Creating an Effective Commission Plan

As a sales professional, I have been paid for sales results my entire career.

Specifically, this included a salary + commission.

As a recipient of commissions, as the administrator of commission plans and as the creator of commission plans, I have learned that the best plans follow two rules:

  1. Keep it SIMPLE.
  2. Be Generous when Rewarding Top Performers.

Below is how to create a commision plans that works.


RULE #1 – Keep It SIMPLE.

Commission plans should be easy for Reps to understand, straightforward for managers to calculate, and a joy for finance to reconcile. (OK, maybe that last one is a stretch)

Beware of complexity. The more complex you make the plan, the more of a pain in the a$$ it will be for you, the Sales Manager or Entrepreneur, to deal with.

A Simple Plan has These Characteristics:

  • Your rep can easily estimate how much he’ll make on a sale.
  • Rep performance to quota is visible real-time in a dashboard or report.
  • Commissions reports should take less than 1 hour to create, review and approve.

Is Your Plan Simple Enough? Chances are, if you are asking this question, it’s not. Here are some clues that you need to simplify your plan:

  • Do you have to explain the commission plan to your reps repeatedly? When I worked for a Fortune 1000 company, the commission plan was so complex that I had to meet with each rep every quarter to explain what they were being paid and why.
  • Does it take you days to reconcile commissions? At countless companies, this is the norm. Commission reconciliation is dreaded by most sales managers.
  • Are your doing a lot of manual lookups, rechecking multiple data sources, and explaining exceptions before commissions are approved?  If so, I offer my condolences. We’ve all been there.

How to Design a Simple, Effective Commission plan

Most importantly, make sure that you are paying commission only for the desired results.

Pay for Sales. Not calls. Not appointments. Not meetings. Not demos. Sales.

If you pay commission for calls, you’ll get calls. I’ve had reps make calls to relatives, to 800 numbers, to voicemails they knew never answered, and even had a rep who called Walmart 25 times a day to boost his call metrics.

If you pay for meetings, reps will book meetings. Just not necessarily with qualified prospects. Or even with real people.

Do you like doing demos so much that you’d do them for people who have no intention of buying? If you pay for demos, you are doing this.

Just in case I wasn’t clear enough, pay commission based on Sales.


Here are 4 Commission Plans that Work.  

1. Fixed amount per sale. This method works when every sale is exactly the same amount. It works really well when your customers almost always buy the same thing.

For example, you might pay $50 per sale of your software package that lists for $1000.

This plan falls apart if a sale can ever include multiple products. By paying a flat commission per sale, you are encouraging reps to sell the least expensive option. Reps tend to default to the easiest sale to earn the commision.

Using the above example, let’s assume that $1000 is for a single site license. You can also sell multiple site licenses to a single customer. Unless you pay more for selling multiple site licenses, your reps will default to selling a single license.


2. Percentage of Sale. This is one of my favorite methods. You pay the rep a percentage of every sale. Sometimes the percentage paid will be different for products vs. services. To ensure a rep doesn’t discount a sale below acceptable margins, management must approve any discounts above a certain threshold.

This method works well for Value Added Resellers, software manufacturers, hardware manufacturers, and companies that sell project based services.

For hardware and software, I’ve seen percentages range from 2-6%. For services I’ve seen percentages from 6-10%.

Using the example from #1 above, a $1000 sale might pay 3% commission of $30.


3. One Month’s Revenue. A common method for SAAS businesses that sell products with Monthly Recurring Revenue  is to pay the rep the 1st Month’s Bookings.

For example, a customer of mine recently purchased CRM software for $65 per user per month. The sales rep will earn a commision of $65 x 8 users or $520.

Most SAAS agreements default to 12 months so this equates to 8.3% Commision on the first year of revenue. If your SAAS company keeps churn and expenses under control, after the first 10 months, it’s all profit for the company. If your business keeps customers for 2 or 3 years, you’ve built a revenue stream that grows exponentially. (For an in depth discussion of the numbers, see this article explaining MRR and Revenue Payback by Jesse Lipson, former CEO of Sharefile.)

Many SAAS companies do not offer additional incentives for reps to multiyear agreements. I think it is because multiyear agreements often require discounting to win and because many SAAS companies try to control churn with post sales support, product functionality, customer success teams, etc.


4. Attainment of Quota.  With more established companies selling higher volumes, this is a common structure. Here a rep is assigned a Commission based on attaining 100% of quota.

For example, a rep’s quarterly quota is $10M. At 100% of plan, his quarterly commission is $10K. If he sells $9M, he’s at 90% of quota and will earn $9K. If he sells $15M, he’s at 150% of quota and will earn $15K.

This works best if you can accurately set quotas that are attainable but not too easy. If quotas are too low, you will end up overpaying. If quotas are unrealistically high, your best reps will leave for other positions where they can earn more and have success.

This type of quota is frequently used at mature software and hardware companies. Some startups will also use this method, although its effectiveness there is less predictable because historical sales data is usually sparse.



RULE #2 – Be Generous with Your Top Performers

Whenever commission plans are built by people who were never paid on commission, I hear things like this:

“Let’s make sure we don’t pay people for a sales that was a bluebird or a gimme”

“We shouldn’t pay for sales made to existing customers”

“Let’s cap commissions. We don’t want to overpay a sales rep.”

My rebuttal to these objections is always the same:

“Why wouldn’t we pay a rep to bring in additional sales? Isn’t that what we want?”

Unless you’re Apple, a Utility Company, or a Monopoly, sales don’t just come to you. You need your reps to find prospects, qualify them, drive deals to close and hunt down new business.

It’s OK if you occasionally overpay a rep or pay for a “gimme”. There will be plenty of difficult sales where your reps will more than earn their keep.

If you look for ways to not pay your reps or change commission plans when a rep has a blowout quarter, I guarantee your reps will recognize what you are doing and the best will leave.

Allstar reps want to earn big commissions.


Avoid Decelerators and Minimum Thresholds

I hate Decelerators and Minimums Thresholds.

  • A Decelerator pays a lower commission rate if the rep sells less than 100% of his quota.
  • A Minimum Threshold is when a rep earns no commission if he sells less than the threshold.

Here’s the deal. Most reps are doing their absolute best to make sales. The effort required to win the first sale of the quarter is no less than it is to win the last sale of the quarter.

With decelerators, you are punishing your rep for a bad quarter. I’ve never seen these work as an incentive to improve sales or moral. I have seen good reps leave companies because of decelerators.

By using these, you are telling your reps, “If you have one bad quarter, it’s just tough luck for you. Good luck paying your bills.”

Both of these also encourage sandbagging. Reps who think they won’t hit the target will sell just enough to meet the minimum threshold or the nearest decelerator level, and then will push all other deals into the next quarter.

In the meantime, your company has delayed closing these opportunities. You lose the immediate revenue. You will also lose some of these opportunities because during the delay, the prospects decided to spend their money elsewhere.


Accelerators

As much as I detest Decelerators, I and every sales professional on the planet loves Accelerators.

Accelerators pay extra when a rep exceeds quota by a specified amount.

I’ve seen accelerators that paid 200% commission if a rep attained 150% quota.  

For one SAAS business, we paid 5X accelerators for reps who exceeded 200% of quota. 

Accelerators encourage your highest producing reps to keep their foot on the gas when they are having a good month, quarter or year. They also help with retaining your top reps – after all, few reps want to leave after they’ve earned a career high commision check – they’ll stick around and try for a repeat.

Big accelerators make for great stories that help with recruiting, drive competition, and build morale. Most sales reps want to be #1 and hearing about another rep’s big payday can motivate them to push to set new records.

Accelerators are not offered at every company but they can make a huge impact when done right.


My most effective SPIF.

Bonuses and Spifs

Bonuses and Spiff are one-off payments for achieving a certain goal.

Spiffs are often offered by manufacturers to get resellers to sell their product. They’ll offer something like $25 for every sale in a quarter or an extra $50 for every sale made after the first 10 sales.

Internally, you can create Spifs for short term sales campaigns, to launch a new product, and even to drive sales at the end of the quarter.  Be creative. You’d be surprised what your reps will deliver.

One of my best Spifs was offering my reps a $100 bill for every sale over $25K they closed in the last two days of a quarter. We needed to make up for a $2M deal that fell out 3 days before quarter close.

Every time I handed a crisp $100 to a rep, the floor went crazy!  We sold an additional $2.2 million and hit our number.  

PS. This was totally not approved by HR or FInance. They were not happy when they found out about it later. This was why we didn’t ask them for permission in the first place. 

I have occasionally used spot bonuses to reward a rep or manager who gave his all but had a bad quarter. Most of the time, this was someone who was covering an extra territory temporarily or a manager that had a team that was short staffed. This has always paid off. People who receive spot bonuses remember how you went to bat for them and will willingly make sacrifices to help you again because they know their efforts are appreciated.


What Should You Do Now?

If your commission plan fails to meet the requirements of Inside Sales Dude, I would first suggest you ask yourself this question:

“Am I getting the sales results I want?”  

If you are, then don’t change anything. If you are not, then consider using my recommendations to create a simple plan that delivers the results you need.

If you’d like help from the Dude in creating an effective commission plan, contact me here.


This is the second post of a 3 Part Series on “Creating a Sales Team for a Startup”.

Part 1 – How Much to Pay a New Sales Rep

Part 2 – Creating an Effective Commission Plan

Part 3 – The Truth About Setting Sales Quotas

Shoot me an email or put a note in the comments if you’d like to provide your insight on any of these topics.


Are you having recruiting, hiring or turnover problems with your sales reps?  

Are you building a new team and want to get it right from the start? 

Contact me here to learn more about how Inside Sales Dude can help.


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