SalesCompInsights

By Scott Barton and Matthew Zink

As we have written numerous times on these pages, quota attainment distribution is a critical diagnostic for a goal-based incentive plan.  The shape of the distribution and its position relative to target attainment impact both the plan’s motivational capabilities and its ROI.

Consider an example:

• Company A sets a goal for its sales organization to produce $100 million in revenue.  It models a normally-distributed, salesperson-attainment scenario to test the impact of pay mix (ratio of base to incentive target pay) and pay rate accelerators on total comp expense.
  • Under the “model” scenario the company pays 113% of its incentive budget at 100% attainment, due to its use of accelerated payment rates for salesperson attainment above 100%, and the model scenario placing approximately half of the sales population into accelerators;
  • Its compensation cost of sale, or CCOS, is 4.26% — i.e., Company A is spending 4.26% of each dollar of revenue on sales comp under this scenario.

•  In a wide distribution scenario, the company experiences an increase to the deviation of salesperson quota attainment – i.e., the left and right edges of the distribution curve grow outward.
  • While the company generates no more revenue in this scenario, it spends more of its incentive budget, due to more salespeople earning at accelerated payment rates;
  • The scenario also produces a less efficient CCOS, given the increased number of salespeople performing at low attainment levels, yet continuing to earn base salary.

• In a third scenario the company experiences an upward shift in average performance, such that all salespeople produce 5% more than what the company modeled under the normal scenario.
  •  Due to its accelerators, the company spends more as a percent of incentive budget than under the normal scenario;
  • The higher cost is at a lower effective rate (CCOS) than under the wide scenario, because revenue increased at a higher rate than comp expense.

• Finally, a forth scenario, and an unfortunate one, is where the average attainment is 100% of revenue target but the shape is bi-modal.  I.e., instead of one, normally-distributed curve there are two – one centered at the lower end of the performance continuum and the other at the upper end.  Think of a two-humped camel, or the tale of two cities:
  • The lower-performing camp produces relatively-high fixed cost as a percent of revenue due to base salary;
  • The higher-performing group produces relatively high variable cost as a percent of revenue due to accelerated payment rates;
  • There is no middle group to offset each, extreme group.

From a purely budgetary perspective, Company A prefers the normal distribution scenario, which provides the lowest spend rate as a percent of incentive budget and revenue.  However, the company’s sales management has a different view.  The wide scenario provides more extreme examples of performance, and pay:

• High performers pull down big pay checks and serve as a source of inspiration to average performers;
• Poor-performing reps opt out of the program (or company), saving sales leadership pain and hassle associated with administrative, “performance-management.”

Obviously, for the sales management, the right-shift scenario is preferred – beat the goal and increase the number of salespeople over quota.  But beyond some point of goal attainment the sales organization’s success carries both short- and long-term consequences.

Short-term Company A – and this is a real example – is dealing with the fact that its overall corporate growth and profitability in its last fiscal year fell below analysts’ expectations, even though a large portion of its sales organization exceeded 110% of their quota. 

How is this possible?  Goals defining company success and sales team success are not aligned.  Misalignment usually stems from: 

• Under-allocation of goal, which is the practice of assigning to the sales team a level of quota that falls short of the corporate goal;
• Excessive use of measures and goals that enable the sales team to earn what they view is sufficient pay, even when their performance on the primary goal of revenue or margin falls short.

Longer term, companies that celebrate sales team success but fail to meet Wall Street’s expectations must take radical steps to get salesperson pay and performance in line with corporate results.  Ultimately the sales team must perform more, or earn less.

The prospect of earning less doesn’t sit well – with salespeople in particular.  Therefore, sales leaders need to ensure the sales compensation program uses measures and goals that align with corporate requirements, and that the resulting performance of the sales team and the company is aligned as well.  Other components of the comp plan, including target pay mix levels and payment rate accelerators, help fine tune the pay-and-performance relationship at difference levels of average attainment. 

The cost of poor quota setting and alignment can be substantial.  In our Company A example, the firm spent about 10% more than the modeled result at 100% average attainment, enough to employ at least four salespeople.  Another scenario could have been an average attainment below 100%.  This outcome better aligns pay and performance as fewer, highly-leveraged salespeople exceed goal.  The cost here, while difficult to measure, can be high as well, as salespeople perceive they can’t meet their income expectations because the company sets its goals too high.

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Sales Productivity Takes a Big Leap Forward

One of the most challenging decisions facing sales leadership is whether to move from a commission to a goal-based plan.  By commission, we mean the relatively simple approach of sales x payment rate = payment.  In a commission plan, payment rate gets the focus – bigger the better for a salesperson.  In a goal-based plan, it’s all about the goal or quota: goal achievement = payment.  There are derivations of these approaches: variable-rate commission schemes where the payment rate changes based on a goal-achievement threshold.  But fundamentally, the commission plan provides a target share of each sale to the rep, where the goal-based plan provides a target payment when the rep has met the required goal.

Two years ago we worked with the sales force of an incumbent local exchange carrier (ILEC).  In 2009 the sales organization adopted a quota-based plan after having used a commission plan.  The firm’s head of HR said moving to a goal based sales compensation program was relatively simple, and one of the better things they’ve done.

In 2008 the company was struggling.  Yet most salespeople earned variable pay based on recurring revenue from previously-done deals.  Many in management thought reps viewed their variable pay as an entitlement, and were not sufficiently motivated to grow new business. 

The program changes for 2009 included a minimum performance threshold for incentive eligibility, and use of both cumulative and discrete goals for monthly payments, depending on the job role.  The new program simplified the calculation methodology by using a standard approach across various performance measures, whereas the previous plan used a variety of calculation rules.  In exchange for the threshold, the plan offered higher payouts for over-goal performance.

During 2009 the company operated under bankruptcy protection in one of history’s worst recessions.  Yet the sales organization performed admirably, coming in for the year just below the goal.  In 2010, management kept the same basic plan structure but increased the goals and minimum performance threshold.   The company emerged from bankruptcy in October and finished the year at 107% of plan.

The company’s mood for 2011 is bullish.  Management has refined the sales comp plans to place more focus on strategic product sales.  A benefit to goal-based plans is management can shift strategic emphasis by changing the quotas and payment rates, without structural changes to the program.  This consistency is a welcome change for reps that grew accustomed to constant changes to the plan, and given all organizational changes. 

Goal setting and allocation is never easy.  “We did a lot of work behind the scenes,” says the head of HR.  “But this paid off in making the program appear simple and sensible to the field.” Management restructured the way in which marketing and sales worked together in goal setting by setting up a core team and calendar, with shared accountability for revenue goals across functional groups.  This helped the entire process become more transparent – a criterion for effective goal management in the sales organization. 

 “Managers often fear they’ll lose their best salespeople by making incentive pay contingent on goal achievement.  You have to take risks, and work through the fear.  If you have solid relationships – salespeople with customers and management with salespeople – fear of losing sales talent is probably overblown.” 

The company lost some salespeople during the transition, but most are back. They’re excited about the culture and being a part of what the company now stands for: a high-performing organization.  Setting goals at the sales rep level enabled the company to take a big leap forward.

Top Questions Answered

This season’s brutal weather hasn’t slowed the number of questions from incentive planners and sales leaders.  Team- and goal-based plans are common themes.  We’ve handpicked a number of related questions from our mailbag, and hope at least a few are on your list of open questions.

Q: What is the ideal mix of individual and team measurement?

A: The ideal mix is consistent with the mix or relative share of the job’s responsibilities that are individual versus team-based.  In our experience team-based measures often take the place of what should be individual measures because either the company cannot measure individual contribution or it wants to avoid internal competition.  Good use of team measures is when the job carries responsibility for a goal that cannot be executed exclusive of other team members.

Q: Can one plan do all?  If a company has both Key Account Reps and Territory Reps, how common is it to have different plans?

A: Not effectively if the company has dissimilar requirements across the jobs considered, and the market requires different cash targets.  It’s for this reason that most companies have different plans to serve a diverse set of sales jobs.

For example, the requirements for a Key Account Rep and Territory Rep could be the same.  That is, base salary and target incentive, performance measures and pay frequency could be identical.  While in our experience we find the performance measurement similar – sales volume in either absolute or relative to goal, the pay targets are not.  Key Account Reps typically have a more-defined pool from which to fish versus the Territory Reps where the variability across territories is higher.  This means the Territory Rep carries a higher risk/reward proposition (higher incentive target as a percent of target total cash, higher upside potential).

There is an age-old debate around what constitutes a different plan.  This is a communication and administrative issue.  We say, if a sales manager can explain the plan to both audiences simultaneously, your one plan for different jobs passes the test.   Or if you can use an identical set of requirements in your system for paying both jobs, with only differences on your rate tables, your one plan passes the test.

Q: Given sales reps often have “unequal” opportunity with respect to their existing customer base, number of customers, type of customers, markets, etc., how do you effectively “level” the playing field among various reps?  

A:  This scenario is one of the strongest arguments for a goal-based incentive program.   With a goal-based approach you set a target incentive commensurate with the role and skill level.  Let’s say Scott and I both have a target incentive of $25,000.  Our goals might be very different, taking into consideration the factors your reference in your question.   If we both meet our goals we earn our $25,000, regardless of what our goals are.   The transition from a commission program to a goal-based incentive approach is one of the more challenging that we observe given the financial and cultural implications, but long-term it can be one of the most productive.

Q: What is the preferred approach for allocating quotas?   Is this typically a process of mutual agreement between the sales rep and management, or is it something that management enforces unilaterally? 

A: Goal setting approaches vary by industry based on the availability of data, go-to-market model and selling roles.  That said, we find that the most effective approaches use a combination of bottom-up and top-down input.   It is common for there to be a gap between what the salesperson says she can do and what the company requires in terms of performance.  While not a negotiation, there should be a clear and equitable set of logic used to close the gap.   Perhaps the most important characteristic is that the salesperson understands their quota, how the gap was closed and how it ties to the overall success of the organization.  Regardless of which approach is used, if the sales manager can’t explain it to their team, the goals will be viewed as arbitrary and unrealistic. 

Q: For goal based incentive plans, would you expect a normal distribution of performance, or a bi-modal distribution?

A:  When the goals are set correctly we would expect to see a normal distribution of performance.  The range of performance varies somewhat by industry, business model and selling role.  The company’s approach to goal setting – promote a culture of winners, 100% is stretch — also play a role.  The rule of thumb we use is to strive for a bell-shaped curve with approximately 60% – 70% of the plan participants achieving their objective.   With this type of distribution, the field force typically views the goals challenging, but realistic – a key characteristic from our perspective.    What varies then is the spread of the curve.   Consider a consumer product goods (CPG) manufacturer and software company.  We expect a narrower range of performance outcomes for salespeople in the CPG organization..  Most software firms have greater variability in the business, and software salespeople experience a broader range of quota-achievement outcomes versus those in CPG.    A final point, we recommend accelerators and thresholds, if included, be set with a goal of 90% percent of the population earning “some” incentive dollars and 10% earning a significant payout, in line with your industry’s pay benchmarks. 

Q: With goal based incentives, do you advocate setting annual performance goals, or goals with shorter time-frames?

A: In general we observe shorter performance cycles (e.g., monthly) as more effective for promoting line of sight and urgency.  However, in businesses with complex, long sales cycles and infrequent but huge deal values, each month in isolation says little about performance success.  In such circumstances annual goals are typical.  To gain the benefit of more frequent performance periods, management will often tie quarterly milestones and cumulative performance to annual goals.  Rarely do we see performance cycles beyond one year due to fiscal reporting norms.

On February 24th, Scott and I conducted a web presentation with Steve DeMarco, VP Worldwide Sales with Xactly.   540 people registered for the session and the week prior we distributed a flash survey on 2011 sales productivity trends.   83% of the respondents expect slight or significant growth in 2011.  Whether this reflects increased optimism or simply the “plan” they were given (assuming the two aren’t one in the same) may be cause for some debate.   Similarly, we may not know where the economy as a whole is heading, but at an individual level these companies expect improved results in the coming year.    We observe the same expectations with sales leaders we have spoken with recently.   Whether it is do or die, improved optimism or simply a requirement of the Board, fewer and fewer Sales VPs are talking about retrenching or holding their own.  They’re focused on taking advantage of an improving environment, investing in their sales force and growing the top line. 

We see this reflected in the allocation of quotas as well.  68% of the respondents raised or are raising quotas for their sales reps.  Another 12% indicated that while they may not be raising quotas, they’re increasing headcount in support of the growth objective.  

Unrealistic quotas are a common complaint regarding the incentive program.  Goal setting approaches do vary by industry and specific company based on the availability of data, go-to-market model and selling roles.  Having said that, we find the most effective approaches use a combination of bottom up and top down input.   For there to be a gap between what the salesperson says she can do and what the company requires in terms of performance shouldn’t be a surprise.  While not a negotiation, there should be a clear approach and explainable logic for how the gap is closed.   Perhaps the most important requirement is that the sales person understands their quota, how the gap was closed and how it ties to the overall success of the organization.  Regardless of which approach is used, if the sales manager can’t explain it to their team, the goals will be viewed as arbitrary and unfair.

A Conversation With Howard Woolf

As a front-line salesperson, sales leader, sales operations executive, company president and CEO, Howard Woolf has spent his career achieving sales success in the technology and communications industries.  We recently had the opportunity to catch up with Howard to discuss his thoughts on effective sales incentive programs.    

MM: Howard, from your perspective, how important is the incentive program in the toolkit of a sales leader? 

HW:  The incentive program, if done right, is the fundamental way a sales manager ‘communicates’ to the salespeople in a way that is sure to get their attention.  Over time it consistently reinforces the mission and method for the organization, along with each individual’s role within it.  Further, the sales plan sets the stage for both direction and behavior, but also builds organizational ’confidence’ which is the key building block for overall success within any sales force.  Unfortunately, when done incorrectly, it has the reverse effect – so it’s important to get the incentive plan right.

MM:  Are there any guiding principles you’ve used to help with your incentive plan decisions?

HW:  Yes, the first is simplicity.  I use the traffic light example.  If a salesperson leaves a customer after getting an order and while stopped at a traffic light, s/he can’t figure out what they earned on that sale, then the plan is too complicated.

Many companies think more is better and they load up the sales incentive plan with corporate ‘good to do’ things and complex measurements. Unfortunately all that does is diffuse the message, often making it hard for a salesperson to be successful even when they are doing the right thing and actually performing well.  In fact you might end up rewarding the wrong people for doing the wrong things, which further destroys morale and can negatively impact performance.  So less is more!

MM:  What are the characteristics of the best plans you’ve seen versus ones that didn’t work so well?

HW:  Beyond being simple, a good plan has to fit within a 360 degree mapping that deals with;  1) goal setting based on each individual assignment (I prefer bottom up with top down tuning);  2) measurements that can readily be made and reported; and  3)  communication that ensures understanding, buy-in and proper execution of the desired behaviors.  Often, automation is involved so that aspect needs to fit with the three key elements as well.  IT should be an ‘enabler’ of the plan and not get in the way of a good plan, which admittedly, can be difficult.

MM:  Having observed the design process from various vantage points, what insights on the do’s or don’ts can you share?   

HW:  Sales is a key function for the company and unfortunately there can be a lot of people within the company who think they are a sales measurement expert.  They’ll suggest all kinds of bells and whistles to the plan  – this is usually how complexity creeps in.  Finance, HR, IT and even Manufacturing and Marketing are looking for a link between the sales plan and their functional goals. 

It is important that the fundamentals of what Sales Management wants to prioritize, communicate and reinforce to the sales people be the pre-eminent definition of the plan.  Keeping it simple, measurable and communicable against the goals of the sales manager  should not get lost  into the many diverse elements of running the company. 

The role of all other functions (Finance, HR, Mfg, Product Management, etc.) is to line up behind the sales manager to help him/her execute to this target without trying to take over the plan for their own needs.  Or  load it down with elements that diffuse the message and limit the potential impact.  The Sales manager should be able to take a step back and say “if the sales people on this plan do well, then the company will have done well against its key goals and the sales force will have played their role in making that happen.”

MM:  Any do’s or don’ts regarding quota setting and management?   

HW:  Yes.  The key to good quota setting is knowledgeable sales management.  When sales management accurately translates the company goals into individual quotas and structures and understands the nature of the individual assignments the plan can be both credible and successful.  Arbitrary and disconnected quota, often top down, are formulas for failure.  The best processes include a bottom up forecast and analysis that is the underlying element of planning the quotas.  Since those forecasts are based on imprecise data, the test is whether the person setting the quota truly understands the business, the customers and the assignment that make up the basis for the quota.  Further, any quota set in advance has to also have a mechanism for fair adjustments (up and down) that connect the reality of the business as it plays out.  So quota management is key to the ongoing validity of the plan and underlies the measurement system as one of the three key elements of the incentive program.

MM:  What expectations should a company have relative to communicating the plan?

HW:  Typically, the new plan provides a great rationale to pull all of the sales team together and communicate the new goals for the year, the company plan to support those goals and how the plan will work.  Usually, this is a good opportunity for workshops with senior management, functional leaders such as product management and local sales management to interact with the salespeople and relate the company deliverables, as well as help line up the background for the plan execution.

However, for plan success, there needs to be a very specific and conscientious communication strategy that starts with the kickoff but gets reinforced throughout the year.  Ongoing communication and reporting on individual and group performance is key to using the plan to reinforce the best behaviour, build morale and enthusiasm, and make any mid-course corrections that might be necessary.  Communication deliverables need to be ‘tight and right’ – written in an easy to understand fashion with crisp detail and include a personal view with clear focus on the measurement and reporting process (along with examples) that will be followed.  The plan administration should have built into its process how it will launch, sustain and communicate the necessary information and ongoing reporting.

MM:  What guidance would you offer for how to deal with the recent economic situation and the growing expectations of a turnaround? 

HW:  It’s always difficult to handle sales compensation when circumstances beyond the control of the salespeople affect their pay.  But the sales role is no different from other critical skills in the company and a sharp management team deals with the situation in a flexible way in order to retain key personnel and also lead them to make the biggest impact that can be made for the company. 

The best companies  maintain their philosophy of ‘pay for performance’ and adjust assignments according to the changing reality.  Typically, what I have seen is targeting salespeople on key and measurable objectives that provide the company the highest impact, given the circumstance, by including those goals or targets within the sales plan quota.  When a salesperson achieves those objectives they can ‘earn’ their incentive pay based on the success. 

A good plan also has timely updates of the quota contemplated within it, as assignments will change, personnel will transfer in and out and organization structures will adjust according to the needs of the business.  The plan should allow for assignment changes accordingly.   Economic changes and/or changes in customer or territory situations should all be handled fairly and promptly.

The test should be that both the ‘individual and the company’ win when the salesperson is re-directed or has their assignment changed and hence, the basis for their quota and measurement.  A good salesperson wants to ‘earn’ their pay and not get a ‘freebie.’  The company gains when salespeople are successful in the performance of their job AND fairly compensated for it.   when both conditions are met sales people tend to stick around and more importantly, they are highly motivated to perform.  Keeping the integrity of the sales plan is vital and only happens if the plan reflects assignments and measurements that are stretch but achievable even when economic conditions change.

Howard Woolf is the founder and managing partner of Howard Woolf & Associates, a professional services firm focused on helping companies improve business performance and sales effectiveness.  He can be reached at hwoolf@comcast.net.

Flexible With the Course While Staying True to Plan

Joe Glenn has been managing field-based and inbound-phone salespeople for over five years.  During that time his company, specializing in communications and computer-services, measured sales performance on a product-unit basis.  The approach is common in retail and consumer-sales environments, and can be effective for driving transactional behavior from salespeople.  Where the unit-based approach falls short, though, is on goal alignment.  That is, the sales organization can exceed its unit goals while the company misses its revenue target.  In many such unit-based incentive plans, reps focus on those products they can most easily sell without appreciating the financial consequences to the company.

Changing a sales force’s incentive plan can be dicey stuff, particularly when the company adopts new measures of performance.  In Joe’s case, not only did he have to onboard a new measure, but each rep would carry a quota and minimum performance standard.

“We have a very flexible, adaptable sales force, which makes annual changes to the sales comp plans relatively straightforward,” said Joe, who about one year ago started sharing with his sales teams the revenue-plan concept.  “They were on board – it made complete sense to them.”  New goals and a goal-setting paradigm raise the stakes, however.  “Salespeople want to know the goals are reasonable and ultimately, do-able.”  Without the benefit of historical data, salespeople didn’t really know whether their revenue-based quotas were in line.  Adding to the anxiety the plan featured a 75%-of-quota threshold.

Creating quotas was another issue.  Joe’s colleagues in sales operations used the company’s billing system as the source for transactional revenue data, a formable task that didn’t come on line until December.   The new incentive plan was slated for rollout the following month.  Joe was forced to use a limited set of historical data for setting Q1 quotas.

The company launched its new plans during the final weeks of December 2010.  Early into January, salespeople, checking their progress against quota on a daily basis, were becoming concerned.  For most reps, their performance was trending well below where they needed to be to reach the threshold, and earn incentive pay.

Rather than waiting until quarter or even month end, Joe took action.  He and his operations colleagues dove back into the data in search of assumptions that, given the benefit of hindsight, might be off.  

The prospect of adjusting quotas mid-cycle is typically fraught with issues.  While in principle Joe believes an organization should stick to its goals, the revenue quotas were new, and he couldn’t risk the organization having a poor Q1 – a likely scenario should the salespeople disengage after perceiving they couldn’t hit the threshold.

“For the quotas to be effective, we had to be open to regular course corrections,” Joe says.  “This could not be a ‘set-it-and-forget-it’ approach.”  He used a transparent process with company leadership to keep them appraised on the evolving quota-setting methodology.  As more data became available, Joe revised his assumptions.  This included expectations for optimal business mix at the assignment level, and factoring customer churn into a four-year, revenue-per-unit (RPU) projection for acquisitions, where discounted monthly recurring revenue in the first year gives way to more typical RPU rates in Year 2 of the contract.

Joe also added a feature to the plan threshold by including a relative-ranking threshold by market.  Threshold would now be either the 75^th percentile performer in each market group, or the absolute approach (75% of individual quota), whichever was lower in the period.  This tactic provided a reality check to performance in the greater Kansas City market, where unusually harsh weather hammered field sales efforts.

While January revenue results came in below even the revised plan number, February’s pipeline is strong, and Joe projects a record Q1.  His sales teams viewed the revised goals challenging but reasonable, and after shaking off the initial anxiety, set out to beat them.  From leadership’s perspective, the additional analysis and revised goals provided a level of granularity that helps each salesperson focus on the right mix of business.  Reps are selling smarter, and thinking more long term.

One can argue that if the company hits its revenue plan, which in Joe’s case appears very likely for Q1, the course taken to get there doesn’t really matter.  Joe will tell you his approach of staying flexible, transparent and course correcting as he goes has everything to do with a favorable outcome.

Joe Glenn is a director of sales for a communications and computer-services company serving California, Kansas and Missouri.

Top Questions — Answered!

We get a lot of questions through this blog and during the course of our consulting work.  Sure, we try to answer all of them in a timely and concise manner.  But this time of year, with Black Friday, plan redesign deadlines and the like, some questions fall through the cracks.  While a few are random (“Is that Tom Cruise pictured on your ‘Show Me the Money’ blog?”), most are quite common, so we’ll attempt to answer the short list of most frequently-asked questions.

1. Team-based incentives — when are they appropriate?

When one individual alone cannot achieve the objective.  Now this oversimplifies things a bit, but it’s a good rule of thumb.  We see instances where a company pays individuals based on team outcomes when it’s really the individual’s contribution that matters.  Yet the company uses a team measure because it can’t measure individual rep influence.  Unfortunate, but necessary in some cases.

In our line of work, the most common application of team-based measures is for global account teams that cover multiple buying influences.  One member of the team can only get the ball so far before having to pass it to a team member.  The company may use MBOs for measuring milestone achievement of each individual rep, but ultimately its the sale that matters and the team must work together to make it happen.

2. Thresholds — when should they be used, and how best to set?

When there is a minimum level of sales required for some level of incentive pay.   How best to set?  The exercise is similar to setting quotas.  After all, a threshold is nothing more than a type of goal.  Difference being, the threshold goal can really rile emotions if set such that too many salespeople fall below the goal.

From an academic perspective, thresholds are part of the payment slope designed to manage the pay distribution.  That is, you’d like there to be a competitive and meaningful difference in pay between a high performer, an average performer and a low performer, assuming all three have a place in your organization.

We see thresholds commonly used in plans for jobs covering accounts or territories with recurring revenue.  Management wants to motivate growth, and avoid sales complacency for earning variable pay on “guaranteed” sales, so it sets a threshold based on this recurring revenue.

An extension of this approach is to set a threshold, but use it as a point to change the rate slope.  That is, pay a discounted rate for the first sale, and all sales up to a threshold performance level, beyond which you apply an accelerated rate up to quota.  The purpose is like an accelerator but below the goal.  Get your reps motivated to push to the next level, and reduce the sting for performance below threshold.

A related question is how best to use a threshold on a cumulative, year-to-date measurement approach (this one’s for you, D.W.).  There is an approach for this, but to adequately explain would exceed my 800-word limit.  And herein lies the problem associated with using thresholds.  The company’s efforts to explain fall short of the salespeople’s capacity to understand.  The simpler approach is to manage performance such that those falling below the threshold earn nothing — no incentive, no base (as Donald Trump would say, “You’re fired”).    Often sales leaders say they’ll do this but do not, thus the logic of a threshold.  And so it goes.

3. Trailers — when and how to use on monthly recurring revenue?

Use only when your competitors do and limit the trail period to (if you can) two years.  Consider using thresholds when you can accurately predict the renewal rate.

We’ve seen a number of SaaS companies pay reps a flat commission rate on 100% of the monthly recurring revenue (MRR).   There’s no trailer, just an annuity so long as customers renew.  After Year 1 or 2 the company discovers it can no longer grow the business with the size sales force in place because reps are making plenty of money off of the annuity stream — they have no incentive to grow the business.

Trailers require the rep to sell new business as the MRR credit from old business trails off.  Simple enough.  Insurance companies have been doing it for years.

It’s a seemingly unfair transition though for people expecting a flat rate on an annuity stream.   And probably tough to fathom for early-stage companies with hungry reps that can and want to double their earnings every year.   Yet at some point the hunger goes away, and the company struggles to grow with its existing sales force.  The longer a company waits to institute a trailer, the more compounded the problem becomes, and the longer the trailer period, the more difficult to align rep and company growth expectations.

Stay tuned for more insights on FAQs.  If we missed one of yours, please let us know.

By Elliot Scott, NewSigma

As a sales organization matures, a number of things can happen that make the original commission-based sales incentive plan increasingly problematic.  So it is not uncommon for companies to transition to a goal-based plan over time.  Mike Meisenheimer covered some of the related issues and options in a two-part series on the topic (http://salescompinsights.com/?s=from+commissions+to+a+goal+based+plan).  But while it is much less common for companies to move in the other direction—from a goal-based plan to a commission plan—it is sometimes the right choice.

What’s So Great About Commission?

It’s a fact of life that commission plans are more motivational.  “If I sell this I earn that” is a lot more immediate than “if I sell this, I retire x% of quota, which according to the payout table may get me an incremental 3%, 5%, or 10% of my target incentive at the end of the period depending upon where I end up on the payout curve.”  That immediacy can really drive sales results, particularly in aggressive, hunting-oriented sales organizations, which is one reason why they often bend over backwards to use commission.

When Your Goals Have No Credibility, One Option Is to Get Rid of Them

I recently helped a company assess and ultimately implement a transition from a goal-based plan “back” to commission.  One of the drivers was that the goal setting process had no credibility with the sales organization.  The plan measures and mechanics were sensible and in fact the goal-setting methodology was objective, data-driven, accurate, and surprisingly fair.  But the company had failed in making the methodology clear to the sales force and disproving the perception of a success penalty, i.e., “If I exceed my goal, I’ll earn some upside this period but I’ll be saddled with a much higher goal going forward, making it harder to earn even target incentive for some time to come…so why bother?”  Okay, while it is true that increasing sales tend to lead to higher quotas (as to some degree they should), the perception of success penalty is often overblown, as it was for this client.  Nevertheless, if the goals are not perceived to be fair, it hardly matters if they are.

The sales people fully understood that territory sales and potential were uneven, and would remain so, so any commission plan would probably favor the larger territories.  But they craved the immediacy and transparency of commission.  Even the sales people with smaller territories told us they would prefer commission.  Being good sales people, we could expect them to shed persuasive tears about how unfairly disadvantaged they were, but they made it quite clear they would rather control their own destiny than hold their earnings hostage to management’s black-box estimate of a fair goal.  (It should be noted that this was an aggressive sales organization, with high pay mix.  It recruited the type of independent, “coin-operated” talent for which commission is particularly attractive.)

The Results Are All That Matters

With some hesitation, we designed and implemented a new plan that was not in any way tied to manufactured territory goals.  We did so in a way that sought to minimize the effects of uneven territories, utilizing some mechanics that “taste like” commission but are a few steps removed from 5% of sales for everyone.  Most importantly, the new plan was simple and transparent.

When we came back halfway through the new plan year to audit the results, we wondered what we would find.  Moving from a goal-based plan to a commission plan is not something sales compensation consultants generally recommend.  But it was clearly the right thing to do for this client at this time.  Despite the problems inherent with commission, the plan had been very well received.  The reps were hungry and engaged, and the company was above target for the first time in years.

About The Author

Elliot Scott has 15+ years experience as a sales compensation and sales effectiveness consultant, with Towers Watson, The Alexander Group, and ZS Associates.  Elliot has worked for clients large and small in dozens of industries, leading both global and domestic projects and is a recognized leader in sales incentive plan assessment, design, and communication.  He can be reached at escott@newsigma.com.

Paying for Growth in a Regulated Environment (First in a Series)

Events playing out in the banking industry over the past 18 months serve as a reminder of how government regulation over sales and marketing can impact incentive practices.  The scenario is a familiar one to those in the retail investment and medical device industries.  There are lessons from those industries that now pertain to regional banking, or any other business, that must motivate its salespeople to sell while adhering to government regulations.

If there’s a silver lining in all this it’s that well-managed, effective sales compensation programs typically use a set of principles to guide specific practices, like which components to use in the incentive plans, and who makes what decisions regarding plan changes.

Regulations pertaining to pay usually come in the form of principles or guidelines.  In the banking industry, the Federal Reserve (Fed) and related agencies recently released its guidance for banking incentive comp practices.   Typically these memos are vague yet consequential.  If ignored, companies under jurisdiction of the agencies face enforcement action and bad publicity.

It’s no surprise then that over 85% of regional banks participating in a recent NewSigma/Varicent survey said federal legislation has had some or a significant impact on the bank’s incentive comp approach for front-line sales and service (non-executive) employees.   That leaves more than a handful of institutions trying to figure out what to do.  For those banks having taken action, many still question how best to design and manage their sales compensation plans in a way that meets the guidelines, but still promotes business growth.

Part of the dilemma when considering these and other regulatory principles is they seem to be in direct conflict with traditional principles of sound sales compensation design.  We think there is some common ground, however.

Let’s take the first principle in the Fed’s recent guidance for banks: “balanced risk taking.”

Management in all industries must strike a balance between risk and reward in the compensation plan, and use the pay mix – the amount of cash pay that base salary versus variable – as the primary lever.  The more pay that is variable, the more risk a salesperson bears in the form of income loss from poor performance.   While a higher base salary mix shifts this risk to the company, it mitigates the risk of bad behaviors that can come from lucrative upside pay.

The most common incentive plan change we observe following regulatory intervention is a reduction to the variable pay mix.  With some extreme cases aside (e.g., residential mortgage brokers), we think this is a mistake in banking.  Mix levels for most sales positions in the industry were below those for comparable jobs in other industries — before the credit crises.  Banks capped the upside pay for most if not all of these jobs, so that instances of bad behavior stemming from lucrative upside pay were remote.  The bigger problem was and still is lack of urgency by the salespeople due limited variable pay mix/risk.

Another risk comes from the misalignment of goals between the salespeople and the enterprise.  E.g., salespeople make a lot of money while the company posts a loss.  A common lever for balance is to link a portion of the salesperson’s variable pay to organizational goals, like company operating margin.  Like a reduction in variable pay mix, this shift reduces the amount of pay tied to the salesperson’s individual production.  Thus, we’re not fans of this practice, either.

Alternative practices for strengthen goal alignment include the use of qualitative, or risk-adjusted, performance measures.  The principle is to measure and pay based on the quality of the transaction or deal.  There are two general approaches for doing this.  One is based on net present value, the other on actual performance of the asset at some later point in time.  Both have tradeoffs.  Qualifying performance at the time of the initial transaction involves some guess work and can over or underpay relative to the asset’s performance over time.  We like this approach though because salespeople responsible for the transaction know up front the value of each type of deal.  We find the reconciliation approach cumbersome, particularly when “clawing back” amounts previously paid.  It makes an incentive opportunity increasingly ineffective as the time horizon, or number of variables, used to value the asset increase.

The whole point of an incentive plan is to motivate people to perform, and present real consequence when they don’t.  Reducing the variable mix, or tying variable pay to organizational measures, misses this point.

More to the point is how management defines performance.  Indeed, the amount of pay at stake can certainly drive behaviors, both good and bad.  But the sales transactions that contributed to regulatory outcomes weren’t good ones that became bad because of pay opportunity.  Paying less on these sales would not have made them better deals.

Banks and other industries faced with regulatory pay guidelines can strike a balance between paying for performance and for responsible behaviors by focusing first on the job roles and underlying performance expectations.

In our next discussion on the topic, we’ll provide an incentive-plan perspective on the the Fed’s other two principles recommended in its recent guidance.

And if you haven’t already devoured the Fed’s 47-page guidance memo, let us recommend some weekend reading:

http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20100621a1.pdf

We continue to receive questions about the why, when and how to move the sales compensation program from a commission to goal-based incentives.  The commission-to-goal transition can be one of the most difficult program changes to implement.  Top earners often view the new plan as a takeaway, requiring them to work harder or differently for the same pay.   Others may view a goal-based plan as more complex and a way for management to control incentive pay.   Some in management may fear the change will drive the company’s A-players toward the exits.

But the trade-offs associated with paying on goal achievement and not just volume can be significant:  Improved focus on strategic goals, an improved link between pay and profitable volume and better management of the compensation expense relative to strategic benchmarks.

We look for a number of signs when helping management to determine if it’s time to shift to a goal-based plan:

• The organization is meeting or exceeding the budget for sales compensation but falling short on product or profit objectives
• A historically transactional sales model is evolving to a more solutions-based approach
• Salespeople are less likely to win deals without extensive support from engineering, marketing, finance, product management and other support organizations
• Direct selling is augmented by multiple channels of distribution serving similar customer segments and territories
• Salespeople continue to mine their legacy book of business with existing products, and have limited motivation to grow new customers or new products
• The high earners are not necessarily the top performers, rather, they’re fortunate to be covering high-volume, mature territories
• There is a desire for less variability in the incentive pay distribution

The more of these signs you recognize within your organization, the more likely it’s time to change.  Again, making the change involves significant hurdles.   Salespeople typically prefer the transparency and reliability of commission programs.   Leadership may be philosophically opposed to paying similar amounts for differences in unit or revenue production.  Finance and operations may have little confidence in setting and maintaining meaningful goals.

Under such circumstances, you might consider incentive plan changes that use goal achievement scores to modify the commission payment; examples include:

• Variable-rate commission, where the rate varies based on goal attainment
• Goal-based gates that enable upside accelerators
• Thresholds for SPIFs or other, additional incentive opportunity
• Goal-based multipliers that increase commissions up or down depending on the attainment score

The objective is to stick with the core commission approach but get salespeople caring about goal attainment.   Eventually, this may not be enough to align incentive pay with the company’s financial objectives.   In Part Two of this series we’ll address the specific strategies for addressing the cultural and operational challenges that stand in the way of this important transition.