule of thumb on sales comp is that a salesperson should be able to calculate their paycheck based on the data in your CRM and your plan. All of the below will put that in jeopardy in different ways.
SPIFs vs Contests
SPIFs are everyone’s favorite tool to throw money at the problem. Having a slow quarter? Just launched a product? Have a cool new incentive to test? Throw money at it! The only issue with all these is that by and large SPIFs don’t work. I have rarely seen a SPIF proposed that didn’t just pay reps more money for the same work they were already doing. If you want to do that, just lower quota and make it simpler for everyone.
The best alternative I’ve seen (and am a big fan of) are contests. Contests pay on relative performance, are more competitive, and generally more motivating. Keep in mind though you want to do a contest on a metric that is not currently paid on in any way (e.g. an contest on deals closed when quota is based on ACV).
Step 8: Refine and Improve
How to Address Comp Plans for Selling New Products
New products are probably the toughest thing to compensate on. By definition they are usually less mature than the original product, they have lower ACV, and sales people are less comfortable with them.
On top of that finance and leadership is probably expecting a similar growth curve as your first product (cause why not?), so there are big goals attached. Combine that with the fact that this may open up all new cross-sell opportunities that didn’t exist, and you risk either completely distracting your team from overall goals or generating less revenue with the same costs.
The best options here are either lower targets for new products as they mature and AEs become comfortable, or dedicated teams with lower ROI targets to start (probably just like when you launched your first product).
Splits / Territories / Geographies
From my sales ops experience, splits are probably my least favorite tool in the compensation toolbelt. The value they bring versus the operational challenges in compensating on them are rarely worth it. They also open the door for a split on every deal where two people had anything to do with it (e.g. ROE disputes), which can be a slippery slope. That said, in Enterprise and/or multi-product sales teams they might be unavoidable. If you find yourself approving 5 splits a quarter, do away with them. If it’s 10+, then you should probably make some official rules around them in terms of the split breakout, situations that merit a split, and how to operationalize them without making enemies in sales ops.
A global account coverage model is always tricky and usually unavoidable if you’re going after big enterprises across multiple geographies. There are a couple approaches on how to cover and pay on them, but there’s no silver bullet. It depends on your product and mostly the customer’s buying decision process, but in general just try to pay everyone fairly without double paying anyone (too much). The customer is always the top priority with these, so it’s ok if comp isn’t perfect to start, but just keep improving it as you go.
Since that was long and hard to remember, I’ll leave you with the three most important takeaways:
- Your sales compensation plan should be able to be explained in a sentence or two and aligned with company goals.
- Your reps should be able to calculate their payout themselves.
- Everyone should feel like they have a fair opportunity to hit their target.
If you can manage that, you will be giving yourself the best chance to have the right balance between impacting tactical behavior and motivating your team to maximize their performance. Good luck!
Also published on Medium.