5 truths of sales compensation plans

As the vice president of the Alexander Group, a revenue growth consulting firm that designs more than 100 major sales compensation projects a year, and best-selling author, David Cichelli knows firsthand how essential it is for sales leaders to truly understand how sales compensation plans work—especially since about one-third of companies are unhappy with their programs. Drawing on 30 years of experience, he shares the five truths every company with a sales force needs to know.

1. Sales compensation plans are powerful—and they work

Sales compensation plans are like virtual supervisors: They constantly tell your sales force what’s important. (Click to tweet.) The good news is that these plans work. However, that can also be the bad news, David says. If you have a poorly designed sales compensation plan, it will work, but it will work against your company’s overall goals. Suddenly, your “virtual supervisor” is reinforcing non-desirable behaviors.

That’s why, when designing sales compensation programs, you need to know the underlying constructs and principles of successful programs. You should not wing it—get educated and pressure-test your plan before it goes into place.

2. Sales compensation plans change often—and they should

Ninety percent of companies make some changes to their programs each year, and David says this is how it should be. Plans need to change.

All companies pass through relatively predictable growth phases, and you need to modify your sales compensation plan at each stage. The goal of fast-growing startups, for instance, is generally to encourage the sales force to sell whatever they can; the compensation package may offer a low base salary with high commissions. During a later phase, however, the company may need to focus sales efforts on very specific clients. As a result, the sales crediting and compensation systems must change.

While it’s important that you change your compensation plans yearly, it’s equally important that your automation systems anticipate these changes. You can’t simply build a rigid automation system through your IT department; you need a flexible system that can adapt to these cyclical changes.

3. Sales compensation plans use the same principles regardless of industry

Whatever the nature of the enterprise—from consumer products to the cloud industry—all sales compensation plans should operate with the same set of principles. Your sales compensation plan should:

• Adopt uniform leverage across all jobs.
• Have 60 to 70 percent of your sales people reaching or exceeding goal.
• Use no more than three measures.
• Be easy to understand.

4. Sales compensation plans need a robust internal process for success

Sales compensation is part of a revenue acquisition ecosystem with numerous pieces of machinery—such as territories, segments, and crediting—all working together.

To keep the machine running smoothly, you need to chart a complete framework of how these pieces coalesce on an annual basis. This governance and process timeline should sequence key activities—such as when you’ll assess designs, when you’ll do audit reports—throughout the year.

Without such a framework in place, you risk finding yourself with jammed-in solutions at the end of the year that are not very well thought through.

5. Sales compensation plans provide a compelling leadership platform

Because it provides crucial feedback and continually reiterates the vision and strategy of the business, your sales compensation plan is a platform for effective communication. (Click to tweet.)

Keep in mind, then, that because your compensation plan is a communication tool (and not an administrative system), your sales leadership team, not the sales operations team, should be the ones to share the plan with the sales force. Train your leadership team on how the plan works and have them do the rollout. This will give the sales reps the motivation they need to buy into the incentive plan.

For more of David’s insights on sales compensation plans, watch his complete presentation, “Five truths of sales compensation.”

View Transcript

Dave Cichelli: Thank you Anaplan for having me come and visit with you. So, tell me about salespeople. Separate genetic life form? Why do they get their own compensation program? No but seriously, why? Does sales ops have its own sales compensation program, HR department? How about finance? You wish, I heard that. I heard a little “I wish we had…” Why do they get their own compensation program?

Why do salespeople get their own compensation program? I mean, we’re going to talk about… I’ll introduce myself in a second here and we’ll talk about salespeople and sales compensation, but I always ask that question. Why do they get their own compensation program? I mean, like they won’t work? Like I said, separate genetic life form. “Mr. and Mrs. Cichelli, you’ve had a sales rep.”

They drive the revenue. Any other reasons why you think they get their own pay system?

Dave: Market practice, probably? That’s a good answer. By the way, these are all true. Any other ideas?

Dave: Drive the right behavior. It’s a variable expense. We’ll starve them to death if they don’t deliver — you have a dark heart. [laughter] Other reasons? I heard another reason, why? Why do they get their own comp program?

You can measure their performance. My theory is, it’s like a virtual supervisor, you know? It’s kind of like telling them over and over again what’s important. And guess what? If you do it well, wow, it works. And if you don’t do it So, well, you get some pretty unusual behavior.

So, I’m Dave Cichelli. I’m with the Alexander group, and let me do a quick introduction. Quick question — Why do salespeople get their own pay plan? That was the question I just asked you. Probably because it acts as… Everything you said. They drive the top line, the variable costs, they focus on producing revenue for the company, and it acts as a supervisor.

Now, as I present to you today, I’m going to present to you a couple ways. One is, I’m a designer. I design the sales compensation programs. Many of you in the room have a voice in that, and some of you in the room are on the administration side, some of you are on the design side, some of you are doing both. But I’m going to speak to you heart-to-heart of the design side, okay?

You need a strong administration platform to keep track of thousands and thousands of transactions. So, no matter what you might hear about doing it on Excel, not a good idea, okay? And if you have one of these things where your Excel sheet, the tabs are so small that you just have the first letter of the person’s name, you flunk, okay? It’s time to move off to a more and stronger platform.

So, who comes up with these designs? Who creates these sales comp designs? They come out of nowhere sometimes. “Well, we were told to put in a ‘flying montillagon’ measure.” I don’t know, where did that come from? “Profitability, we’re going to do solutions selling, they’re not filling out sales force. That’s got to be in the plan.”

Wow. Those are known as tweaks. Bad, bad, bad. You will need my business card. You do enough years of that, it will get really, really messy and almost impossible to administer.

Okay, here’s another favorite question they ask you. “Why can’t you automate it? What’s wrong with you?” Actually, I’m going to tell you there’s nothing wrong with you. It’s the design side. So, I’m going to sort of knight you as designers. I’m going to give you some pointers about how to get in front of this design issue so that you’re not chasing this subject around in circles with weird crediting practices and wacky quota things, okay? So, it’s upstream, so we can solve a lot of them by having more discipline in our design process.

So, within a half hour here, I’m going to give you two days of sales compensation — No, I’m just going to give you some highlights, some things to think about. So, who am I? We’re revenue growth consultants. We help design sales organizations, how they’re structured and how they’re deployed.

My specialty is sales compensation. I’ve been doing it for 30 years. We have lots of research on the subject. We do 100 of these projects a year. In fact, a number of you in the room are clients. And I teach this class to thousands of students, HR people, HR comp people in the world of work. So, it’s a subject that I have developed a little bit of experience with.

Okay, yikes! The sales comp program is in distress. Now, I know the statistics on this. About a third of the companies are unhappy with their sales compensation programs. Quick question for you. What percentage of companies change their sales compensation program? And I do this question every year. I go out and say, “Did you change your comp program this year?” What percentage of the companies say, “Yes we did?” I’m not talking quotas, I’m just saying the designs.

90? You are so wise. That’s the number. 89%, 90%, 91%. Now, if you know that, you have to anticipate changes every year. So, you have to have systems that can accommodate changes every year. That means somebody’s got to be in charge of the design process, and that’s you. So, I’m putting you in charge of the design process. That means you start in December, not in November, not some runaround activity in December. [In] September, you start looking at the plans every year.

Okay, So, here’s the evidence to the bounds. Misaligned with company goals, too many plans — these are the things that we hear — excessive pay, weird quota outcomes with lumpy performance, field frustration, exceptions galore. If you’re laughing, you’re guilty.

Legal issues pending, that’s not good. A letter from a lawyer representing one of your sales reps? Whose fault is that? That’s your fault. You didn’t write your terms and conditions and you didn’t follow your policies, okay. And if it happens in California, pay it. You’re going to lose — just forewarning you.

Okay, So, a couple quick things. This is a chart you should know. This is how variable compensation programs work. You should understand how this chart works. You should use this chart to explain to your management team the different types of variable compensation plans. Now, I could speak about this chart for two days, but I’m going to give it to you real quick. Full-commission plans are on the left-hand side. They are set aside for producers. Life insurance, currency and bond traders, stock brokers, piece rate workers. That’s what the left-hand side is. There is no target pay. They get a percentage of everything there.

Real estate agents, mortgage origination. There is no target pay. There is no base salary. That’s the most… And by the way, if you think about it, isn’t that how sales people are paid? And by the way, the cost of variable there, costs are fully variable to the company.

On the right-hand side are the target pay systems. I’m going to go all the way to the right. There’s the so-called gain sharing plans. By the way, this is all variable comp programs. Gain sharing plans get a little extra money, three to five percent. Then there’s the add-on plans, these kicker programs that add on to the base salary.

Then there’s the MIP plans, management incentive plans, 2x cap design. Well what do you mean, 2x cap? Dave, explain to that me. Okay, So, congratulations, you’re vice president. You have a base salary of 250,000. Your target bonus for the year is 25% based upon company performance, blah blah blah. At the end of the year, you can get up to 50%. That’s known as a MIP design. That works on a worldwide basis, generally set aside for managers. It’s also used by consumer products good companies, 2x cap designs, and pre-sales salespeople in technology companies use 2x cap designs for the pre-sales person.

The 3x uncap is the most common design for business-to-business sellers. You need to understand this math. “What do you mean 3x uncap, Dave?” Ready? I’m going to do the math for you real quickly, ready? And by the way, this is universal. All your pay plans should operate like this on a worldwide basis.

What do you mean 3x uncap? Take 100,000, whatever it is in currency, split it into two pieces — 70/30. How do you make that split? Degree of persuasion in the job. I have 70 in base, 30 in target incentive. The best earners should be able to earn how much? The 90th percentile. 3x uncapped design, the 90th percentile should be able to earn 160,000. Where’d you get that Dave? 30 times three, 90 added to the 70, 160.

So, that’s known as a 3x uncapped design, and that’s the basic formula for structuring sales compensation program. Well, is it capped at 160? No, no. About 10% will make it past that, not very far.

Now, what you just learned was there are principles for designing sales compensation programs. You should not be winging it. You need to get educated. There’s a series of… I once redid some plumbing at my house. So, the inspector comes in and he looks at all my plumbing, and I have to get it signed off as a permit. He goes “First time?” Yeah, it was the first time because I don’t know plumbing, and it kind of looks like it, you know? I had pipes going everywhere.

Here’s the point. Why did I present this to you? Because if you’re designing sales compensation programs, you need to know the underlying constructs and principles about how to do it.

All right, so that was a chart you should know and understand when somebody says “Hey, we’ve got to put a comp program together.” What type? Add-on? Gain sharing? 2x cap? 3x uncap? Full commission? Are they producer sales jobs? You’ve got a lot of questions to ask as soon as somebody shows up.

Okay, so here are our five truths. They’re powerful and they work. They change often and they should. They use the same principles regardless of industry. So, we’re unique, you know? We’re the cloud industry, we’re consumer products. Same principles, operate, building codes.

We need robust internal processes for success. Provide compelling leadership platform. Okay, so what does that mean? It works. So, you kind of know it works, you know? You change something and, guess what, you get different behavior. So, the good news about sales compensation is it does work. The bad news about it is it works. You can get some really unusually bad things happening if you don’t pay close attention to the designs.

You’ve heard about some of these. The famous one is the Sears Automotive. This was back in, I think it was pre-disco. This was when you would go in to get your car, to get tires or something, and they’d say “You know, your struts are bad. Those need to be replaced.” This was in the state of California. “Those need to be replaced bad.” You go, “God, that sounds bad. Struts.”

Or a bushing. Let’s say “Oh, your bushings are shot.” By the way, do you know what a bushing is? Does anyone know what a bushing is on a car? It’s just a little piece of rubber that a pipe goes through. They do tend to wear out and they shake a little bit. You? You just paid $450 to replace a couple of little rubber sleeves called bushings, okay?

So, the point being about it is, you have to be vigilant when you design these things, because you can get some sort of unusual behaviors out of these. Yes, they work and that’s the good news. And yes, they work and that’s the bad news. So, you have to pressure-test these programs to make sure you don’t have any unusual things happening.

They change often. You already answered the question. You guys knew it. 90% of the companies change their sales compensation program on an annual basis. They’re supposed to. You’re supposed to. If not, you’re running like antiques roadshow. “Well, we don’t want to change the plan.” What? How’s that? “We haven’t changed the plans in 15 years.”

I mean, that’s like something on American Pickers. “Well, we’ve got this thing. It was given to me by my aunt. Former sales rep came in and we took that plan.” What? No.

Now, how many have to do a major redesign, top-to-bottom? About 12%, 15%, 10%. I ask this question every year on a survey. By the way, if you want to participate in these surveys, just give me a card and right surveys. No sales person will call on you. We do surveys every year about sales compensation practices. We’ve been doing it for 15 years.

So, what does that mean? That means you have to anticipate that plans are going to change. That means your automation systems have to be flexible, okay? So, you can’t just build a very rigid automation thing from your ID department. It ain’t gonna happen, because the plans need to change.

All right, earthquakes. Why are there changes all the time? Well, now here’s a trivia question for those of you who are not Californians. Southern California has how many earthquakes a year? My wife calls up says “God, we had an earthquake!” I say “That’s bad. How bad was it?” She says, “Not bad.” I say “Oh, that’s good. That’s really good.”

Okay, how many earthquakes do you think Southern California has a year? Now, in Northern California, the number’s about 200. Southern California, any guesses? Throw out a number.
Dave: 400? Yeah, keep going. 10,000. Why do we like earthquakes in Southern California? Little tiny ones, all the time. Remember, Los Angeles is heading for Alaska, okay?

So, you should think about your sales compensation program that way. You’re going to have lots of changes. You’re going to have an overlay specialist. You’re going to solutions selling. You’re going to introduce a profitability measure. In fact, you’re going to do it in a relatively predictable fashion. Sales organizations are a function of their growth rate.

So, a start-up organization on the far left-hand side, what kind of compensation program do you have? What do you think? ICR’s, low base salary, sell whatever you can and we’ll pay you a lot of money.

As the business grows, you start to scale up. You start doing triangles. You go to sales meeting, “Well, we’ve got these big customers, then we’ve got the middle-sized customers, and then we’ve got this small business market.” Okay, so there’s a whole area of triangles that are drawn about the segmentation model.

Okay, phase three. Somebody says “You know what? Not all business is good business. Only some business is good business. We need focus.” So, kind of bad things happen. Sales force used to go special places on their annual trip. Now they go down to the local Holiday Inn.

So, downsizing, finance presents at national sales meetings. Bad sign. “Hi, I’m Fred from finance. We’re here to talk to the sales department.” Bad. Very bad. It’s all phase three stuff, okay?

And then phase four somebody says “Wait a minute, not all business is good business. Only some business is good business, and we need focus.” So, the rise of segmentation and segmented selling models all occurs in a relatively predictable fashion, and as a result, the jobs change. And as a result, the quota’s crediting and compensations systems change.

So, quick question. David, is that the end of it there? Is that like a Mercator projection, you just sail right off the end? No, it’s actually a circle. You go around and restart it again, and that’s how businesses grow and change. So that was your Harvard MBA, by the way. Congratulations, we’ll be giving you a certificate on your way out the door.

The principles are the same. So, how you design a sales compensation program — eligibility, total target comp, pay mix — all those principles are universal. Well, give me an example, David, of pay mix. 70/30, 60/40. How do you pick that number? The principle is degree of personal persuasion in the job. The jobs with more aggressive selling, the deeper the mix, the lower the base salary component.

Is there anything deeper than a 50/50? No, that’s about it. 50/50 is about as deep as they go. Well how about a 90/10 plan? Too shallow. They usually top out around 85/15. Well then you’re telling me the pay mixes change by job? Yes.

How many pay plans do you have in sales compensation? When you’re doing a sales compensation program, how many pay incentive programs are you going to have? Equal to the number of jobs you have. So, if you have 20 distinct jobs, you’re going to have 20 dissimilar pay systems. However, they’re all going to sit on the same set of principles. The same principles about total target comp, mix, leverage, measures.

Let me give you some examples of those. So that was what we were talking about before. That’s the 3x uncap design. That principal is universal. If you have a worldwide sales organization, this would operate on a worldwide basis. This is the degree of difficulty of quotas. That’s a standard principle too, 60% should exceed quota, 40% should not. Why is that? Because the low performers are paying the high performers. That’s basically how target sales comp works, okay?

And then measures, some principles. No more than three measures. You will save yourself so much agony in terms of plan management if you enforce this rule. No more than three measures, and the measures have to be output measures. So, no CRM measures, no corporate galactic measures, no activity measures, no wishful thinking measures, no measures less than 15%.

So, no compliance measures. “You know, if you don’t get sales force filled out, we’re not going to pay you.” What? Whatever happened to supervision? You’re wasting your money if you’re spending it on compliance issues.

So, what was the point I’m making here? What I’m doing is I’m giving you a quick exposure to the constructs around sales compensation. Why am I doing that? Because I want you to learn them. I want you to get educated. I want you to read a book or go to a class because you will make the company perform better, the sales reps will be happier, the pay systems will work better if you have content knowledge about how to do this. And it is not rocket science stuff. It is not like a black box “Well it depends.” It’s well established, okay? You can actually learn how to do this and do it well.

Please keep your plans simple. A client says, “What do you mean it’s complicated?” What is that, five different commission rates, three different bonuses? Okay, let’s simplify this thing. Let’s make these plans as simple as possible. Again, it makes it easier to administer, but that’s not really a purpose that’s clear. Remember what sales comp is, it’s a virtual supervisor. So, we want to get the messages tight, what we’re saying to our sales people. We don’t want a zillion different measures in there.

Okay, and then of course we don’t want to torture ourselves in terms of trying to keep track of credit splits and odd decisions that are being made and 99 accounts and other types of ways of burying sales credit.

All right, principle checklist. Adopt a uniform leverage across all jobs. Okay, remember 70/30, 60/40. Make sure you’re picking the right leverage by the type of job. Have 60-70% reaching or exceeding quota. No more than three measures. Make it easy to understand.

All right. Now I’m just going to click off these next two principles pretty quickly the real purpose of what I had to say here today was “Look, sales comp is part of this big, huge revenue acquisition ecosystem. There’s territories. There’s segments. There’s crediting. There’s a whole bunch of pieces of machinery working here, okay?”

Sales comp gets the most visibility. It requires an investment of time by you. Learn how the constructs work so that you can provide good advice about the designs that they’re going to be changing each year.

So, here’s something you should publish. You should be publishing a complete schedule, all right? When are we going to look at the designs? When are we going to assess them? When are we going to do audit reports? So, a complete framework of laying out how all the pieces work on an annual basis, somebody’s got to do it. If you don’t have it, guess what? You’re the best person available, so this is the schedule. This is the schedule we should be looking at.

And one of the things you’ll say is “And by the
way, in September, we’re going to start our design for the next fiscal year.” Why don’t you be the process lead? Why not? Nobody else is doing it. Otherwise you’re going to get run into these jammed-in solutions at the end of the year, not well thought through.

Let me give you some career advice, okay? If you go to see your management and complain something’s not working, they have a way of resisting. That’s nice. But if you go with a solution, if you go with a process, if you go with a way of conducting a project, they yield to competency. That’s true no matter what type of company you’re in. If you bring something that shows competency in this subject, they will say “You know what? You’ve got it.” That’s what they’re looking for. They’re not looking for you to complain. They’re not looking for you to say it’s broken or anything like that. They’re looking for somebody with an answer. Than can be you.

And then finally, this sales comp is not a formula. It provided a platform for great communications. It’s a way of communicating to the sales force what’s important. What does that mean? Well, we in sales operations, we don’t communicate the plan. We have the line managers communicate the plan. What if they don’t understand it? Well bring them in and train them, because this is a leadership tool. It’s not an administrative system.

So, bring forth your leadership team, train them how to do it, have them do the rollout, have them do the communications and say “2018, what’s important is solutions selling or profitable revenue growth” or whatever the message is that goes with your comp program. Okay.

In summary, they are powerful and they work. They change often and they should. Use the same principles regardless of industry. You need an internal, robust process for success. It’s a compelling platform for leadership messages. And one other thing — oh, I didn’t have it in here. The chart says, “No tweaking,” okay? So, this whole thing that you do every year, where you tweak the conversation programs? No, we want to have a good planning process. And you know what? We need you to do that.

Now, I’m complimenting those of you in the room who already do this. You already have a planning process. You already have a design committee. You already have a schedule for doing things. You’re already educated in those subjects, so my hat’s off to you. The rest of us, let’s get this thing under control.

Okay, let me open it for questions. Yes sir?

So, the question was timing. I’ve surveyed that question. How many get it at the first of the year? Zero. How many actually publish before the end of the year? It’s less than 10%. Why? They don’t want to disrupt the sales force.

So about 60% get the plan rolled out within the first month. And then the laggards, particularly those on quarterly plans, “Well it’s not effective til March 1, their check’s not going to be cut.” And so they’ll let it slide from January to February. But if you’re doing monthly programs, you’ve gotta have that plan out within the first month. Sometimes they’ll wait until the national sales meeting, like in February, and they’ll roll it out then. Young lady, question?

Decelerators, okay. Here’s the issue. Decelerators are not very motivational, really upset the sales force. But the choice is caps, because if you have mega orders… First of all, if oyu have a mega order issue, pull the mega orders out completely, treat them separately. That might take away the need for a regressive formula. If you do have a regressive formula though, you’re going to have to have some way of selling it.

The way I do it is I’ll say, “Well the alternative is for us to cap your program, because we can’t see these big orders out there.” But if you take the big orders away and you treat them separately in a different schedule, you might not need that regressive formula. One or two more questions? Yeah.

A teaming, sort of? Yeah, so actually you need a different job. It’s called a populate depopulate model. So, create the job — here’s what you do. You sit with your planning team. “What if nobody existed? We had no people, we had no jobs, we had no pay plans. What would we really like to do?”

You go “Well, we would like to have a team called a pursuit team, or a major account team.” Well then design that and recruit people into it with its pay system, and have them depopulate the old job. That’s called a populate/depopulate. It’s very hard for a Friday. You’re an individual, go out and kill it. Monday, you’re part of this collective group, hang out together. It doesn’t work.